Covid-19 Insights - Global Legal Briefing29 May 2020
Contract Law & Force Majeure
According to Article 401 of the RCC, unless otherwise provided by law or the contract, a person shall not be liable for non-performance or undue performance of its obligations assumed in the course of its entrepreneurial activities, if the performance of these obligations is impossible due to an "irresistible force", i.e. an extraordinary and unavoidable event in the given circumstances (also known in practice as the 'force majeure'). Such circumstances do not include, in particular, a breach of obligations on the side of the debtor's counterparties, the absence of goods on the market necessary for execution (e.g. supply), or the lack of necessary monetary funds59.
The Supreme Court of the Russian Federation (the "Supreme Court") has provided further interpretation and guidance to the concept of "force majeure" by clarifying that by virtue of Article 401 (3) of the Russian Civil Code, in order to recognize an event as a force majeure circumstance, it must be extraordinary, inevitable under the given conditions and external in relation to the debtor's activity60.
The Supreme Court has also noted that the emergency requirement implies the exclusivity of the circumstance under consideration, the occurrence of which is not usual under specific conditions. Unless otherwise provided by law, a circumstance shall be deemed inevitable if any participant in the civil commerce carrying out activities similar to the debtor could not avoid the onset of this circumstance or its consequences, i.e. one of the characteristics of force majeure circumstances (along with emergency and inevitability) is its relative nature. Force majeure circumstances cannot be recognized, the occurrence of which depended on the will or actions of the party to the obligation, for example, the debtor lacking the necessary funds, breach of obligations by its counterparties, illegal actions of its representatives.
From the given explanations, it follows that recognition of the spread of COVID-19 as force majeure cannot be universal for all categories of debtors, regardless of the type of their activity, the conditions for its implementation, including the region in which the business operates, due to which the existence of force majeure event should be established taking into account the circumstances of a particular case (including the time period for fulfillment of the obligation, the nature of the unfulfilled obligation, reasonableness and good faith the debtor's actions, etc.).
In relation to the rules of Article 401 of the Civil Code of the Russian Federation, the circumstances caused by the threat of the spread of COVID-19, as well as measures taken by state authorities and local self-government to limit its distribution, in particular, the establishment of mandatory rules of conduct when introducing a high alert or emergency, a ban on the movement of vehicles, restriction of the movement of individuals, suspension of enterprises and institutions, cancellation and rescheduling of mass events, the introduction of a regime of self-isolation of citizens, etc., may be recognized as force majeure, if it is established that they comply with the above criteria for such circumstances and the nexus between these circumstances and the default61.
Therefore, to summarize and to be excused for the non-performance of obligation under a contract due to COVID-19, a party needs to prove that (a) the circumstances in question are extraordinary and beyond the control of the parties, and (b) that the non-performance of the obligation is a direct result of these circumstances.
By the way, the official Decree No. 20-UM of the Mayor of Moscow dated 14 March 2020 "On Introduction of the High Alert Regime" (as amended) classifies the spread of COVID-19 as a force majeure event. The Chamber of Commerce and Industry of the Russian Federation has also declared that the measures taken against COVID-19 (not the pandemic itself) may be deemed as such circumstance. Therefore, Russian Government considers COVID-19 as force majeure.
In addition, Russian law generally permits parties to designate in the contract a list of events or circumstances, the occurrence of which could be regarded as grounds for releasing each party from liability for breach of the contract (or otherwise change the grounds for liability of the parties). In other words, parties are entitled to negotiate and agree on various force majeure issues.
In the light of the above, COVID-19 and all related consequences, depending on certain circumstances and mentioned criteria, can fall under the concept of "force majeure" event under the Russian law. Otherwise, epidemics and prohibitive measures of certain states and agencies, as well as other circumstances, which are beyond the control of parties, can serve as grounds for releasing the party from liability for non-performance of its obligations by virtue of contract (e.g. supply, distribution or franchise agreement). Of course, when proving the force majeure event, especially in cross-border deals, a relevant certificate of force majeure, including the one issued by the Russian Chamber of Commerce and Industry will highly be recommended as documentary evidence.
The Russian Chamber of Commerce and Industry (and its territorial divisions) are empowered to issue the official certificates of force majeure. Therefore, COVID-19-related certificates are highly expected at this time as evidence of force majeure that will apparently affect the performance of contractual obligations during this very difficult period.
