Recent amendments to Russian civil code may allow a ‘weak party’ in a contract to terminate it

May 2015 | EXPERT BRIEFING | LITIGATION & DISPUTE RESOLUTION

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Due to current financial crises and sanctions that have been imposed, many companies fail to duly perform their contractual obligations. To avoid penalties, they try either to challenge the terms of the contracts or to terminate the contracts in court on the grounds of a material change in circumstances or force majeure.

However, Russian courts are reluctant to terminate contracts on these grounds and almost never take the responsibility for changing the conditions of a particular contract. The adopted amendments to clause 428.3 of the Civil Code will provide the courts with a legal instrument to justify the termination of agreements, where one party was put in a substantially weaker position than its counterparty.

On 8 March 2015, the Federal Law No. 42-FZ ‘On amendments to the First Part of the Civil Code’ was enacted. Among other changes to the Civil Code, this law has amended Article 428 of the Code (regulating contracts of adhesion) by expanding its application to negotiated contracts. It may substantially change the balance of interests between the parties to such contracts as commercial leases and loans.

Current legal framework

Article 428.2 of the Russian Civil Code provides that: “The party adhering to the contract has the right to demand rescission… of the contract, if the adhesion contract… deprives this party of the rights generally granted under contracts of this type… or contains other conditions which are clearly onerous for the adhering party and which it would not have accepted based on its reasonably understood interests had it had the opportunity to participate in defining the conditions of the contract”.

The previous version of Article 428.3 specifically excluded the application of these termination rules if both parties to an agreement are engaged in entrepreneurial activities.

Some time ago, despite the explicit prohibition of Article 428.3, the Plenum of the Supreme Commercial Court of the Russian Federation in its Directive ‘On Freedom of Contact and its Limits’ (clause 9) had taken the position that “when considering claims that derived from contracts, including those performance of which is related to the execution by the parties of their entrepreneurial activities”, the courts should take into account that: “In cases when it will be found out that when executing a contract, draft of which was suggested by one of the parties and contained the terms and conditions being clearly onerous for its counterparty and materially upsetting the balance of interests of the parties (unfair contractual terms), and the counterparty was put into the situation hindering negotiation of a different content of certain terms and conditions of the contract (i.e. became weaker party to the contract), a court may apply to such contract provisions of Article 428.2 of the Russian Civil Code, amending or rescinding the corresponding contract upon requirement of such counterparty.”

Thus, long before the enactment of the 8 March legislation, the Supreme Commercial Court instructed all commercial courts in Russia to disregard the provisions of Article 428.3 of the Civil Code in applying the rules designed for the contracts of adhesion to potentially all commercial transactions. The instructions of the Supreme Commercial Court were taken seriously by commercial courts. In this context, the judgment rendered in matter No. А12-1193/2014 is particularly noteworthy.

Court rules in favour of arguably weak party under a commercial lease

In 2007, a landlord and a tenant entered into a long-term lease agreement in respect of 138.1 square metres of retail space in a shopping centre in Volgograd. Initially under the lease agreement, the tenant had the right to unilaterally terminate the lease. In 2009, however, by an addendum to the lease agreement, the parties removed this right of the tenant from the contract.

From 2011 through 2014, the tenant faced business challenges of which it informed the landlord on numerous occasions and asked the landlord to either renegotiate the rent or terminate the lease agreement. The landlord repeatedly refused to accommodate the tenant’s requests and each year exercised its right under the lease agreement to adjust the rent upward.

In 2014, the tenant brought a claim against the landlord in the Commercial (Arbitrazh) Court of Volgograd Region seeking termination of the lease agreement on the grounds of a material change in circumstances (Article 451 of the Russian Civil Code).

The Commercial Court upheld the tenant’s claim, citing, however, clause 428.2 of the Civil Code. The Commercial Court took into consideration the clarification of the Plenum of the Supreme Commercial Court.

The court ruled to apply to the lease relationships the ‘adhesion’ doctrine, based on the following. First, the terms and conditions of the lease agreement and the addendum thereto had been proposed by the landlord. The court considered that, by removing the tenant’s right of unilateral termination while retaining such right for itself, the landlord abused its right (Article 10 of the Civil Code). According to the court, this deletion upset the balance of the parties’ interests and made the tenant a ‘weak’ party of the agreement.

Second, despite repeated requests from the tenant to renegotiate rent or terminate the agreement due to its difficult financial situation, which was properly substantiated, the landlord repeatedly raised the rent. The court determined that the tenant would not be able to continue its entrepreneurial activities if the lease agreement was not terminated.

At the same time, the commercial courts of all levels failed to explain why the tenant had not been able to negotiate the unfair terms of the agreement. The landlord tried to argue that all tenants of the shopping centre had the opportunity to provide their comments to the draft lease agreement proposed by the landlord. Moreover, some tenants of the same shopping centre executed lease agreements together with the statement of disagreements, which, according to the landlord, proved that any tenant had the opportunity to influence the terms and conditions of the lease proposed by the landlord.

Extension of the ‘weak’ party approach beyond agreements of adhesion

With enactment of a new version of Article 428.3 after 1 June 2015, the courts may be asked to address the ‘weak party’ aspect in many commercial disputes. Now, Article 428.3 provides that: “Rules provided under sub-clause 2 of this clause [428] shall be applied also to agreements that are not adhesive agreements but where conditions of such agreements are determined by one of the parties while the other party due to obvious disparity of negotiation capacity is put in a position that substantially prevents it from negotiating other terms of certain provisions of a contract”.

The new wording poses a lot of questions since it does not provide guidance as to what should constitute an “obvious disparity of negotiation capacity” and does not set forth any criteria for “substantial” prevention from negotiation of alternative conditions of the agreement. These doctrines are new to Russian civil law and it may take courts years to adopt a uniform approach to these matters.

Is there a way to mitigate the risk of termination of commercial contract under new rule?

To prepare for the forthcoming enactment of Article 428.3 of the Russian Civil Code, certain business organisations (banks, developers and managers of commercial properties) may be advised to undertake certain preventive measures to avoid the risk of application to their commercial contracts new rules on termination and demonstrate that there is no “obvious disparity of negotiation capacity” between them and their counterparties. First, an alleged ‘strong’ party is advised to build up some evidence that the executed agreement reflects the compromise reached in the course of negotiations with the other side. For example, it might be advisable to execute the agreement through exchange of so-called statements of disagreement (protocol raznoglasiy in Russian) or keep track of documents exchanged in the course of negotiations (such as formal letters, minutes of meetings, etc.) to demonstrate to the judge that negotiations did occur. Second, an alleged ‘strong’ party is advised to encourage the other side to be represented in negotiations by an experienced qualified legal adviser. Finally, particularly close attention should be paid to the provisions of the agreement excluding or limiting the rights of one of the parties to the agreement while retaining similar rights for the other party.

Instead of insisting that the ‘weak’ party waive its termination right, the ‘strong’ party is advised to consider other ways of discouraging the ‘weak’ party from terminating the contract. For example, it has been confirmed recently that the so-called ‘termination fee’ should be deemed legal and enforceable under Russian law. Thus, the ‘weak’ party may be granted the right of termination of contract on condition of paying a substantial termination fee.

Dmitry Kunitsa is a partner and Ekaterina Tsvetkova is an associate at Morgan Lewis. Mr Kunitsa can be contacted on +7 495 212 2500 or by email: dkunitsa@morganlewis.com. Ms Tsvetkova can be contacted on +7 495 212 2500 or by email: etsvetkova@morganlewis.com.

Dmitry Kunitsa and Ekaterina Tsvetkova

Morgan Lewis