Contracts under Russian law in the face of COVID-19
Businesses are increasingly receiving notices from their counterparties stating that due and timely performance of contractual obligations has become impossible and/or asking to amend contractual terms and conditions due to the situation resulting from COVID-19.
Many practical questions arise in relation to the legal treatment of the underlying events and allocation of the burden of their financial consequences. Obviously, the answer to these questions depends on, among other things, the applicable law, the provisions of the relevant contract, the place of performance of the contract and the specific measures taken by the relevant authorities to prevent the spread of the pandemic and address its consequences.
Below is an analysis from the Russian law perspective of the key aspects which, in our experience, businesses should consider when analysing the impact of the relevant events.
The legal qualification of the pandemic
From the Russian civil law perspective, the qualification of the COVID-19 pandemic and its consequences is not yet clear.
The position of several executive authorities
Certain Russian executive authorities have used the term “force majeure” within the meaning of Article 401 of the Civil Code of the Russian Federation (the Civil Code) in relation to COVID-19 and in relation to certain measures
taken in connection with COVID-19 since the first countermeasures were announced in Russia. The term, for example, has been used in the Order of the Mayor of Moscow No. 20-УМ dated 14 March 2020, the Decree of the Governor of Moscow Region No. 115-ПГ dated 13 March 2020 and in the Note of the Russian Ministry of Finance “On performance of the procurement from the sole supplier (contractor) in the event of the introduction of a high alert regime” dated 19 March 2020. Nevertheless, when assessing the role of the legislative acts of the government authorities of different constituent entities of the Russian Federation, one should keep in mind that the civil law issues are within the competence of the federal authorities.
Discretion of the court
Nevertheless, under Russian law, the decision as to whether an event constitutes force majeure is made by the court on the request of the party claiming relief for force majeure.
From the legal perspective, the official position of the executive authorities does not bind the court (although it might be taken into account along with other evidence).
According to business media, the Russian Government is considering proposing a federal law that would simplify the recognition of such events as force majeure. However, as of 8 April 2020 no such legislation has been announced.
Does your contract contain special rules?
Russian law allows for the terms of a contract to provide for rules that differ from the rules established by default by statute. Therefore, when considering whether there are grounds for release from obligations or liability, the provisions of the contract must be considered first and foremost.
How to establish whether an event might qualify as force majeure?
Unless otherwise stated in the contract, the applicable law (Article 401 of the Civil Code) provides that an event qualifies as force majeure if a party is able to prove that the performance of the obligations has been impossible due to the event simultaneously having the following features1:
- emergency – the nature of the event is exceptional, its occurrence is not common in the relevant circumstances and the party claiming the force majeure could not have reasonably foreseen it when the contract was made; therefore, for the purpose of qualifying the COVID-19 pandemic as force majeure, the timing of entry into the contract could play a significant role2;
- inevitability – any other party to a civil transaction
engaged in a similar activity could not have avoided the occurrence of this event or its consequences3.
Russian court practice has not developed a uniform approach as to what extent the party must use its endeavours in order to avoid the occurrence of the relevant event. Therefore, any endeavours made by the party to do so will be assessed by the court on a case by case basis, taking into account the relevant circumstances.
If the list of force majeure events in the contract includes a pandemic or an epidemic, this would simplify the process of proving that COVID-19 qualifies as a force majeure event. In any case (unless the contract provides otherwise), the party will be required to prove that the event has met the above tests.
Is it possible to qualify the COVID-19 pandemic as force majeure if the contract was entered into after the declaration of the pandemic?
As mentioned above, if the contract was concluded after the declaration of the pandemic, it is less likely that such COVID-19 would be qualified as a force majeure event. In such a case, the parties should negotiate and agree on specific provisions regarding the limitation of liability if certain events of default have occurred as result of the pandemic or restrictions and limitations introduced by the government authorities in connection therewith.
