Currency Clauses in Russian Contracts and Sanctions Restrictions

April 30, 2022

BRACE Law Firm ©

The impact of sanctions on existing and future contracts has significant economic weight. Companies operating both domestically and internationally now face sanctions risks related to foreign currency payments. When entering into agreements, parties often included a vital condition regarding foreign currency settlements to hedge against a potential weakening of the ruble. In the current environment, the currency market and currency transactions are highly unstable. However, market relations are evolving and adapting to the current situation.

The ruble is the legal tender, mandatory for acceptance at face value throughout the Russian Federation. Based on Article 317(2) of the Civil Code of the Russian Federation (the "Civil Code"), a monetary obligation may provide for payment in rubles in an amount equivalent to a certain amount in foreign currency or in accounting units (ECU, special drawing rights, etc.). In such cases, the amount payable in rubles shall be determined at the official exchange rate of the relevant currency or accounting units on the date of payment, unless the law or an agreement between the parties establishes a different rate or a different date for its determination.

Furthermore, the use of foreign currency and payment documents in foreign currency for settlements within the Russian Federation is permitted in cases, under the procedure, and on the terms determined by law or in the manner established by law (Article 317(1) of the Civil Code).

When entering into a contract, the parties must agree on the payment terms as one of the material terms of the agreement. In cases where foreign currency is used for settlements, it is customary to include a currency clause in the contract — a provision regarding the price or payment in foreign currency. Generally, currency clauses are included in foreign trade contracts and agreements concerning the supply of goods, loan agreements, leases, etc. For a clearer understanding of the contract terms in this regard, it is customary to distinguish between the "price currency" and the "payment currency". These values may differ, making the agreement on this point a critical part of contract formation.

In addition to the Civil Code, the primary law governing currency-related legal relations is Federal Law No. 173-FZ dated December 10, 2003, On Currency Regulation and Currency Control (the "Law No. 173-FZ" or the "Law on Currency Regulation"). According to Article 1(2) of this law, foreign currency includes:

a) banknotes, treasury notes, and coins in circulation that are legal tender in the relevant foreign state (or group of states), as well as those being withdrawn or already withdrawn from circulation but subject to exchange;

b) funds in bank accounts and bank deposits denominated in the currency units of foreign states or international monetary or accounting units.

Types of Currency Clauses

Including currency clause provisions in a contract is a vital element of a foreign trade transaction. Several types of currency clauses are distinguished, such as:

• unilateral and bilateral (where the risk of one or both parties is hedged);
• indirect and direct.

An indirect currency clause is characterized by the fact that the transaction currency and the payment currency are different. This occurs because the payment under the contract is made in the national currency, while the obligation in the contract is expressed in another currency. In this case, the price of the purchased goods is denominated in a currency commonly used in international settlements or when the price depends on the currency of the country of origin of the goods.

A direct currency clause is used when the transaction price currency and the payment currency coincide. Such clauses are often used in foreign trade agreements and protect both parties to the transaction.

Anti-Crisis Measures Regarding Currency Clauses

At the same time, sanctions imposed on the Russian Federation by foreign states have led to increased state control over currency operations. For example, Decree of the President of the Russian Federation No. 79 dated February 28, 2022, On the Application of Special Economic Measures in Connection with Unfriendly Actions of the United States of America and Foreign States and International Organizations Siding with Them, prohibited the following effective March 1, 2022:

a) the execution of currency operations related to residents providing foreign currency to non-residents under loan agreements;

b) the crediting of foreign currency by residents to their accounts (deposits) opened in banks and other financial market organizations located outside the Russian Federation, as well as the transfer of funds without opening a bank account using electronic means of payment provided by foreign payment service providers.

Additionally, on March 1, 2022, the President of the Russian Federation signed Decree No. 81, On Additional Temporary Economic Measures to Ensure the Financial Stability of the Russian Federation. According to Section 1(g) of this decree, effective March 2, 2022, the export from the Russian Federation of cash foreign currency and (or) monetary instruments in foreign currency in an amount exceeding the equivalent of $10,000 USD, calculated at the official exchange rate of the Central Bank of the Russian Federation set on the date of export, is prohibited. This norm was introduced to preserve foreign currency cash within the Russian Federation.

The unstable global situation has also affected economic transactions. Typically, in existing contracts, a link to foreign currency served as a guarantee for settlements. On March 31, 2022, the Federal Antimonopoly Service (FAS) submitted a bill, On Amending Articles 317 and 424 of Part One of the Civil Code of the Russian Federation, for consideration. The bill prohibits setting contract prices linked to foreign currency or indicators of exchange or over-the-counter indices in global commodity markets. Such contract terms are deemed null and void. The bill banning foreign-currency-linked pricing was submitted to the Council for Codification and Improvement of Civil Legislation under the President of the Russian Federation. As stated in the explanatory note, the bill was developed in accordance with the Plan of Priority Actions to ensure the development of the Russian economy under external sanctions pressure.

