Legal Liability and Damages in International Trade Contracts & Russian Law

June 30, 2023

BRACE Law Firm ©

The liability imposed on partners under international trade contracts guarantees performance by the parties to an international transaction. Parties document this liability in the contract as compensation for incurred losses, the imposition of fines on the party that breached its obligations, and the recovery of interest for the use of others' funds.

Notably, the contracting parties to an international transaction independently establish liability measures for breaches of an international trade contract. They may choose to limit liability to the compensation of losses or supplement the contract with other types of liability. Furthermore, liability measures for contract breaches in international trade depend not only on the consequences specified in the contract but also on the substantive law governing the contract. If the parties have not chosen the applicable law, international legal norms in this field apply to the transaction in accordance with the norms of international law.

If the parties to an international trade contract have not regulated the issue of mutual liability, international legal norms applicable to the type of international trade activity are used to resolve disputes. Specifically, for sales contracts, the United Nations Convention on Contracts for the International Sale of Goods (the "Vienna Convention") applies. The Vienna Convention provides that if one party breaches its obligations, the other party may:

• suspend performance of its obligations if, after the conclusion of the contract, it becomes apparent that the other party will not perform a substantial part of its obligations as a result of a serious deficiency in its ability to perform or in its creditworthiness, or its conduct in preparing to perform or in performing the contract; [2]
• terminate the contract;
• recover losses incurred due to the breach of contract.

Under the UNIDROIT Principles of International Commercial Contracts (the "UNIDROIT Principles"), non-performance is the failure by a party to perform any of its obligations under the contract, including defective performance or late performance. [3] Any non-performance gives the aggrieved party a right to damages either exclusively or in conjunction with any other remedies, except where the UNIDROIT Principles exclude liability for non-performance. [4]

A party suspending performance, whether before or after the goods have been dispatched, must immediately notify the other party and must proceed with performance if the other party provides adequate assurance of performance. [5]

Furthermore, if it becomes clear prior to the date for performance that one of the parties will commit a fundamental breach of the contract, the other party may declare the contract terminated. [6] If time allows, the party intending to declare the contract terminated must give reasonable notice to the other party to provide an opportunity to provide adequate assurance of performance. [7]

Termination of the contract releases both parties from their obligations under it, while subject to any damages which may be due. [8] However, a buyer loses the right to declare the contract terminated or to require the seller to deliver substitute goods if it is impossible for the buyer to make restitution of the goods substantially in the condition in which it received them. [9]

Under Russian law, a contract may be modified or terminated by a court decision at the request of one of the parties only: [10]

• in the event of a material breach of the contract by the other party;
• in other cases provided for by regulations or the contract.

A breach of contract by one of the parties is considered material if it results in such damage to the other party that the latter is substantially deprived of what it was entitled to expect upon entering into the contract.

Compensation for Losses in International Trade

In the course of business activities, parties to international transactions include liability measures in the international trade contract for breaches of obligations, including the compensation of losses incurred by the other party.

Under the Vienna Convention, damages for a breach of contract by one party consist of a sum equal to the loss, including lost profits, suffered by the other party as a consequence of the breach. Such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the contract as a possible consequence of the breach, in light of the facts and matters of which it then knew or ought to have known.[11] Furthermore, the UNIDROIT Principles determine that, regardless of whether the contract was avoided, a party that knew or ought to have known of the grounds for avoidance is liable for damages. Such compensation should put the other party in the position it would have been in if it had not entered into the contract. [12]

Under the norms of the Vienna Convention, if the seller fails to perform any of its obligations under the contract or the Convention, the buyer may: [13]

• exercise its rights (require performance, establish an additional period for performance, declare the contract terminated, reduce the contract price, etc.);
• claim damages. [14]

If the contract is terminated and if, in a reasonable manner and within a reasonable time after termination, the buyer has bought goods in replacement or the seller has resold the goods, the party claiming damages may recover the difference between the contract price and the price in the substitute transaction, [15] as well as any further damages. [16]

Notably, although the provisions of the Vienna Convention provide for the recovery of losses from a seller who has breached obligations, including breaches related to the delivery of goods, these provisions are general and do not regulate issues regarding the calculation of damages, such as interest for delays in delivery.