Proof of causation
In addition to proving that the event meets the tests of emergency and inevitability, also it is also necessary to prove that due performance of contractual obligations was impossible as a result of such event (and not because of something else). In practice, quite often contractual parties give notice of force majeure without taking into account the causal link between the default and the event. We recommend closely reviewing whether the causal link to COVID-19 is properly demonstrated before giving notice of force majeure.
What factors affected the performance of the obligations?
Although the term “pandemic” or “epidemic” is used frequently in contractual provisions on force majeure, Russian court practice does not have a clear-cut answer as to whether the pandemic/epidemic itself might be considered a force majeure event. In many cases, the default would likely be caused by a number of factors (eg restrictions related to public events4, transportation, export of certain types of goods5, etc.).
In view of the above, the court will have to establish the cause of the default with regard to the circumstances of each individual case.
Acts of government authorities affecting due performance of the obligation
As already mentioned above, in a significant number of the cases the spread of the COVID-19 pandemic is unlikely to be the only factor affecting the performance of the contract. In fact, the obstacles to performance may well be the result of the pandemic and other events, in particular the restrictions enacted by the government authorities, whether federal (regional) or municipal. In addition, some contracts expressly envision that acts of government authorities qualify as force majeure events.
It should be noted that Russian law provides a separate regulation contained in article 417 RF CC in the event that performance of a contract is frustrated by the acts of the government authorities. According to that regulation, if performance of the obligation becomes impossible in full or in part, as result of adoption of an act of the federal/regional or municipal authority, the obligation shall be deemed terminated in full or in the relevant part.
It is worth considering the difference between the consequences prescribed, on the one hand by the rules on force majeure and, on the other, by the rules on termination of the obligation as a result of the adoption of an act of the federal (regional) or municipal authority. Where a government authority adopts an act which makes the due performance of the obligation impossible (for instance, due to quarantine measures), such an obligation is deemed terminated. At the same time, where an event qualifies as force majeure, the party to the obligation would need to make all reasonable and necessary endeavours in order to perform the obligation in a due and proper manner and only in case of default (improper performance) of the relevant obligation might such party be released from liability.
The question of whether the rules on force majeure or the rules contained in article 417 RF CC should apply to the situation resulting from the COVID-19 pandemic remains uncertain and, in each case, should be answered with due consideration of the specific circumstances.
Circumstances not considered force majeure
Article 401 of RF CC expressly states that the following are not considered force majeure:
- default by subcontractors or other counterparties on which a party to a contract relied in order to perform its own obligations – note that the law does not provide for an exception to this rule even if the failure of the subcontractor to perform an obligation was the result of force majeure circumstances, and therefore, defaults in supply chains resulting from a pandemic or the failure of a general contractor to receive materials from its supplier may not be recognised as force majeure
- the absence of the market of goods required for the performance of obligations; or
- the party’s lack of funds.
Therefore, a party to the contract is unlikely to be released from the obligation to pay for goods already delivered or services rendered, even if the circumstances around COVID- 19 adversely affected its financial condition.
Events or circumstances cannot be recognised as force majeure if their occurrence resulted from the actions or the failure to act of the party claiming the release from liability due to force majeure6. For example, the contractual party’s refusal to deliver goods or perform works due to quarantine and other measures that were imposed by the contractual party itself (ie by its management bodies) in excess of those prescribed by acts of state authorities cannot be attributed to force majeure.
How to prove the occurrence of a force majeure event?
In the event of a dispute over the existence and consequences of a force majeure event in court or arbitration, the burden of proof lies with the party making the claim for force majeure.
Under subclause “н”, cl. 3, article 15 of Law of the Russian Federation No. 5340-1 “On chambers of commerce and industry in the Russian Federation” dated 7 July 1993, the Chamber of Commerce and Industry of the Russian Federation (CCI) certifies force majeure circumstances in accordance with the terms of foreign trade transactions and international treaties of the Russian Federation, as well as customs established in the field of business, including seaport customs.
Since 26 March, the CCI has been issuing force majeure certificates in accordance with the terms of foreign trade transactions and cross-border agreements free of charge. In addition, the CCI has opened a hotline on issues of force majeure in connection with the spread of COVID-19.
