Reverse Reaction.

18.10.2011

International Financial Law Review (IFLR).

Many lawyers have recently noted two trends in Russia that should be mutually complementary but that, in reality, unfortunately have opposite results in most cases. 

We are referring here to the developments in the civil, primarily corporate, legislation that pursue a multitude of objectives, one being to equip our legal framework with a tool kit enabling business to complete transactions with local assets within the Russian jurisdiction.

A range of issues. Owing to their novelty, absence of relevant court practice or prohibitory interpretations in practice, legislative developments quite often just encourage the parties to formalise their relations outside Russia. Here is a commonplace but illustrative example that, I believe, is crucial for respect for contractual obligations to grow in Russia as the cornerstone of a market economy and civilised business. By this I mean freedom of contract and the need to make it a prevailing principle of civil law, at least in relations between commercial enterprises.

When two companies (the parties to a contract) whose purpose is profit-making agree on something, why should they not enjoy complete judicial protection if this agreement in no way affects third parties’ rights and legal interests or public policy? After all, they have unlimited legal capacity, pursue their own business interests, do business at their own risk and agree to be bound by a private law document that concerns only them.

So why do Russian courts persist in seeking out civil law provisions from which, they think, some arrangement or another between the parties departs, reducing contractual fines and completely or partially invalidating agreements. Why are the courts so insistent in endeavouring to find a weaker party in a dispute and to protect it? Surely this should not be the case in commercial relations, since they are not like consumer protection, where vulnerability of one party is taken for granted?

There can hardly be any doubt that virtually any kind of verdict may be supported by some legal provision or other, at will. For instance, the effective legislation does not require courts to reduce penalties claimed under a disputed contract, but rather grants them the right to do so, and the courts exercise this right quite frequently. I am convinced that the solution lies in changing the approach to dispute resolution by reinforcing the significance of freedom of contract. This principle is, of course, too broad to be discussed in detail here. Russia has, so far, in general been pursuing legislative improvement, time after time offering the business community more and more new, often rather superficial, provisions that, moreover, sometimes fail the test of law enforcement practice.

Disputable “improvements”. Some time ago, the possibility of concluding shareholders’ and participants’ agreements under Russian law was introduced, or rather affirmed to be more precise. Care has been taken to protect third party rights by stating that breach of such agreements may not constitute grounds for contesting relevant resolutions of the entity’s governing bodies. A new type of financial punishment for the breaching party has been introduced in the form of pre-determined compensation (quasi liquidated damages), the purpose being to manage the threat of it being reduced by court judgement. All this seems to provide an ample legislative framework for this corporate tool. Even so, I believe many lawyers will share my concerns that the courts might still regard compensation as a kind of penalty, so take every opportunity to reduce it.

Waiver of rights, which is a common instrument of most shareholder agreements, has so far obtained no judicial support in Russia either. Setting up a joint business and making investments presume a certain sequence and interdependence of acts by the founders in view of all the circumstances and conditions enabling commencement, discharge or completion of performance. Meanwhile, relevant article 157 of the Russian Civil Code regulating conditional transactions is mainly interpreted as prohibiting any link between emergence or termination of rights or obligations and circumstances that depend on the will of the parties.

In addition, the trend to improve civil law legislation, which unfortunately follows established practice, virtually proposes express prohibition of transactions conditional on circumstances that depend on or are controlled by a party. This not only runs counter to the globally accepted practice focusing on business needs and requirements but is also irrational from the viewpoint of the recently declared objective of making Moscow an international financial centre.

We can only hope that, especially in view of the increasing number of legal rules, law enforcement practice will be capable of departing from prohibitive interpretations of most contractual provisions and will provide more security for contractual rights agreed between parties.

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