The bill proposes to repeal Article 317(2) of the Civil Code, which provides that a monetary obligation may stipulate payment in rubles in an amount equivalent to an amount in foreign currency or accounting units. Simultaneously, it proposes to supplement Article 424 of the Civil Code with a new Section 4, according to which the price cannot be determined in an amount equivalent to an amount in foreign currency or indicators of exchange and (or) over-the-counter price indicators in global commodity markets. It is also proposed that this provision shall not apply to transactions executed in the course of foreign trade activity.

All existing contracts would need to be amended within 30 days of the law's entry into force. If the parties fail to reach an agreement within this period, contract performance under the bill must be conducted at the ruble exchange rate or commodity market price indicators as of January 1, 2022.

If this bill is adopted, the prohibition on linking contract prices to foreign currency will eliminate the possibility of concluding long-term contracts. Most entrepreneurs will seek workarounds and factor in potential additional costs to the contract to maintain the ability to supply goods whose cost directly depends on the foreign exchange rate. Contracts without full prepayment will become minimal, as payment-upon-delivery terms will become simply loss-making for entrepreneurs in most cases.

This situation would allow entrepreneurs to either voluntarily terminate contracts or change material terms by mutual agreement. This would only be possible if both parties agree and if one of them is not a state institution. Terminating a contract for a budget organization under the framework of Federal Law No. 44-FZ dated April 5, 2013, On the Contract System in the Procurement of Goods, Works, and Services for State and Municipal Needs (the "Contract System Law"), is becoming extremely difficult in the current environment.

As a rule, contract termination or modification is carried out in accordance with Article 451 of the Civil Code, Change and Termination of a Contract due to a Substantial Change of Circumstances. A change of circumstances is considered substantial when they have changed so much that, if the parties could have reasonably foreseen it, the contract would not have been concluded at all or would have been concluded on significantly different terms.

Parties could not have clearly anticipated the current global situation when entering into contracts; therefore, referencing this article will become possible when amending or terminating agreements. If the parties have not reached an agreement on bringing the contract into line with the substantially changed circumstances or on its termination, the contract may be terminated—or, on the grounds provided for in Article 451(4) of the Civil Code, modified by a court at the request of an interested party—provided the following conditions are met simultaneously:

• at the time the contract was concluded, the parties assumed that such a change of circumstances would not occur;
• the change of circumstances was caused by reasons that the interested party could not overcome after they arose, despite exercising the degree of care and diligence required by the nature of the contract and the conditions of turnover;
• performance of the contract without changing its terms would so significantly disrupt the balance of the parties' property interests under the contract and would cause the interested party such damage that it would largely be deprived of what it was entitled to expect when entering into the contract;
• it does not follow from customs or the essence of the contract that the risk of the change of circumstances is borne by the interested party.

Upon termination of a contract due to substantially changed circumstances, the court, at the request of either party, determines the consequences of the termination based on the need for a fair distribution of the expenses incurred by the parties in connection with the performance of this contract.

Modification of a contract due to a substantial change of circumstances is permitted by court decision in exceptional cases where contract termination would be contrary to public interests or would result in damage to the parties significantly exceeding the costs required to perform the contract on the terms modified by the court.

It is worth noting that, for instance, the Review of Judicial Practice of the Supreme Court of the Russian Federation No. 1 (2017), approved by the Presidium of the Supreme Court of the Russian Federation on February 16, 2017, reflects that an increase in a debtor's ruble payments under a loan agreement due to an increase in the exchange rate of the debt currency does not, in itself, indicate a change in the contractual balance of property interests. Consequently, a change in the foreign exchange rate against the ruble cannot be regarded as a substantial change of circumstances serving as a basis for contract modification under Article 451 of the Civil Code.

The draft expert opinion of the Council for Codification and Improvement of Civil Legislation under the President of the Russian Federation regarding the bill to amend Articles 317 and 424 of the Civil Code states that adopting this regulation under the Plan of Priority Actions is an extraordinary measure. However, the bill proposes to change the general rule of the Civil Code, meaning the proposed regulation would persist even after the extraordinary circumstances cease. The Council considers such an approach categorically unacceptable.

To eliminate the risk of unequal consideration, parties may choose not to set the amount of a monetary obligation as a fixed sum (in a specific number of currency units) but rather agree on a method for determining the amount. One such method is established in Article 317(2) of the Civil Code in its current edition. Under this norm, parties may agree that the debtor under a monetary obligation is obliged to pay an amount in rubles equivalent to a certain amount of foreign currency or accounting units.

Restricting the freedom of parties to reach such agreements finds no support from a currency regulation perspective. The purpose of the public-law prohibition on residents settling in foreign currency is to ensure demand for the national currency in domestic turnover. This goal is achieved even when using a "currency clause," because despite the price link to foreign currency or the price of a generic item, performance under Article 317(2) of the Civil Code must be carried out in rubles.