However, a certificate of the CCI is not an ultimate unconditional confirmation of force majeure and neither is it, by itself, a basis for exemption from liability. It is considered as one piece of evidence (even if the parties for such a general contractor, unless otherwise stipulated in the relevant contract;
expressly provided that force majeure is to be confirmed by a certificate of the CCI of the Russian Federation).7
Should a notice of force majeure be sent?
Russian law does not expressly establish the obligation to notify the other party to a contract of the occurrence of a force majeure event. The obligation to send a notice, the timing of such notification and any other requirements are usually established by the contract. However, if the parties do not provide for such requirements in the contract, it may be argued that a notification should be sent on the basis of the general principles and the spirit of Russian civil law, including, among other things, the principles of good faith, reasonableness and fairness. In a number of cases the courts have stated that a party to a contract must take all reasonable steps to mitigate the damage caused its counterparty by the force majeure event, including notifying the counterparty of the occurrence of such circumstances and, if it fails to do so, to pay damages.
In the absence of specific rules in the contract, notification should be made as soon as practically possible (or, at least, within a reasonable time). The notification should contain a sufficiently detailed description of the relevant events, the obligations which are impossible to perform, an explanation of the causal link and a forecast for the possible performance of the obligations. If it is impossible to deliver a sufficiently detailed notification, the party should deliver the initial notification with as much detail as possible and follow up with clarification as events develop.
Will the contract terminate due to force majeure?
The occurrence of a force majeure event does not automatically terminate an obligation if the performance remains possible after the relevant event has ceased.9
The occurrence of a force majeure event may lead to the termination of the agreement, for example, if the obligations under the agreement cannot be performed for reasons for which neither party is responsible (article 416 of the Civil Code of the Russian Federation).
If the authorities issue acts that prevent the performance of obligations, this may also be the basis for termination of the contract on the grounds provided for in article 417 of the Civil Code of the Russian Federation.
Changes in market conditions as a basis for changing or terminating the contract
Due to changes in market conditions, currency exchange rates and fears of a recession due to the COVID-19 pandemic, as well as other events (including refusal to extend the OPEC+ deal), many companies have changed their commercial assessment of ongoing or planned projects.
M&A transactions with Russian assets, as well as commercial real estate transactions, are particularly affected by this.
In this regard, a frequent question is whether a party has the right to insist on amending or terminating the contract if such party has lost commercial interest in it (regardless of the presence or absence of force majeure). Russian law contains regulations (article 451 RF CC), which provide for such a possibility in the event of a “significant change in circumstances”.
The basis for amendment or termination of a contract in this way is a material change in the circumstances which the parties had relied upon at the moment of entry into the contract. A change in circumstances is recognised as significant when such circumstances have changed so much that, if the parties could have reasonably foreseen it, they would not have entered into the contract at all or it would have been concluded on significantly different terms. It should be noted that amendment of a contract due to a significant change in circumstances is allowed only by a court decision and only in exceptional cases, namely, when the termination of the contract contradicts the public interest or will cause damage to the parties that significantly exceed the costs required for the performance of the contract on the terms as amended by the court.
As evidenced by Russian court practice, the courts consider a number of circumstances to be part of the commercial risk which the parties should have foreseen, and the occurrence of which cannot be considered as a significant change in circumstances. Such circumstances include, amongst others, currency risk and computer software failures. At the same time, the COVID-19 situation raises new questions for market participants and the courts, the clear answers to which have not yet been given in legislation or court practice.
Determining the term for performance of contractual obligations in connection with the declaration of a non-working period starting 30 March and ending on 30 April 2020
In accordance with the Order of the President of the Russian Federation No. 206 “On declaration of non-working days in the Russian Federation” dated 25 March 2020 (the Initial Order) the period from 30 March 2020 until 3 April 2020 was declared to be a “non-working period with full salary pay”. A subsequent Order of the President “On measures to ensure the sanitary and epidemiological wellbeing of the population of the Russian Federation in view of the spread of the new coronavirus infection (COVID-19)” dated 2 April 2020 (the Extension Order) provided that the period of “non-working days with full pay” shall last until 30 April 2020.
