By 18 February, 2013 0 Comments Read More →

Supreme Commercial Court to Address Disproportionality of Penalties as Public Policy Defence

Russian Supreme Commercial Court

For years Russian courts have struggled with the question of whether an obviously disproportionate amount of damages/penalties awarded by an arbitral tribunal may lead to refusal to enforce the award.

The prevailing practice has been to reject this proposition since it entails review of the merits of the case. Yet lower instance courts have sometimes supported the argument relying on the general principle of Russian commercial law that damages should be proportionate to the loss caused.

On 23 April 2013 the Presidium of the Supreme Commercial Court will hear a case in which lower courts refused enforcement of an award on this basis. The decision of the three-judge panel to refer the case to the Presidium highlights several important issues that the Presidium may resolve, including the definition of circumstances in which the amount of damages awarded or the process of their determination may justify refusal to enforce an award.

Facts of the case

The case arises out of a 2010 agreement between OJSC Federal Grid Company (“FGC”) and LLC FNK Engineering (“FNK Engineering”) for the design of blueprints. FGC agreed to pay c. 47 million roubles for the blueprints to be delivered in stages according to the agreed schedule and was entitled to a 0.1% (of the contract price) penalty interest per day of delay. In the event, FNK Engineering delayed delivery by 59 days and FGC requested payment of c. 2.5 million roubles by way of penalty interest.

The dispute between the parties came before a domestic arbitral tribunal administered by the Arbitral Court of the Russian Union of Industrialists and Entrepreneurs, the forum provided for in the agreement. The tribunal awarded the entire amount of the penalty interest claims to FGC.

The Moscow Commercial Court and the Federal Commercial Court for the Moscow Circuit refused enforcement of the award. They held that the amount of penalty interest was disproportionate and therefore enforcement of the award would be contrary to fundamental principles of Russian law.
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Opinion of the three-judge panel

On 1 February 2013 a three-judge panel of the Supreme Commercial Court (Judges Babkin, Valyavina and Sarbash) granted FGC’s application to refer the case for supervisory review by the Supreme Commercial Court.

The panel explained that the lower courts engaged in a review of the merits of the case and the arbitral tribunal’s analysis of the proportionality of penalty interest awarded. This exceeded their limited mandate in the enforcement of arbitral award proceedings and therefore called for reversal. This is a conclusion that has already been articulated in a number of cases.

However, the panel went on to describe two situations where the amount of penalty interest awarded may justify refusal to enforce an award on the basis of contradiction of fundamental principles of Russian law (public policy).

The first situation arises where the penalty interest awarded “would clearly have not been awarded in similar circumstances” since the amount “extraordinarily” exceeds the highest amounts of penalty interest applied in commercial dealings and is “obviously” contrary to the principle of good faith.

The threshold proposed by the panel is clearly a very high one. Yet it suggests that in certain cases the amount awarded by the tribunal may justify annulment/refusal to enforce. At the same time, such cases will clearly be extraordinary.

The second situation would be the arbitral tribunal’s flat refusal to even engage in proportionality analysis where proportionality of penalty interest is challenged by one of the parties.
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This situation is unlikely to arise in practice.  However, with the risk of potential annulment/refusal to enforce the award tribunals would be well-advised to spell out the fact that they have considered the proportionality of the penalty interest awarded.
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The full text of the Ruling of the three-judge panel is available here (in Russian).

Sergey Usoskin

About the Author:

Sergey Usoskin is an advocate (member of the Russian bar) and a senior associate at Ivanyan&Partners. He has experience advising clients on and representing them in commercial and investment arbitration matters as well as before the Russian court (including the Supreme Commercial Court). He is a graduate of St Petersburg State University, Faculty of Law and University College London Faculty of Laws.

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