Set-off in International Transactions: Legal Framework and Currency Regulation in Russia

September 30, 2023

BRACE Law Firm ©

Russian legislation provides for the termination of an obligation, in whole or in part, by setting off a mutual homogeneous claim. However, the possibility and conditions for set-off in international trade have significant specific features.

Under Russian law, general rules require that claims be mutual, their subjects be homogeneous, and the performance period must have commenced for the claim of the party initiating the set-off through a unilateral expression of will (the "active claim"). [1] These conditions for set-off must exist at the time the party makes the set-off statement. To terminate an obligation by set-off, the corresponding party must receive the set-off statement.[2] The existence of conditions for a set-off without a set-off statement does not terminate or change the obligations of the parties.

Before a set-off statement is made, parties may not refuse to accept proper performance under mutual claims, nor may they demand the return of performance provided before the set-off statement. Compliance with the mutuality criterion for set-off under Article 410 of the Civil Code of the Russian Federation (the "Civil Code") assumes that the creditor under the active claim is the debtor under the claim against which the active claim is set off (the "passive claim"). [3]

At the same time, Article 410 of the Civil Code does not prohibit the conclusion of a set-off agreement to terminate non-homogeneous obligations or obligations with performance periods that have not yet commenced. As the Plenum of the Supreme Arbitration Court clarified, the norms of the Civil Code establishing the prerequisites for terminating an obligation by a unilateral set-off statement do not imply a prohibition [4] on agreements between contracting parties to terminate non-homogeneous obligations or obligations with performance periods that have not yet commenced, etc.

In the framework of foreign trade interaction, in addition to the norms of civil legislation, one must also follow the norms of 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 Clause 4 of Article 24 of this law, parties may perform obligations under export contracts by any method permitted by Russian legislation, [5] including the set-off of their claims against a non-resident and obligations to that non-resident.

A critical aspect of performing foreign trade contracts is the requirement for residents to ensure that non-residents receive or return foreign currency or Russian rubles due to them under the contracts. Meanwhile, setting off mutual claims is a method of terminating obligations and does not involve the return of currency. However, currency legislation provides exceptions to this provision, allowing the set-off of mutual claims between a resident and a non-resident as specified in Clause 2 of Article 19 of Law No. 173-FZ. In accordance with these exceptions, residents are entitled not to credit foreign currency or Russian rubles to their bank accounts in authorized banks.

Furthermore, it is important to note that when conducting a set-off in international transactions, one must pay attention to the law applicable to the foreign trade contract and consider either the provisions of Russian law regulating set-off or the foreign law determined for the foreign trade transaction.

In Which Cases Is Set-Off of Mutual Obligations Permitted in Foreign Trade Contracts?

When setting off mutual claims under a foreign trade contract between a resident and a non-resident, no monetary settlements are made; the obligation terminates upon the statement of one of the parties to the transaction. Currency legislation allows the termination of obligations by setting off mutual claims if the terms of the foreign trade contract fall under the situations specified in the Law on Currency Regulation:

