Problematic aspects of the practice of reducing penalties in Russian civil law

Vronskaya Mariya Vladimirovna PhD in Law Associate Professor at the Department of Private Law of Vladivostok State University of Economics and Service  690014, Russia, Vladivostok, Primorsky Krai, 42 Balyaeva str., sq. 119 m.vronskaya@mail.ru Other publications by this author

Ekhlakova Yuliya Vasil'evna lawyer, Legal Clinic LLC 690014, Russia, Primorsky Krai, Vladivostok, Gogol str., 41 Golya7795@mail.ru

Article 309 of the Civil Code of the Russian Federation (hereinafter referred to as the Civil Code of the Russian Federation) declares that obligations must be fulfilled properly. Pursuing the goal of reducing or weakening the negative impact of non-fulfillment or improper fulfillment of an obligation, the legislator fixed in Article 329 of the Civil Code of the Russian Federation a list of methods the use of which makes it possible to ensure the fulfillment of an obligation, including in accordance with Articles 330-333 of the Civil Code of the Russian Federation ^[1]. The widespread use of a penalty as an interim measure not only in Russia, but also in other countries is explained by the interest of the parties to the contract in the timely fulfillment of obligations, the possibility of using a penalty to induce the debtor to repay the debt in a timely manner. The penalty is of particular importance in market conditions, when, in many respects, due to its security function, the balance of interests of the parties is observed. Recoverable regardless of the damage caused, the penalty becomes especially popular, since it frees the creditor from the need to apply any preventive measures to the debtor, and in case of violation of the obligation to justify the existence and amount of losses.

At the same time, the established practice of applying Articles 330-333 of the Civil Code of the Russian Federation contributes to the effective use of penalties to ensure the fulfillment of obligations. Representatives of the scientific community attribute this to the lack of a legal definition of "lost profit" in the law, clear criteria for the apparent disproportionality of the penalty to the consequences of non-fulfillment of the obligation, with the presence in Article 330 of the Civil Code of the Russian Federation of the evaluation category "apparent disproportionality", which the courts interpret very differently, and sometimes bypassing explanations on this score of higher judicial instances. The practice of dispute resolution on the recovery of penalties for non-fulfillment of obligations under an international agreement is contradictory due to shortcomings in the sources of national and non-State law.  Legal uncertainty is created by the norms of Parts 1 and 2 of Article 333 of the Civil Code of the Russian Federation, which do not allow making an unambiguous conclusion about the legality of applying their provisions to reduce the legal penalty to persons engaged in entrepreneurial activity.

The institution of a penalty in the civil law of Russia has always been given a lot of attention. O. G. Alekseeva, E. R. Aminov, M. V. Bando ^[2], K.A. Grave ^[3], V.K. Reicher ^[4], M.Ya. Parchment ^[5] and others were among the first to raise the topic of penalties in their works. The penalty as an integral component of the institution of enforcement of obligations has been raised at various times in the works of: D.I. Meyer ^[6], M.I. Braginsky, V.V. Vitryansky ^[7], E.A. Sukhanov ^[8], B.M. Gongalo ^[9], etc.

As an interim measure and a measure of liability for non-fulfillment of obligations under the contract, the penalty was studied in the dissertations of: M.S. Artemenko ^[10], V.A. Vyatchina ^[11], E.M. Malikova ^[12], A.I. Konovalov ^[13], Yu.V. Dolmatova ^[14], etc. A significant scientific contribution to the study of the penalty as an interim measure was made by D.A. Grishin. The monograph "Penalty: theory, practice, legislation", which is based on the dissertation of the same author "Penalty: questions of theory and practice" ^[15] is distinguished by a high scientific level of study of theoretical and a number of practical problems related to the penalty, as well as a comprehensive analysis of the institute of penalty and its relationship with other civil law institutions. The features of the penalty in the context of civil law reform, as well as the problems of developing a contractual condition for a penalty are elaborated in detail in G.I. Melikov's dissertation study "Penalty: problems of legal nature and use in contractual relations in the light of civil law reform" ^[16].