Under Russian civil legislation, losses include expenses that the person whose right has been violated has incurred or will have to incur to restore the violated right, the loss of or damage to its property (Actual Damage), as well as lost income that this person would have received under ordinary conditions of civil circulation if its right had not been violated (Lost Profits). [17] The person whose right is violated may claim full compensation for incurred losses unless the law or the contract provides for a smaller amount of compensation. [18]

The amount of damages must be established with a reasonable degree of certainty. Under Clause 1 of Article 15 of the Civil Code, a claim for damages cannot be denied solely because the exact amount cannot be established. In such cases, the court determines the amount of damages to be recovered, taking into account all the circumstances of the case and proceeding from the principles of fairness and proportionality of liability to the violation committed. [19]

If the person who violated the right received income as a result, the person whose right was violated is entitled to claim compensation for lost profits in an amount no less than such income, in addition to other losses. [20] For liability to arise, there must be a cause of action [21] (a combination of conditions) for the offense, including:

• the fact of a breach by another person of its assigned duties (commission of illegal actions or omissions);
• the existence of a causal link between the committed violation and the resulting losses, as well as the amount of losses caused.

Failure to prove one of the necessary grounds for compensation of losses precludes the satisfaction of the claims.

If the contract is terminated and if, in a reasonable manner and within a reasonable time after termination, the buyer has bought goods in replacement or the seller has resold the goods, the party claiming damages may recover the difference between the contract price and the price in the substitute transaction, as well as any further damages. [22]

Parties may also grant an additional period for the performance of obligations. During this additional period, the aggrieved party may suspend performance of its own mutual obligations and claim damages but may not resort to any other remedy. If it receives notice from the other party that the latter will not perform within that period, or if at the end of that period proper performance has not been made, the aggrieved party may resort to any of the remedies provided under the UNIDROIT Principles.[23]

Penalties, Fines, and Judicial Penalties

The Vienna Convention does not contain provisions regarding penalties; however, if the seller fails to perform any of its obligations under the international trade contract, the buyer's exercise of its right to other remedies does not deprive it of the right to claim damages.[24] Under Russian law, a penalty (fine or late fee [25]) is a sum of money determined by law or contract that the debtor is obliged to pay to the creditor in the event of non-performance or improper performance, particularly in the case of a delay in performance. The creditor is not required to prove that it suffered losses when claiming the payment of a penalty.[26]

Under Article 331 of the Civil Code, an agreement on a penalty must be made in writing regardless of the form of the main obligation. Failure to comply with the written form results in the invalidity of the penalty agreement. If the penalty to be paid is clearly disproportionate to the consequences of the breach of the obligation, the court has the right to reduce it. If the obligation is breached by a person conducting business activities, the court may reduce the penalty only upon the debtor's application for such a reduction.[27]

According to Clause 60 of the Resolution of the Plenum of the Supreme Court of the Russian Federation No. 7 dated March 24, 2016, On the Application by Courts of Certain Provisions of the Civil Code of the Russian Federation on Liability for Breach of Obligations (the "Resolution of the Plenum of the SC RF No. 7"), under Clause 1 of Article 394 of the Civil Code, if a penalty is established for non-performance or improper performance of an obligation, then losses are compensated in the part not covered by the penalty (offset penalty). The law or the contract may provide for cases where only the penalty but not losses may be recovered (exclusive penalty); or where losses may be recovered in full in addition to the penalty (punitive penalty); or where, at the creditor's choice, either the penalty or losses may be recovered (alternative penalty).

When concluding an international trade contract, the parties determine the applicable law. The parties' agreement on the choice of applicable law must be expressly stated or must clearly follow from the terms of the contract or the circumstances of the case.[28] In this case, when resolving the issue of recovering a penalty (fine), the parties to the international trade contract must be guided by Clauses 1 and 2 of Article 401 of the Civil Code. Liability in the form of a penalty (fine) for a breach of obligation must arise only if fault is present—specifically, if the breach occurred due to reasons depending on the company.[29]

In addition to the penalties that international trade participants may establish, the UNIDROIT Principles provide for a type of liability known as a judicial penalty:[30]

• If the court orders a party to perform, it may also direct that party to pay a penalty if it fails to comply with the decision.
• The penalty shall be paid to the aggrieved party unless mandatory provisions of the law of the forum provide otherwise. Payment of the penalty to the aggrieved party does not exclude any claim for damages.