• When crediting foreign currency or Russian rubles to the accounts of resident legal entities or third parties in banks outside Russia for the purpose of performing obligations of resident legal entities under credit agreements and loan agreements with non-resident organizations that are agents of foreign governments. This also applies to credit and loan agreements concluded with residents of EAEU member states or with residents of foreign states (territories) with which automatic exchange of financial information is carried out, for a term exceeding two years. [6]
• When non-resident customers and/or other non-resident third parties pay or reimburse the local expenses of residents [7] under contracts concluded with non-residents during the performance of activities by such residents related to the construction, reconstruction, or modernization of facilities outside Russia. This applies for the period of construction, reconstruction, or modernization, after which the remaining funds must be transferred to the resident's accounts opened in authorized banks.
• When using foreign currency received by residents from holding exhibitions, sporting, cultural, and other similar events outside Russia to cover the expenses of their holding, for the period of such events.
• When conducting a set-off of mutual claims [8] under obligations between those engaged in: 4.1. Fishing outside Russia by residents and non-residents providing services to such residents outside Russia under agency agreements (contracts); 4.2. Transport services between residents and non-residents providing services to such residents outside Russia under contracts (agreements). This also applies to the set-off of mutual claims under obligations between resident and non-resident transport organizations if settlements between them are carried out through specialized settlement organizations established by international organizations in the field of international transport, of which such resident transport organizations are members. It further applies if settlements between resident and non-resident transport organizations are carried out in accordance with rules adopted by international organizations in the field of international transport that establish the procedure for mutual settlements for international transport and related services.
• When conducting a set-off of mutual claims under obligations arising from reinsurance contracts or contracts for the provision of services related to the conclusion and performance of reinsurance contracts between a non-resident and a resident that are insurance organizations or insurance brokers.
• When crediting foreign currency or Russian rubles to the accounts of resident transport organizations [9] in banks outside Russia for the purpose of paying expenses incurred by such transport organizations outside Russia related to the payment of: 6.1. Air navigation, airport, port fees, and other mandatory fees in the territories of foreign states; 6.2. Expenses related to the maintenance of aircraft, river and sea vessels, and other transport vehicles of such transport organizations and their passengers located outside Russia; 6.3. Expenses for ensuring the activities of branches, representative offices, and other subdivisions of such transport organizations located outside Russia.
• When conducting a set-off of mutual claims under obligations arising from contracts concluded between residents exporting natural gas in a gaseous state and non-residents, providing for the purchase and sale of natural gas in a gaseous state, and contracts providing for the obligations of non-residents to such residents in connection with the transit of natural gas in a gaseous state through the territories of foreign states.
• When a resident provides a non-resident with foreign currency or Russian rubles under a loan agreement related to the financing of geological study, exploration, and/or extraction of minerals, if said loan agreement contains terms stating that the return of the provided funds depends on the fact and volume of mineral extraction and/or the amount of revenue from their sale, and upon the occurrence of the conditions specified in the loan agreement, the funds are not returned.
• When conducting a set-off of mutual homogeneous claims under loan agreements concluded between a resident and a non-resident, provided that the non-resident's mutual claim arose as a result of providing a loan to the resident by crediting funds to the resident's account opened in an authorized bank.
• When a resident provides a non-resident with foreign currency or Russian rubles under a loan agreement related to the financing of investment and/or innovation activities, if upon the occurrence of the conditions specified in the loan agreement, the funds are not returned in the amount of the resident's contribution to the charter capital, securities, or the acquisition of debt obligations of the same non-resident, or if the funds are not returned due to the insolvency (bankruptcy) of the non-resident. In this case, the resident must meet one of the following conditions: 10.1. Be a legal entity included in the list of legal entities providing state support for innovation activities in forms established by Federal Law No. 127-FZ dated August 23, 1996, On Science and State Science and Technology Policy; 10.2. Be a business company in which at least 50% of the shares (stakes in the charter capital) are owned by the entities specified in Clause 10.1, or a business company in which the legal entities specified in Clause 10.1 have the right to directly and/or indirectly dispose of at least 50% of the votes attached to the voting shares (stakes) constituting the charter capital of such a business company; 10.3. Be a managing partner of an investment partnership in which the share of the legal entities specified in Clause 10.1 in the ownership of the common property of the partners is at least 50%; 10.4. Be a management company of an investment fund in which at least 50% of the shares (investment units) belong to the legal entities specified in Clause 10.1.
• When conducting a set-off of mutual claims under obligations arising from contracts for the provision of international electronic communication services, including international roaming services, between a non-resident and a resident that are international electronic communication operators, including cases where settlements between them involve specialized settlement organizations registered in the territories of member states of the International Telecommunication Union.
• When crediting foreign currency or Russian rubles to accounts opened in banks located outside the Russian Federation by Russian state educational organizations of higher education and their branches located outside the Russian Federation, under education contracts with non-resident individuals providing for the provision of educational services outside the Russian Federation.
• When conducting a set-off of mutual claims under obligations arising from foreign trade contracts (agreements) concluded between residents and non-residents, the terms of which provide for the provision of services to non-residents not specified in this part and included in the list of services [10] approved by the Government of the Russian Federation in consultation with the Central Bank of the Russian Federation.
• When conducting a set-off of mutual claims under obligations arising from foreign trade contracts (agreements) concluded between residents and non-residents, the terms of which provide for the transfer of goods to non-residents, or when replacing a non-resident's obligation to a resident with a new obligation for the purpose of the resident performing the duty to receive from the non-resident to its bank accounts in authorized banks foreign currency or Russian rubles due in accordance with the terms of said contracts (agreements), in cases not provided for by this part and included in the list of permitted cases for such set-offs or replacement of non-resident obligations with new obligations, approved by the Government of Russia in consultation with the Central Bank of the Russian Federation.