Despite the wide range of scientific research on the chosen topic, today there is still a need for additional study of theoretical and practical issues related to the use of penalties as a way to ensure the fulfillment of obligations. The criteria for the apparent disproportionality of the penalty to the consequences of non-fulfillment of the obligation have not been worked out properly; the norms of Article 333 of the Civil Code of the Russian Federation do not contain the maximum limit of the penalty to be reduced, difficulties arise in the practice of reducing the legal penalty at the request of a person engaged in entrepreneurial activity.

Considering the domestic civil law doctrine, it can be noted that the long-term dispute over the concept of a penalty was resolved by the legislator, who fixed in paragraph 1 of Article 330 of the Civil Code of the Russian Federation the definition according to which a penalty determined by law or contract is nothing more than a sum of money that the debtor is obliged to pay to the creditor in case of non-fulfillment or improper fulfillment by the latter of the obligation ^[1]. However, unlike the concept of a penalty, the question of its legal nature remains open to the present time, due to the dual nature of the penalty, its positioning in the doctrine and in the law both as a measure of civil liability and as an interim measure. We believe that determining the legal nature of the penalty, we should proceed from the following features:  the condition of the penalty is stipulated by the parties to the contract not after the obligation is violated, as is the case with civil liability measures, but long before the violation, which characterizes the penalty, first of all, as an interim measure, which, nevertheless, is based on the sanctions mechanism applied to the debtor.  We also believe that it is necessary to determine the legal nature of the penalty based on its purpose (ensuring proper performance of the main obligation), and not on the degree of security or guarantee of the claim for its recovery, which remains the prerogative of the state, since the parties to the contract have the right to choose another interim measure (pledge or surety) as the source of performance of a specific obligation. From our point of view, the understanding of the legal nature of the penalty is best facilitated by the position of the higher courts, according to which the penalty is positioned both as a way to ensure the fulfillment of the obligation and as a measure of property liability for its violation.

Regardless of what type of penalty is used by the subjects of civil legal relations, its importance for ensuring the fulfillment of obligations can hardly be overestimated. As practice shows, the penalty serves as a guarantee of ensuring the proper performance of the main obligation. Due to the penalty, the parties to the contract are stimulated to properly fulfill the main obligation, and are also warned that if they violate them, they will be obliged to transfer a sum of money as compensation to the creditor.

We also believe that the current practice of reducing all types of penalties by courts, without exception, regardless of its type (legal or contractual), size, purpose and type of legal relations does not contribute to effective law enforcement, and also weakens the security value of the penalty. And although some federal laws in some cases establish a clearly overestimated amount, from our point of view, the legal essence of the penalty as an interim measure suffers with this approach. The penalty must be commensurate with the violated interest of the parties to the contractual relationship. But if the penalty is reduced without taking into account the above circumstances, it loses its specificity and becomes unable to fulfill its basic function – to ensure proper performance of the obligation.

We believe that the consolidation in the Civil Code of the Russian Federation of clear criteria (grounds) for reducing the penalty, the maximum amount of the penalty to be reduced in accordance with Article 333 of the Civil Code of the Russian Federation, as well as a direct indication of the law on the possibility of reducing the legal penalty at the request of the entrepreneur, will help to avoid excessively broad judicial discretion and arbitrary interpretation by the courts of the concept of "obvious disproportionality" of the penalty to the consequences of non-fulfillment of the obligation (Item 1 of Article 333 of the Civil Code of the Russian Federation).

The analysis of court decisions showed that in about 80% of cases, the appellate instances and the Supreme Court of the Russian Federation agree with the approach of lower courts in the application of Articles 333 of the Civil Code of the Russian Federation, however, in some cases, the highest court is forced to point out judicial errors, misinterpretation of the norms of the Civil Code and explanations of the Supreme Court of the Russian Federation, the absence in the reasoning part of the decision grounds for reducing the penalty or for refusing to reduce it.

To prove the above, let's consider some situations from law enforcement practice.