Contract Performance - Delivery Obligations in Supply Contracts
Delayed delivery because of COVID-19 can be explained and discussed. The party may seek for a relief of liability for breach of a contract by relying on force majeure event (COVID-19) during the period of the same. However, the occurrence of the force majeure event does not fully release the party (debtor) from its contractual obligation to supply the contracted goods, if the performance of such obligation will be feasible after the current epidemic situation terminates. Therefore, if the COVID-19 - being an event of "irresistible force" (as noted above) - constitutes a temporary impediment for the performance of the party's obligation, the performance will be suspended (without any liability or breach) only for the period of such event, and will be revived immediately upon the termination of such event. As a result, under such circumstances, delayed delivery may be cured and accepted, especially if the contract has a special reference to a pandemic or epidemic situation, or if the court finds COVID-19 as force majeure in the course of court proceedings. Of course, the party in delay must act in good faith. At the same time, the non-defaulting party has the right to repudiate from the contract if, as a result of the delay, it is no longer interested in receiving the benefit under the contract, provided that the defaulting party shall not be liable to the non-defaulting party for any losses caused by the delay in performing the obligations due to the occurrence of the force majeure circumstances62.
Contract Performance - Closing the Unit; Product Seasoning Issues
Article 523 of the Russian Civil Code lists certain cases when unilateral repudiation from a supply contract is possible on the side of a supplier and customer. Changing the needs inthe ordered goods as well as the change of strategic decision to close business, or other "seasoned goods" circumstances, are not specified by the mentioned Article of the Russian Civil Code.
Again, the COVID-1 9 - being an event of "irresistible force" - shall constitute a temporary impediment for the performance of the party's obligation, and the performance will be suspended (without any liability or breach) only for the period of such event, after which will be revived immediately upon the termination of such event. Therefore, a customer must accept the performance made by the supplier immediately after the end of COVID-19. Simple or strategic decision of the customer with regard to the business or the shop during the epidemic shall not cure the situation.
At the same time, under the Russian law, contractual obligations of parties may be terminated due to impossibility of their performance (Article 416 of the Russian Civil Code), or on the basis of the act of state agency (Article 41 7 of the Russian Civil Code). More specifically, termination of the relevant contractual obligations under Article 416 of the Russian Civil Code may take place if, in connection with certain circumstances arising after execution of the contract, there is an actual, objective and permanent impossibility of performance of those obligations63. Termination of obligations by virtue of Article 41 7 of the Russian Civil Code is possible if state or local authorities adopt acts or measures that make it impossible to perform obligations under a contract. Of course, these circumstances must be proved documentarily, not just declared.
Therefore, under these specific rules of law, "seasoning" can be explained and allow the customer to repudiate from the contract (on this part), as a result of COVID-1 9. But, simple or strategic decision of the customer with regard to the business or the shop during the pandemic situation shall not be cured through Articles 416 and 417 of the Russian Civil Code.
Contract Performance - Minimum Sales Obligations in Distributorship
Minimum sales and minimum quantities can be essential for the parties in certain instances when they enter into the deal. Due to COVID-1 9 - that may also be regarded as "material change of circumstances" - the agreed minimum amounts can hardly be reached, or not reached at all. In this case, parties may rely on the provisions of Article 451 of the Russian Civil Code.
Unlike the situations above, in case of a "material change of circumstances", parties may still have an opportunity to perform their obligations under a contract. According to Article 451(1) of the Russian Civil Code, a material change of circumstances upon which the parties have relied when executing the contract is a ground for amending or terminating the relevant contract. A change of circumstances is regarded as material when the parties' circumstances have changed in such a way that the parties would not have entered into the contract at all, or would have entered into it on significantly different terms, had they been able to reasonably foresee the change at issue.
Unless otherwise provided by the contract and does not follow from its essence, such circumstances that the parties could not have foreseen when concluding contracts may serve as grounds for amending and terminating the contracts on the basis of Article 451 of the Russian Civil Code, if the contract had not been concluded under these circumstances or would have been concluded under significantly different conditions.
Moreover, under Article 451 (4) of the Russian Civil Code, a change in the contract due to a material change of circumstances at the request of one of the parties is possible only in exceptional cases when the termination of the contract is contrary to public interests or will entail damages to the parties significantly exceeding the costs required to perform the contract on the conditions as amended by the court. When satisfying a claim to amend the terms of the contract, courts must indicate what public interests contradict the termination of the contract or justify the significant damages to the parties from the termination of the contract64.