Interest for the Use of Others' Funds for Non-Performance, Late Performance, or Causing Losses

Under Article 78 of the Vienna Convention, if a party fails to pay the price or any other sum that is in arrears, the other party is entitled to interest on it, without prejudice to any claim for damages. The Vienna Convention does not regulate issues regarding the amount of interest for delays in payment for goods; therefore, when drafting an international trade contract, it is necessary to determine the law applicable to the contract.

Under Russian law, in cases of unlawful retention of funds, evasion of their return, or other delay in their payment, interest on the debt amount is payable. The interest rate is determined by the key rate of the Bank of Russia in effect during the relevant periods. These rules apply unless a different interest rate[31] is established by law or contract.[32]

In transactions between foreign partners, settlements under international trade contracts are carried out in foreign currency rather than Russian rubles. Therefore, Article 395 of the Civil Code must be applied in conjunction with currency legislation. Based on the interpretation of Articles 309, 317, and 395 of the Civil Code, if there is a delay in performing a monetary obligation where the currency of the debt is a foreign currency, interest for the unlawful retention of funds or other delay in payment must be calculated in that foreign currency. The purpose of paying such interest is to restore the creditor's financial position and compensate for income not received from the potential use of funds not returned on time by the debtor. [33] Several cases serve as examples of the recovery of interest for the use of others' funds:

• Decision of the ICAC at the CCI of the RF dated March 24, 2022, in case No. M-1/2021. The ICAC partially satisfied the claim for the recovery of debt for the delivery of goods and interest for the use of others' funds because the goods were delivered properly, the payment period had expired, and no payment was made.
• Decision of the ICAC at the CCI of the RF dated April 16, 2021, in case No. M-93/2020. The ICAC partially satisfied the claim for the recovery of debt and interest for the use of others' funds because the respondent repeatedly violated the debt repayment schedule and no payments were made to the claimant's account. The claimant failed to provide evidence of Croatian legal norms providing for the right to recover interest on a debt and calculated the interest amount based on Russian civil law, which was inapplicable in that case.
• Decision of the ICAC at the CCI of the RF dated February 5, 2021, in case No. M-196/2019. The ICAC partially satisfied the claims for the recovery of debt and interest for the use of others' funds under a supply contract because the respondent performed its obligations improperly.

If the parties have not chosen the applicable law in the international trade contract, the arbitration court applies the law determined in accordance with the conflict-of-laws rules it considers applicable. [34] Under Russian law, in the absence of an agreement between the parties on the applicable law, the law of the country where the party performing the service of decisive importance for the contract has its residence or main place of business at the time of the contract's conclusion applies. [35] The party performing the service of decisive importance is considered to be the seller in a sale and purchase agreement.

The UNIDROIT Principles also provide for interest in the event of non-performance of obligations:

• annual interest for non-payment; [36]
• annual interest on the amount of damages. [37]

Annual interest is provided for in the following cases:

• If a party does not pay a sum of money when it falls due, the aggrieved party is entitled to annual interest on that sum from the time when payment is due until the time of payment, regardless of whether the party is excused for the non-payment.
• The rate of interest shall be the average bank short-term lending rate to prime borrowers prevailing for the currency of payment at the place for payment, or where no such rate exists at that place, then the same rate in the state of the currency of payment. In the absence of such a rate at either place, the interest rate shall be the appropriate rate fixed by the law of the state of the currency of payment.
• The aggrieved party is entitled to additional damages if the non-payment caused it greater harm.

Annual interest on the amount of damages, unless otherwise agreed, is calculated on the amount of damages payable for the non-performance of a non-monetary obligation and accrues from the time non-performance occurred.

Methods of Monetary Recovery and Currency for Calculating Damages

The UNIDROIT Principles determine the methods of monetary recovery[38] and the currency for calculating damages, [39] according to which damages must be paid as a single lump sum. However, they may be paid in installments if the nature of the harm makes this appropriate. Damages paid in installments may be indexed.

Given that international transactions involve foreign partners from different countries, another important UNIDROIT principle is that damages should be calculated either in the currency in which the monetary obligation was expressed or in the currency in which the harm was suffered, depending on which is more appropriate to the circumstances.