1. Having considered the cassation complaint of LLC "Mosenergo Heat Supply Company" (hereinafter – the Company) for the unmotivated refusal of the courts to reduce the penalty accrued upon the failure to fulfill the obligation of the Municipal Unitary Enterprise "Kotelniki" to pay for the resources supplied by the Company in the period from July 2019 to September 2019 within the framework of the concluded contract, the Judicial Board for Economic Disputes of the Supreme Court of the Russian Federation in Determining dated 07.02.2022, in case No. A40-343318/2019, she indicated that the reasoning part of the judicial act in this case does not contain a justification for the decision taken by the court to refuse to satisfy the Company's claim to reduce the penalty. Thus, the court did not consider the plaintiff's claim on the merits, referring to the appellant's insufficient argumentation of its unlawful rejection by the court of first instance. A similar justification is given in the judicial act of the cassation instance. Based on the results of the consideration of the disputed case, the Supreme Court of the Russian Federation determined to recognize the above judicial acts as inconsistent with the provisions of Articles 170, 271, 306 of the APC of the Russian Federation. As indicated by the Supreme Court of the Russian Federation, the court of first instance, when deciding to refuse the Company a claim for a reduction of the penalty, did not provide any justification for its disproportionality. In addition, the judicial acts of the lower courts do not specify the grounds for rejecting the Company's application to reduce the penalty, yet the grounds mentioned by the court of appeal for refusing to reduce it do not comply with the civil legislation of the Russian Federation, in particular Article 333 of the Civil Code of the Russian Federation, explanations of Russian law enforcement practice, as well as materials of the disputed case.

We believe that the conclusions of the Supreme Court of the Russian Federation in this case are of particular importance due to the fairly wide spread in practice (9%) of situations in which certain arguments of the defendant in favor of the application of Article 333 of the Civil Code of the Russian Federation (reduction of the penalty) or refusal to reduce its size are not properly evaluated, and in the motivational part decisions contrary to the norm of clause 4 of Article 198 of the Civil Procedure Code of the Russian Federation are not specified.

2. The amount of the penalty, far exceeding the cost of goods, works, services under the contract, serves as the basis for reducing the penalty in accordance with Article 333 of the Civil Code of the Russian Federation.  At the same time, the analysis of court decisions showed that courts do not always comply with the requirements of the law in this part. Thus, considering one case in which the amount of the penalty exceeded 72% of the value of the unpaid goods, the court considered the penalty clearly disproportionate to the consequences of non-fulfillment of the obligation and pointed to the validity of the decision of the court of first instance to reduce its size in accordance with paragraph 1 of Article 333 of the Civil Code of the Russian Federation], and in another case, the court denied the claim to reduce the amount of the penalty, despite the fact that it exceeded the cost of the work performed under the contract by 162 times.

3. In some cases, the courts of appeal reject the debtor's petitions stated in the appeals for a reduction in the amount of the penalty in accordance with Article 333 of the Civil Code of the Russian Federation, arguing that the debtor did not make such a statement in the court of first instance, and it can take place only when considering the case in the first instance. 

Thus, in the Decision of the Tenth Arbitration Court of Appeal dated December 26, 2017 in case No. A41-54226/17, the court stated: "the petition stated in the text of the appeal for the application of Article 333 of the Civil Code of the Russian Federation to the amount of the penalty to be collected is not subject to satisfaction, since the plaintiff did not make such a statement in the court of first instance, in connection with which the defendant bears the risk of adverse consequences caused by the absence of the declared petition in the form of collecting a penalty from him in the amount claimed by the plaintiff. In this regard, the reduction of the penalty on the initiative of the court is not allowed."  

It should be noted that in May 2018, the Supreme Court of the Russian Federation issued a Ruling in case No. A43-26319/2016 (hereinafter referred to as the Ruling), where the court indicated that the claim for a reduction in the amount of the penalty can be claimed by the debtor only at the stage of consideration of the case by the court of first instance, and consideration of such an application by the appellate instance is possible only when he proceeded to consider the case in accordance with the rules of procedure in the court of first instance. It should be noted that this Definition contains a reference to the Resolution of the Plenum of the Armed Forces of the Russian Federation No. 7 dated 03/24/2016.