Therefore, Russian law and judicial practice makes it generally possible that measures taken in connection with the spread of COVID-1 9 could make the fulfilment of contractual obligations so burdensome for the parties that they will be recognized by the court as "material change of circumstances". This means that parties will be able, for example, to rely on these grounds for the purpose of modifying the relevant contract in accordance with Article 451 of the Russian Civil Code.
Contract Performance - Payments Obligation in Franchising Contracts
As noted above, franchisees can be just suspended from payment of royalties during the period of COVID-19. Complete release of their liability to pay royalties under the concluded contract will not be possible. Of course, it is necessary to review and rely on the concrete royalty basis, payment period and method of calculation of the same to see whether the period of COVID-1 9 really has any negative impact on the deal. For example, annual fixed royalties to be paid at the end of the year may still be paid at the end of the year, if pandemic situation is terminated in summer, while monthly payments dependent on net sales can be "freezed" obviously. Minimum royalties or other fees can be amended pursuant to the provisions of Article 451 of the Russian Civil Code due to material change of circumstances, as noted above.
Contract Performance - Aspects of Commercial Lease
Russian Government decided to support tenants and lessees during these uncertain times and provided "rent holidays" to the leasing businesses. More specifically, according to the recently issued Resolution of the Russian Government No. 439 dated April 3, 2020 "On requirements to conditions and periods of postponement of rent payments under real estate leases (the "Resolution") a tenant is now entitled to postpone rent payments in case the following conditions are met: (a) lease is made in relation to any real estate, except for residential one; (b) lease is made before the launch by the relevant Russian region of the regime of high-alert or extreme situation (the "Regime"); and (c) tenant's activity falls under the list of the most injured industries due to the spread of Covid-19.
Rent payments may be postponed from the date of introduction of the Regime by the respective Russian region until 1 October 2020. Upon termination of the Regime and until 1 October 2020 the tenant may postpone 50% of rent payments. The parties may decrease the amount of rent, which should be postponed under the additional (amendment) agreement. Operating expenses and other utility payments may not be postponed even if they are included in the rent (and not provided separately), except when the landlord is released from such payments under the regulations of the respective Russian region. The tenant who meets the criteria mentioned above shall approach the landlord and ask it to sign the lease amendment agreement. The amendment agreement should be concluded within 30 days. In case of a long-term lease the amendment agreement must also be registered. Finally, landlords are prohibited to ask for any penalties, interests or any other payments, including those already provided for in the lease agreements.
Conclusion and Recommendations
From the point of view of practical and general recommendations for the contractual parties affected by COVID-1 9, the following legal actions can be recommended at this point: (1) reviewing the exact contractual terms, including force majeure clauses, and doing the appropriate legal risk analysis; (2) confirming with lawyers that COVID-1 9 is the force majeure event and securing a legal opinion, as well as additional pieces of evidence (e.g. obtaining an official certificate from Russian Chamber of Commerce and Industry); (3) evaluating a list of operable measures that can be made and discussed with the other side in connection with the pandemic situation; (4) notifying the other side and establishing communications on the issue; (5) considering the amendment or termination (as applicable) of the underlying contract; (6) proceeding to execution of amendment or termination and registration formalities (if needed). Otherwise, the parties will have to assess the possibility of going to the court.
60. Section 8 of the Resolution of the Plenum of the Supreme Court of March 24, 2016 No. 7 "On the Application by Courts of Certain Provisions of the Civil Code of the Russian Federation on Liability for Breach of Obligations"
61. See Question and Comment 7 of the "Review of selected issues of judicial practice related to the application of legislation and measures to counteract the spread of the new coronavirus infection (COVID-19) No. 1 in the Russian Federation" (Approved by the Presidium of the Supreme Court of the Russian Federation on 21 April 2020)
62. Section 9 of the Resolution of the Plenum of the Supreme Court of March 24, 2016 No. 7 "On the Application by Courts of Certain Provisions of the Civil Code of the Russian Federation on Liability for Breach of Obligations"
64. See Question and Comment 8 of the "Review of selected issues of judicial practice related to the application of legislation and measures to counteract the spread of the new coronavirus infection (COVID-19) No. 1 in the Russian Federation" (Approved by the Presidium of the Supreme Court of the Russian Federation on 21 April 2020)