Exemption from Liability under an International Trade Contract

In the performance of an international trade contract, parties may be exempt from liability upon the occurrence of certain events. Under Article 79 of the Vienna Convention, a party is not liable for a failure to perform any of its obligations if it proves that the failure was due to an impediment beyond its control and that it could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences. [40]

If a party's failure to perform is due to the failure of a third person engaged by it to perform the whole or a part of the contract, that party is exempt from liability only if:

• it is exempt under the preceding paragraph;
• the engaged person would also be exempt if the provisions of that paragraph were applied to them.

Exemption from liability applies only for the period during which the impediment exists. A similar norm is reflected in the UNIDROIT Principles, which state that if the impediment is temporary, the exemption shall have effect for a period of time that is reasonable, taking into account the impact of the impediment on the performance of the contract.

A party may not rely on a failure of the other party to perform to the extent that such failure was caused by the first party's acts or omissions. [41]

Under Article 7.1.7 of the UNIDROIT Principles, a party is exempt from liability for non-performance if it proves that the non-performance was due to an impediment beyond its control and that it could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome the impediment or its consequences. Furthermore, an obligation is terminated by the impossibility of performance if it is caused by a circumstance that arose after the obligation was created and for which neither party is responsible. [42]

To be exempt from liability, the non-performing party must notify the other party of the impediment and its effect on its ability to perform. If the notice is not received by the other party within a reasonable time after the non-performing party knew or ought to have known of the impediment, the latter is liable for damages resulting from the non-receipt of such notice. Under the UNIDROIT Principles, the non-performing party must notify the other party of the occurrence of the impediment and its effect on its ability to perform. If the notice is not received within a reasonable time after the non-performing party knew or ought to have known of the impediment, it is liable for damages resulting from such non-receipt.

Under Russian legal norms, a person who fails to perform or improperly performs an obligation while conducting business activities shall be liable unless it proves that proper performance was impossible due to force majeure, i.e., extraordinary and unavoidable circumstances under the given conditions. Such circumstances do not include, in particular, a breach of obligations by the debtor's counterparties, the absence of goods necessary for performance on the market, or the debtor's lack of necessary funds. [43]

When concluding international trade contracts, foreign partners must determine not only the goods, price, and delivery terms, but also regulate liability issues for non-performance, late performance, and breaches of contract for both the buyer and the seller. A breach of an international trade contract can occur by either party due to reasons both within and beyond their control. Furthermore, international legal norms do not provide for certain types of liability, and the procedure for calculating liability is not defined for those that are provided.

To eliminate misunderstandings between parties regarding liability under international trade contracts, foreign partners must include a liability section in the contract alongside all material and additional terms. Finally, to hold the other party liable for non-performance or improper performance, the aggrieved party must prepare an evidentiary base to protect its violated rights. In the absence of such evidence, a court decision will not be in favor of the filing party. [44]