At the same time, due to the established practice under Article 333 of the Civil Code of the Russian Federation, this Definition is controversial, especially since the Resolution of the Plenum of the Supreme Court of the Russian Federation dated 03/24/2016 No. 7 "On the application by courts of certain provisions of the Civil Code of the Russian Federation on liability for breach of obligations" clarifications are given on the application of Article 333 of the Civil Code of the Russian Federation, according to which if the obligations if they are not executed by a commercial organization or an individual entrepreneur who receives income from his activities, then the court may reduce the penalty to such a debtor if he has a reasonable application to be filed in any form. In addition, the reduction of the penalty by the courts of appeal is a very common phenomenon. This statement is consistent with the practice of the Tenth Arbitration Court of Appeal, which issued a corresponding ruling on November 23, 2017, guided by the high amount of the penalty (0.5% of the debt amount for each day of delay), twice the amount of the principal debt. The same court made a similar decision a month later in another case, taking into account that the defendant in the case is a unitary enterprise whose functions are related to satisfying public interests, ensuring state needs, and also based on an excessively high, in the opinion of the court, the amount of the penalty (0.5%).

As we can see, the appellate instances have different understandings of the procedure for considering cases related to the reduction of the penalty and the submission of an application by the debtor, in some cases accepting them for consideration, and in others not. We believe that such a multidirectional judicial practice does not contribute to effective law enforcement. We also believe that in this matter the courts should, first of all, start from the Ruling of the Constitutional Court of the Russian Federation dated December 21, 2000 No. 263-O "On refusal to accept for consideration the complaint of citizen Yuri Alexandrovich Nagovitsyn for violation of his constitutional rights, paragraph 1 of Article 333 of the Civil Code of the Russian Federation", which emphasizes the right of the court to assess the possibility of reduction of the penalty in each specific case, taking into account the circumstances of the case and the relationship of the parties. And if the party did not use any procedural right, then it will have to be responsible for the consequences of such inaction on its own.

We believe that considering the claim (application) for the recovery of a penalty in accordance with Article 333 of the Civil Code of the Russian Federation, the court should prioritize not the time of filing the application (consideration of the case in the first instance or at the appeal stage), but the risks of misuse of other people's funds.

The judicial practice on the application of paragraph 1 of Article 333 of the Civil Code of the Russian Federation in relation to persons engaged in entrepreneurial activity is ambiguous. The analysis of the decisions showed that the courts assess the possibilities of applying this legal provision differently when it comes to reducing the size of the legal penalty to persons engaged in entrepreneurial activity. And if in some cases the courts reduce the legal penalty to these subjects of civil relations according to the rules provided for reducing the contractual penalty, in others they do not.

At the same time, we found court decisions in which the court expressed doubt about the legality of the approach under consideration. So, considering one of the cases, the court noted that the civil legislation does not contain a norm that directly allows reducing the legal penalty, and the legal penalty itself (its size) is nothing more than a guarantee that the state gives to the creditor if the debtor violates his interests by non-fulfillment of the obligation. A similar decision was made in another case, after considering which, the court refused the request to reduce the legal penalty, justifying its decision by the fact that it contradicts the objectives of Federal Law No. 35-FZ of March 26, 2003 "On Electric Power Industry" and violates the rights and legitimate interests of the plaintiff. In addition, the court noted that the reduction of the legal penalty is fraught with a decrease in the special legal guarantees provided to the creditor and considered it possible to allow such a reduction in exceptional cases if the defendant is able to prove that the collected penalty will create prerequisites for the creditor to receive unreasonable benefits.

We believe that the reason for such an ambiguous approach of the courts to reducing the size of the legal penalty in accordance with paragraph 1 of Article 333 of the Civil Code of the Russian Federation should, first of all, be sought in the norms of federal legislation fixing its size, in this regard, the authors come to the following conclusions, and subsequent legislative proposals.

The resolution by the courts of the Russian Federation of disputes on the recovery of a penalty is accompanied by some problems, among which the following were highlighted:

1 the absence of a unified approach of judges to the interpretation of the norms of Articles 330, 333 of the Civil Code of the Russian Federation regulating the penalty as an interim measure, as well as explanations of the Supreme Court of the Russian Federation on the procedure for applying the norms on reducing its size (Article 333 of the Civil Code of the Russian Federation). 