One of the key legal issues in connection with this is how the non-working period may affect the term for performance of contractual obligations. Article 193 RF CC provides that “if the last day of a term is a non-working day, then the last day of the term is deemed to be the nearest following working day”. A literal interpretation of article 193 RF CC together with the abovementioned orders suggests that, unless otherwise provided by the agreement, for the purposes of calculating the contractual term in accordance with article 193 RF CC, the period beginning 30 March and ending on 3o April is composed of non-working days.
However, there are a number of exceptions. Firstly, banks are generally continuing to conduct payments from Monday till Friday each week as usual during this period. While banks were not specifically named as an exception in the Initial Order, the Central Bank of Russia issued a clarification that the Rouble payments system of the Central Bank will continue to operate during 30 March – 3 April, and the banks were expected to work “in the same regime as during the New Year holidays”.
The Extension Order expressly provided that it does not apply to certain types of organizations, including, among others, organizations in the food and medicine sectors, medical organizations, and organizations that provide indispensable financial services (in the first instance, payments and settlements).
The Central Bank of Russia also issued a press release regarding the work of the financial sector during the period from 4 until 30 April. According it, the Extension Order does not apply to commercial banks, private pension funds, management companies and depositories responsible for the accrual and payment of pensions, investment funds; insurance companies that provide health insurance and mandatory third-party liability vehicle insurance, and stock exchange infrastructure.
Also, in its press release, the Central Bank of Russia has expressed a view that contractual maturity periods in financial transactions shall not be altered by the application of the Extension Order.
It is noteworthy that in accordance with court practice and the principle of the freedom of contract, a contract may provide for its own definition of a “working day”. In this vein, it is important to take into consideration the provisions of each contract in respect of the terms for performance of the obligations, including, among others, the wording of contractual definitions such as “working day”, “non-working day” and “banking day”. Such definitions are often linked to the days on which banks conduct “normal” or “general” operations.
The Extension Order and the press release of the Central Bank of Russia referred to “indispensable” and “critical” operations, therefore, it is not entirely clear whether the days when Russian banks conduct such operations will qualify as “working” days for the purpose of interpretation of a contract. However, given that the banks are generally available to provide payment services to their clients during those day, if the relevant definition is envisioned in the contract, it is likely that such days might be deemed to be working days for the purpose of determining when an obligation should be performed.
Careful analysis of the wording of the contract, as well as the terms of the relevant obligations and the circumstances, is needed. A party to a contact needs to:
- assess potential issues with performance of its contracts, taking into account the (un)availability of personnel, materials and/or subcontractors;
- check the terms of its obligations and the relevant provisions, including the definition of “working days”;
- analyze the remedies and reliefs applicable to the relevant provisions; and
- work out the strategy of managing the risks of non- performance.
If you would like to discuss any of the issues raised in this briefing, please contact your usual Freshfields contact.
1 See Decision of the Supreme Court of the Russian Federation No. 306-ЭС14-7853 dated 24 March 2015.
2 Par. 2 cl. 8 of Decree of the Plenum of the Supreme Court No. 7 dated 24 March 2016.
3 Par. 3 cl. 8 of Decree of the Plenum of the Supreme Court No. 7 dated 24 March 2016.
4 Order of the Mayor of Moscow No. 17-УМ dated 10 March 2020
(prohibiting events in Moscow with more than 5,000 participants).
5 Russian Government Decree No. 223 dated 2 March 2020 (prohibiting the export of certain types of medical goods from the Russian Federation).
6 Par. 4 cl. 8 of Decree of the Plenum of the Supreme Court No. 7 dated 24 March 2016.
7 See the Decision of the arbitration court of the Povolzhskiy District dated September 17, 2014 on Case No. А65-1052/2014.
8 See cl. 10 of the Decree of the Plenum of the Supreme Court No. 7 dated 24 March 2016.
9 Par. 1 cl. 9 of the Decree of the Plenum of the Supreme Court No. 7 dated 24 March 2016.