Awarding Excessive Amount of Penalty Interest May Contradict Russian Public Policy

Electricity TransmissionYesterday the Presidium of the Supreme Commercial Court of the Russian Federation affirmed relevant lower courts’ decisions to set aside a domestic arbitral award. It found that enforcement of an award requiring the respondent to pay penalty interest in the amount clearly exceeding the damages suffered by the claimant violates Russian public policy.  While the wording of the decision is dangerously broad, it should be assessed in light of the Supreme Commercial Court’s earlier pronouncements on public policy defence and the peculiar facts of the case.
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The post will argue that the court may set aside an award only if it finds that the tribunal actually awarded punitive damages (or a pure fine) rather than penalty interest or liquidated damages. The court should undertake such a review only if there is evidence that the amount awarded by the tribunal is clearly unrelated to any damages actually sustained by the claimant.
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Facts of the Case

The case arises out of a contract for development of electricity grid blueprints between two Russian companies. When the contractor had failed to deliver the first instalment of the blueprints the client claimed penalty interest at the rate provided in the contract (0.5% of the full contract price per day of delay).

The claim was submitted to arbitration administered by the Russian Union of Entrepreneurs and Industrialists (one of the largest Russian organisations for business interests). The defendant argued among other things that the amount of penalty interest is clearly disproportionate. The tribunal disagreed with this argument and awarded the full amount claimed.

Resolution of the Supreme Commercial Court  

The court began by noting that under Russian law the purpose of any form of civil liability is to compensate the claimant’s damages. It follows that a court may refuse enforcement of an award on public policy grounds if it finds that the amount of penalty interest is disproportionate to the damage suffered by the claimant.

Turning to the facts of the case before it the Supreme Commercial Court looked at three factors.

First, the court found that the claimant in fact failed to produce any evidence of actual damages it suffered (it remains unclear whether evidence was provided during the course of arbitration).

Second, the penalty interest rate applied by the tribunal far exceeded the rates which were common for commercial dealings in Russia. Surprisingly, the Presidium referred to Russia’s Central Bank refinancing rate as the relevant benchmark, even though the dispute before the tribunal concerned performance of a non-monetary obligation.

Finally, the Supreme Commercial Court noted that the tribunal ordered the respondent to pay penalty interest in the amount exceeding the full price of the works it contracted to perform. This was despite the fact that the respondent’s only breach was its failure to timely deliver one of the instalments under the contract.

Apparently, the combination of these factors led the Supreme Commercial Court to conclude that the award is contrary to Russian public policy.
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For example, the last factor by itself may not be determinative. Failure to perform obligations under a commercial contract regularly causes damages exceeding the contract price. Unless liability of the party in question is limited by contract or law there is no reason to impose such a limit with reference to public policy.

Issues to Consider and Issues Left Unanswered

The Resolution highlights that the claimant should produce some evidence of actual damages even if it is claiming penalty interest/liquidated damages. Similarly, the tribunal should set out in detail its reasons for finding the amount of penalty interest to be proportionate. Failure to adhere to these rules may lead to unenforceability of the award in Russia.

The unfortunate aspect of the Resolution is that it appears to allow the court to consider de novo whether the amounts the tribunal awarded are proportionate. However, one should read this statement in its context. First, according to very next sentence the court may annul an award only if the penalty interest is “clearly” («явно») disproportionate. Second, a contradiction to public policy arises only where disproportionality of the penalty interest/liquidated damages evidences their punitive nature (see clause 7 of the Review of the Practice on Public Policy Defense adopted by the Supreme Commercial Court on 26 February 2013).  In the same document the Supreme Commercial Court also observed that the courts may consider whether the party in a stronger bargaining position actually imposed the penalty provision on the other party, an aspect that may have influenced the courts’ thinking in this case as well.

It remains unclear why the court should annul the award in its entirety. If it finds that the amount awarded is excessive, the court may still enforce the award in part. If the party seeking enforcement of the award agrees to such an outcome (to avoid the need to relitigate the same issue before an arbitral tribunal) this appears to be the course the court should adopt.

The full text of the Resolution is available here (in Russian).

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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