1 the absence of a clear argumentation in the reasoning part of the court decision in support of the apparent disproportionality of the penalty to the consequences of non-fulfillment of the obligation, which entails unmotivated refusals and violates the requirements of paragraph 4 of Article 198 of the Civil Procedure Code of the Russian Federation.

2 the law enforcement officer ambiguously interprets the rules for filing an application for a reduction of the penalty, as a result of which petitions for the application of Article 333 of the Civil Code of the Russian Federation may be rejected by appellate instances.

3 a controversial position from the point of view of the law is taken by the courts when resolving the issue of the possibility of reducing the legal penalty by persons engaged in entrepreneurial activity (paragraph 1 of Article 333 of the Civil Code of the Russian Federation).

4 there is no uniformity of judges in terms of reducing the amount of the penalty in the conditions of the spread of coronavirus infection and the introduction of appropriate restrictive measures; in situations where the amount of the penalty significantly exceeds the price of goods, works, services that are the subject of the contract, etc.

Due to the fact that any divergence of judicial practice does not contribute to effective law enforcement, we believe that in matters of reducing the penalty, the courts should be guided by the Ruling of the Constitutional Court of the Russian Federation No. 263-O of December 21, 2000, which emphasizes the right of the court to assess the possibility of reducing the penalty in each case, taking into account the circumstances of the case, and the relationship of the parties.

We believe that the development of a unified position of judges on the issues of penalty recovery will be facilitated by the consolidation in the Civil Code of the Russian Federation of clear criteria for the "apparent disproportionality" of the penalty to the consequences of non-fulfillment of obligations, additional explanations of the Supreme Court of the Russian Federation on the application of the rules on the reduction of the penalty in accordance with Article 333 of the Civil Code of the Russian Federation, as well as recommendations for improving the norms of the Civil Code of the Russian Federation regarding the application of the penalty as an interim measure.

Based on the results of our research, we identified the above problems in the regulation of penalties as a way to ensure the fulfillment of obligations and proposed their solutions.

So, in order to resolve the identified problems, we propose the following possible:

1) to fix in Article 333 of the Civil Code of the Russian Federation clear grounds (criteria) for reducing the penalty in order to avoid excessively broad judicial discretion and virtually arbitrary interpretation by the courts of the apparent disproportionality of the penalty to the consequences of non-fulfillment of the obligation. We believe that a situation when, at the stage of concluding a contract, the debtor agrees to a penalty of any size, and then realizes that the court is very likely to significantly reduce its size anyway, the value of the penalty that stimulates the debtor to properly fulfill the obligation is lost. In this sense, it also seems justified to fix in the Civil Code of the Russian Federation the maximum limit of the penalty, which is subject to recovery in case of non-fulfillment or improper fulfillment of the obligation. We believe that the maximum limit of the penalty to be reduced may be the value of the main obligation, which cannot be exceeded when determining the amount of the penalty to be reduced. This approach, in particular, is provided for in the legislation on consumer protection and other legal acts of the Russian Federation;

2) formulate additional comments in paragraph 2 of the Resolution of the Plenum of the Supreme Arbitration Court of the Russian Federation of December 22, 2011 No. 81 "On certain issues of the application of Article 333 of the Civil Code of the Russian Federation" on the criteria to be applied in order to determine unjustified (illegal) benefits. Taking into account the fact that the debtor always faces the task of proving the unjustified benefit of the creditor in order to reduce the penalty, we believe that the highest court should give all the necessary explanations on this issue, and the legislator should fix the official interpretation of the concept of "unreasonable benefit" in Article 333 of the Civil Code of the Russian Federation;

3) amend the second paragraph of paragraph 1 of Article 333 of the Civil Code of the Russian Federation, stating it in the following form: "If the obligation is violated by a person engaged in entrepreneurial activity, the court has the right to reduce the contractual penalty, subject to the debtor's application for such reduction."