Considering the actions of unfriendly countries against the Russian Federation, the President adopted several decrees regulating interaction in the field of currency legislation, including when conducting set-offs under foreign trade transactions:

• Decree of the President of Russia No. 79 dated February 28, 2022, On the Application of Special Economic Measures in Connection with the Unfriendly Actions of the United States and Foreign States and International Organizations That Have Joined Them (the "Decree No. 79");
• Decree of the President of Russia No. 81 dated March 1, 2022, On Additional Temporary Economic Measures to Ensure the Financial Stability of the Russian Federation, etc.

It is also important to note that Decree of the President of Russia No. 529 dated August 8, 2022, On the Temporary Procedure for Performing Obligations under Bank Account (Deposit) Agreements Expressed in Foreign Currency and Obligations under Bonds Issued by Foreign Organizations, allows Russian legal entities and individual entrepreneurs engaged in foreign trade activities and/or providing and returning loans to conduct a set-off of their claims against non-residents and obligations to them, or to replace non-resident obligations with new obligations, except in cases determined by the Government of the Russian Federation in consultation with the Central Bank of the Russian Federation. Furthermore, the text of the clarifications of the Central Bank of the Russian Federation [11] states that the provided possibility to conduct a set-off of claims against a non-resident or the replacement of a non-resident's obligations with new obligations is a right, but not an obligation, of resident legal entities.

In Which Cases Is Set-Off Prohibited in International Transactions?

Article 411 of the Civil Code provides for cases where the set-off of claims is not permitted:

• Claims for compensation for harm caused to life or health;
• Claims for life maintenance;
• Claims for the recovery of alimony;
• Claims for which the statute of limitations has expired;
• Other cases provided for by law or contract.

Currency legislation determines the possibilities for conducting settlements between counterparties when using the set-off of mutual homogeneous claims.

In specified cases, set-off does not result in the legal consequences for which it was intended, particularly if the set-off contradicts the terms of the contract or if the statute of limitations for the active claim has expired. Upon the expiration of the statute of limitations for an active claim, the debtor under it who has received a set-off statement is not obliged to inform the creditor about the missed statute of limitations in response.[12] At the same time, the expiration of the statute of limitations for a passive claim is not an obstacle to set-off.[13]

Moreover, set-off under foreign economic contracts within the framework of currency legislation is not conducted when two mutual supply agreements are concluded — one where the supplier is a Russian company and another where the supplier is a foreign company. Currency legislation does not prohibit conducting set-offs between a resident and a non-resident; however, set-offs with foreign companies are possible only in cases specified by law. The possibility of set-off under two mutual supply agreements is not specified in Clause 2 of Article 19 of Law No. 173-FZ. An agreement to set off mutual claims that excludes the crediting of funds due under a foreign trade contract to the resident's account leads to the failure to ensure the repatriation of revenue, which constitutes an administrative offense.

Legal Consequences of Non-Compliance with the Set-Off Prohibition in Foreign Trade

Failure to comply with the rules of currency legislation when conducting a set-off under a foreign economic contract may lead to administrative or criminal liability.

Thus, Article 15.25 [14] of the CAO RF provides for administrative liability for conducting illegal currency operations, i.e., conducting operations prohibited by the currency legislation of the Russian Federation, or conducting currency operations without fulfilling the established requirements for using a special account and reservation requirements, as well as the debiting and/or crediting of funds, internal and external securities from a special account and to a special account without fulfilling the established reservation requirement. Non-compliance with this rule of law in the aspect of set-off is possible when the parties believe that by conducting a set-off of mutual claims, no currency operation exists.[15]

The evasion of obligations for the repatriation of funds in foreign currency or Russian rubles in accordance with Article 193 of the Criminal Code of the Russian Federation is punishable by a fine of 200,000 to 500,000 rubles, or in the amount of the salary or other income of the convicted person for a period of one to three years, or by compulsory labor for a term of up to three years, or by imprisonment for a term of up to three years.

In unstable political and economic conditions, changes to currency legislation occur regularly. Therefore, current information in the field of currency regulation must be constantly studied to minimize the adverse consequences associated with non-compliance with currency legislation.

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References

[1] Article 410 of the Civil Code.

[2] Clause 4 of Informational Letter of the Presidium of the Supreme Arbitration Court of the Russian Federation No. 65 dated December 29, 2001, Review of the Practice of Resolving Disputes Related to the Termination of Obligations by Setting Off Mutual Homogeneous Claims.

[3] Resolution of the Plenum of the Supreme Court of the Russian Federation No. 6 dated June 11, 2020, On Certain Issues of Application of the Provisions of the Civil Code of the Russian Federation on the Termination of Obligations.