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References

1. United Nations Convention on Contracts for the International Sale of Goods, signed in Vienna on April 11, 1980.
2. Clause 1 of Article 71 of the Vienna Convention.
3. Article 7.1.1 of the UNIDROIT Principles.
4. Clause 7.4.1 of the UNIDROIT Principles.
5. Decision of the ICAC at the CCI of the RF dated February 29, 2000, in case No. 148/1999. The ICAC denied the claims for the recovery of compensation for failure to perform contract obligations because the claimant provided no legal justification for this claim, and also denied the claim for the recovery of a fine for delayed delivery because the respondent had the right to suspend shipment, having serious doubts about the claimant's creditworthiness.
6. Decision of the panel of arbitrators of the ICAC at the CCI of the RF dated September 3, 2018, in case No. M-4/2018. The ICAC denied the claim for contract termination, recovery of the advance payment, a fine for delayed delivery, and interest on the unreturned advance payment because the claimant did not clarify which export licenses the respondent was required to obtain. The claimant provided no evidence that the respondent failed to take necessary actions to obtain export licenses for the equipment delivery.
7. Article 72 of the Vienna Convention.
8. Clause 1 of Article 81 of the Vienna Convention.
9. Clause 1 of Article 82 of the Vienna Convention.
10. Clause 2 of Article 450 of the Civil Code.
11. Article 74 of the Vienna Convention.
12. Article 3.18 of the UNIDROIT Principles.
13. Article 45 of the Vienna Convention.
14. Decision of the sole arbitrator of the ICAC at the CCI of the RF dated February 16, 2022, in case No. M-85/2021. The ICAC satisfied the claim for the recovery of the main debt and a fine because the respondent's breach of contract obligations was proven, which resulted in the delivered goods becoming unfit for sale.
15. Article 75 of the Vienna Convention.
16. Resolution of the FAS of the Volga-Vyatka District dated October 20, 2011, in case No. A43-30022/2010 On the Recovery of Losses. Circumstances: The parties entered into a supply contract. Due to the respondent's breach, the claimant refused performance. Following a competitive procedure, the parties entered into a new supply contract. The claimant categorized the difference between the price in the replacement contract and the price in the terminated contract as losses. Decision: The claim was partially satisfied since the fact that the claimant purchased goods from the respondent at a higher price within a reasonable time after termination was confirmed.
17. Clause 2 of Article 15 of the Civil Code.
18. Clause 1 of Article 15 of the Civil Code.
19. Clause 12 of the Resolution of the Plenum of the Supreme Court of the Russian Federation No. 25 dated June 23, 2015, On the Application by Courts of Certain Provisions of Section I of Part One of the Civil Code of the Russian Federation.
20. Decision of the Arbitration Court of Moscow dated May 24, 2018, in case No. A40-56928/04-5-453 On the Joint and Several Recovery of Losses in US Dollars and Ordering the Company, Ltd. to Cease Use of Software for the KT-1 Aircraft Simulator. Decision: The claim was partially satisfied.
21. Decision of the Arbitration Court of Moscow dated June 6, 2019, in case No. A40-6063/19-127-53. Claim: Recovery of a debt in euros under a contract, losses in euros, and lost profits in euros. Counterclaim: Recovery of a debt in euros as justified and subject to satisfaction. Decision: The claim was partially satisfied.
22. Article 75 of the Vienna Convention.
23. Article 7.1.5 of the UNIDROIT Principles.
24. Clause 2 of Article 45 of the Vienna Convention.
25. Decision of the panel of arbitrators of the ICAC at the CCI of the RF dated February 10, 2022, in case No. M-53/2021. The ICAC satisfied the claim for the recovery of penalties, expenses for the purchase and replacement of spare parts, components, modernization of technological processes under an equipment supply contract, and arbitration fees because the respondent failed to complete the commissioning of the equipment within the contract period and the equipment was not operational due to being incomplete and of poor quality.
26. Clause 1 of Article 330 of the Civil Code.
27. Clause 1 of Article 333 of the Civil Code.
28. Clause 2 of Article 1210 of the Civil Code.
29. Review of Judicial Practice, Appendix to the Letter of the FCS of the RF dated September 30, 2004, No. 01-06/2037 Review of Judicial Practice in Cases on the Compensation of Harm (Losses) Caused by Illegal Decisions, Actions (Omissions) of Customs Authorities and Their Officials.
30. Article 7.2.4 of the UNIDROIT Principles.
31. Clause 39 of the Resolution of the Plenum of the SC RF No. 7.
32. Clause 1 of Article 395 of the Civil Code.
33. 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.
34. Rules of Arbitration of International Commercial Disputes (Appendix 2 to the Order of the CCI of the RF dated January 11, 2017, No. 6). This document entered into force on the date of deposit (deposited by the Decree of the Ministry of Justice of Russia dated January 27, 2017, No. 109-r) and applies to arbitration proceedings started from that date.
35. Clause 1 of Article 1211 of the Civil Code.
36. Article 7.4.9 of the UNIDROIT Principles.
37. Article 7.4.10 of the UNIDROIT Principles.
38. Article 7.4.11 of the UNIDROIT Principles.
39. Article 7.4.12 of the UNIDROIT Principles.
40. Decision of the panel of arbitrators of the ICAC at the CCI of the RF dated July 3, 2019, in case No. M-243/2018. The ICAC satisfied the claims for the recovery of debt under a supply contract and interest because the delivery was acknowledged by the respondent and the US sanctions are not force majeure circumstances.
41. Article 80 of the Vienna Convention.
42. Clause 1 of Article 416 of the Civil Code.
43. Clause 3 of Article 401 of the Civil Code.
44. Decision of the panel of arbitrators of the ICAC at the CCI of the RF dated February 7, 2019, in case No. M-112/2018. The ICAC partially satisfied the claim for a penalty under a supply contract because the respondent performed improperly. Claims regarding part of the penalty and interest for the use of others' funds were left without consideration because the claimant failed to provide a calculation for each claim and failed to pay the arbitration fee.