The procedure for determining the size of a monetary obligation specified in Article 317(2) is one possible method, but not the only one.

The parties' desire to protect themselves from the risk of unequal consideration can be achieved not only by linking the ruble price to a foreign currency value but also, for example, by linking it to the market value of any generic item (a ton of steel, a barrel of oil, etc.), including market values that do not have exchange or over-the-counter price indicators in global commodity markets but will be determined at the time of settlement according to the rules the parties established in the transaction.

Thus, establishing the nullity of the method for determining the amount of a monetary obligation specified in the current edition of Article 317(2) is not sufficiently justified, as the parties' goal can be achieved through agreeing on a different procedure.

Article 424(4) of the Civil Code, as drafted in the bill, establishes the nullity of "currency clauses" and proposes that payment be made at a price determined according to the rules of Article 424(3) of the Civil Code.

One of the values of the principle of freedom of contract is that the regulation created by the parties in the contract — including the price they set — is certain for them. The combination of various terms contained in a contract allows for the establishment of a balance of mutual concessions.

Applying the rule of Article 424(3) for settlements could cause significant difficulties and disagreements for parties in many transactions, leading to a situation where they only learn the price of their performance after a court decision on a lawsuit filed by one of them enters into force.

Furthermore, the bill does not account for the fact that parties may distribute economic benefits through terms other than the price. The project proposes that in all contracts containing FX-linked price clauses, the price should be determined based on market value. However, the parties' interests may be expressed not only in the price but also in other terms, such as liability limitations, additional performance guarantees, etc.

As a result of the nullity of the price agreement and the application of an imperative rule for price determination while keeping other contract terms in force, the contractual balance of interests of the parties may be significantly disrupted, yielding a result that neither party intended when entering into the contract.

Such an approach contradicts the fundamental principles of civil legislation — specifically, the principles of freedom of contract and the prohibition of arbitrary interference in private affairs (Article 1 of the Civil Code).

The application of the proposed version of Article 424(4) of the Civil Code will force Economic Entities selling goods (works, services) to minimize risks through alternative methods, namely: selling goods only upon full prepayment, increasing prices by factoring in inflation risks, and reducing the number of long-term contracts, which may negatively impact civil circulation as a whole.

Article 424(4) of the Civil Code in the Draft's version permits "currency clauses" for obligations arising from foreign trade activities. The proposal to ban "currency clauses" in domestic turnover while allowing them in foreign trade may put domestic entrepreneurs engaged in foreign trade — who are part of a chain of contracts — in an extremely difficult position. They will bear the risk of national currency inflation relative to foreign creditors but will be unable to pass this risk on to subsequent debtors in the chain under domestic contracts. Moreover, such debtors may be in default, and therefore, they should bear the risks associated with exchange rate fluctuations.

Such an approach makes the work of domestic foreign trade participants extremely unprofitable and may lead to their bankruptcy.

The removal of Article 317(2) from the Civil Code, which regulates "currency clauses", while simultaneously preserving them in foreign trade transactions (per the proposed Article 424(4)), is seen by the Council as inconsistent and contradictory. The bill stipulates that the provisions on the nullity of "currency clauses" do not apply to foreign trade transactions; however, if Article 317(2) is removed, it becomes unclear exactly how parties to a foreign trade transaction should formulate a "currency clause" or what rules will apply to it. Thus, removing Article 317(2) will lead to an undesirable legislative gap.

The true goal of the bill's authors is to solve a current problem: as a result of sharp fluctuations in the national currency, debtors in a range of legal relationships found themselves in a disproportionately disadvantaged position due to currency clauses — a situation they claim they could not foresee and would not have agreed to.

However, this problem, faced by a certain number of subjects in civil law relationships, can already be resolved through existing civil law mechanisms — specifically, by applying the provisions of Articles 451 and 428 of the Civil Code or other norms (depending on the circumstances). There is no need to change the law to apply these existing provisions of the Civil Code.

Thus, the Council for Codification and Improvement of Civil Legislation concluded: "The Draft does not achieve the legislative goals that would promote the stabilization of civil circulation and is in conflict with the fundamental principles of civil legislation."

Any market fluctuation leads to entrepreneurs either adapting to the situation or leaving the market entirely, particularly small and medium-sized businesses. The inability to adjust the cost of goods based on a changing market could drive many entrepreneurs to bankruptcy. Meanwhile, the drastic measures proposed by the FAS to amend the Civil Code may only affect domestic transactions, leaving the ability to adjust contract terms only for foreign trade deals.

The proposed changes are global in terms of amending the Civil Code, yet they are designed for a specific situation in the modern world. The situation may change quickly tomorrow, but the amendments to the Civil Code will remain, and another restructuring would require a significant amount of time.