[4] Clause 4 of Resolution of the Plenum of the Supreme Arbitration Court of the Russian Federation No. 16 dated March 14, 2014, On Freedom of Contract and Its Limits.

[5] Letter of the Federal Tax Service of Russia No. KV-3-17/12899@ dated November 18, 2022.

[6] Resolution of the Arbitration Court of the Moscow District dated October 2, 2018, No. F05-15935/2018 in case No. A40-216273/17, On the cancellation of the resolution on bringing to liability under Part 5 of Article 15.25 of the CAO RF for failure to fulfill the obligation to return to the Russian Federation within the established period funds paid to non-residents for goods not imported into the Russian Federation. Decision: The claim was denied because the company did not ensure the return to the Russian Federation of funds paid to the non-resident for goods not imported into the Russian Federation within the period established by the contract.

[7] Resolution of the Arbitration Court of the Moscow District dated August 24, 2021, No. F05-18574/2021 in case No. A40-60548/2020, On the cancellation of the resolution on bringing to liability under Part 1 of Article 15.25 of the CAO RF for conducting illegal currency operations. Decision: The claim was denied because the fact of the company crediting funds in foreign currency to an account opened in a foreign bank, bypassing an account in an authorized bank of the Russian Federation, was established.

[8] Resolution of the Arbitration Court of the Volga-Vyatka District dated April 17, 2023, No. F01-3568/2022 in case No. A82-5181/2021, On the recovery of debt under a contract for the provision of passenger transport. Circumstances: By a set-off notice, the defendant confirmed the set-off of an overpayment under an international air transport contract against the debt under a contract for the provision of passenger transport. The plaintiff stated that the parties concluded a charter contract under which the carrier does not sell seats to passengers. Decision: The claim was partially satisfied because the fact of the existence of the debt in the amount recovered by the court was confirmed. The remaining part of the claim was denied because, having access to its internal documents (information about passengers), the plaintiff did not submit a counter-calculation of the debt amount under the contract and did not refute the defendant's arguments about corrections.

[9] Informational Letter of the Bank of Russia No. IN-014-12/2 dated January 23, 2019, On the issue of applying the term "transport organizations" in the field of railway transport for the purposes of Federal Law No. 173-FZ dated December 10, 2003, On Currency Regulation and Currency Control.

[10] Decree of the Government of the Russian Federation No. 1516 dated September 23, 2020, On approval of the list of services upon the provision of which residents are entitled not to credit foreign currency or currency of the Russian Federation to their bank accounts in authorized banks in the event of conducting a set-off of mutual claims under obligations arising from foreign trade contracts (agreements) concluded between residents and non-residents, the terms of which provide for the provision of services to non-residents.

[11] Official Clarification of the Bank of Russia No. 11-OR dated November 23, 2022, On the application of certain provisions of Decree of the President of the Russian Federation No. 95 dated March 5, 2022, On the Temporary Procedure for Performing Obligations to Certain Foreign Creditors, Decree of the President of the Russian Federation No. 430 dated July 5, 2022, On the Repatriation by Residents - Participants in Foreign Economic Activity of Foreign Currency and Currency of the Russian Federation, and Decree of the President of the Russian Federation No. 529 dated August 8, 2022, On the Temporary Procedure for Performing Obligations under Bank Account (Deposit) Agreements Expressed in Foreign Currency and Obligations under Bonds Issued by Foreign Organizations.

[12] Clause 3 of Article 199 of the Civil Code.

[13] Clause 18 of Resolution of the Plenum of the Supreme Court of the Russian Federation No. 6 dated June 11, 2020, On Certain Issues of Application of the Provisions of the Civil Code of the Russian Federation on the Termination of Obligations.

[14] Decision of the Arbitration Court of the Republic of Buryatia dated January 17, 2019, in case No. A10-2783/2018. Category of dispute: Cases in connection with bringing to administrative liability. Claim: On the cancellation of acts on bringing to administrative liability under Article 15.25 of the CAO RF (violation of currency legislation and acts of currency regulation bodies). Decision: The claim was denied.

[15] Resolution of the Federal Arbitration Court of the East Siberian District dated February 28, 2007, No. A10-3741/06-F02-694/07-S1 in case No. A10-3741/06. The court rightfully refused to recognize as illegal the resolution of the financial and budget supervision body on the recovery of a fine, since the completed transaction (loan agreement) is not included in the list of transactions for which resident legal entities can conduct settlements with non-resident individuals without using bank accounts in authorized banks.