The right of withdrawal from a fee-based take-or-pay contract for services
Pepeliaev Group advises that the Supreme Court's Judicial Board for Economic Disputes is considering the issue of a customer’s right under a fee-based contract for services to withdraw from it where such contract contains a take-or-pay condition[1].
By ‘take-or-pay’ the parties have agreed to understand that the Customer has an obligation (1) to dispatch a guaranteed annual volume of coal, and (2) to pay for the transshipment of the volume of coal that was not supplied. The Customer was released from the take-or-pay obligation with respect to coal that was not supplied for transshipment other than through its fault. A penalty, at the transshipment rate, was to be accrued on the volume of coal that was not supplied through the Customer’s fault.
The Customer had the right to withdraw from the Contract only if the Operator defaulted on a number of its obligations (such as an obligation to accept the cargo by the deadline). In that case the Customer was to be released from the obligation under the take-or-pay condition.
By citing article 782 of the Russian Civil Code[3], the Company notified the Operator of its withdrawal from the Contract.
The Operator, in turn, challenged the above withdrawal in court by arguing that the withdrawal was unlawful.
The court held that, by its legal nature, the Contract in dispute was a fee-based contract for services. Therefore, the Customer lawfully used its right to unilaterally withdraw from the Contract for no cause, where such right was granted to it under the imperative rule in article 782 of the Civil Code. No restriction of such right by the agreement of parties is allowed.
Citing the provisions of articles 421(3), 806(1), 904 and 782(1) of the Civil Code, the court pointed out that, even if the Contract is classified as a mixed-type contract containing elements of freight forwarding, storage and other contracts, the statutory regulation of each of the elements allowed the Customer to unilaterally withdraw from the Contract for no cause.
Russian legislation does not regulate a ‘take-or-pay’ contractual structure which stipulates that one party has an obligation to accept a service and pay for it a minimum established amount, or pay a penalty for breaching the extent of performance. It is aimed at reducing the risks and financial losses of a service provider.
This contractual structure does not limit the Customer’s right to withdraw from the Contract.
The adverse consequences the Operator may face as a result of the Customer’s withdrawal from the Contract are to be eliminated by other methods for which legislation provides, specifically, by the reimbursement of the actual costs incurred for the purpose of fulfilling the Contract rather than by declaring the unilateral withdrawal to be unlawful.
The court of cassation agreed with the above conclusions.
What to think about and what to do
The question arises as to how the above conclusions of the Supreme Court (considering the reaffirmed imperative nature of article 782(1) of the Civil Code) align with the clarifications laid down in Resolution No. 54 of the Plenum of the Supreme Court “On certain issues of applying the Russian Civil Code’s general provisions concerning obligations and the performance of them” dated 22 November 2016.
Please be reminded that the above Resolution (clause 15(2)) clarifies that no condition can be included in a contract that a monetary sum is to be paid if either party exercises its right to unilaterally withdraw from it when such a right is established by an imperative provision. Such a condition in a contract contravenes the essence of the statutory regulation of the corresponding type of obligation (articles 168(2) and 180 of the Civil Code) and, therefore, it is void. The Judicial Board has not considered this aspect.
Although the Supreme Court virtually admitted that ‘take-or-pay’ conditions can be included in fee-based contracts for services and provided its view of the legal nature and main elements of the contractual structure, questions remain as to how these conditions can be applied in practice. These questions do not boil solely down to the divergence of the current position of the Judicial Board and the Supreme Court’s Plenum No. 54 dated 22 November 2016[6].
In our view, the court ruling at hand does not eliminate difficulties as regards legal protection with respect to the conditions obliging a customer to make a payment for a unilateral withdrawal from a contract for no cause based on article 782(1) of the Civil Code. In agreeing upon provisions to this effect in contracts, various scenarios should be calculated to the fullest degree in long-term contractual relationships.
We are also ready to provide other legal support, including in the context of settling disputes and pre-trial dispute resolution, during negotiations with contracting parties, in drafting contracts and agreements, and within proceedings in commercial courts of all levels. We will also provide recommendations on selecting the optimal business solutions for any commercial and corporate law matters.
[1] A take-or-pay condition stipulates that a customer has an obligation to make a certain payment even if the customer decides not to use the services he has ordered from the service provider.
[2] The Ruling of the Supreme Court’s Judicial Board for Economic Disputes dated 20 August 2021 in case No. А40-328885/2019.
[3] According to article 782(1) of the Civil Code, a customer may withdraw from a fee-based contract for services if it has paid to the service provider the expenses the latter has actually incurred.
[4] These, specifically, may include a guaranteed reservation of production facilities for the customer’s needs, its priority and guaranteed servicing at any moment, the removal from markets of certain volumes of services (goods or work) of the service provider specifically for the customer, a reduction of prices as compared with ordinary customers, fixing the price for a long period of time, adjusting the service provider’s production base for the customer's needs, including by making capital investments in its reconstruction, and others.
[5] The Supreme Court’s Judicial Board for Economic Disputes did not comment on this matter.
[6] For example, if an obligation to pay (even if there are no requested services) is viewed as a payment for withdrawal from a contract and it has been proven that the size of the payment is disproportionate to the adverse consequences triggered by the withdrawal from the contract and the other party deliberately abused its right when it requested such payment to be made in such amount, the collection of the amount can be denied in full or in part (article 10(2) of the Civil Code and clause 16(2) of Resolution No. 54 of the Supreme Court’s Plenum dated 22 November 2016).
Facts of the case[2]
The Entity (the ‘Operator’) and the Company (the ‘Customer’) concluded a Contract whereby the operator guaranteed to the customer, for an agreed fee, to carry out a range of work and services concerning the freight forwarding, transshipping, storing and accumulating of coal that was being transported outside Russia, as well as other work and services during the transshipment. The Company undertook to timely supply coal to the Operator for transshipment in the corresponding volumes under the take-or-pay condition and pay the fee.By ‘take-or-pay’ the parties have agreed to understand that the Customer has an obligation (1) to dispatch a guaranteed annual volume of coal, and (2) to pay for the transshipment of the volume of coal that was not supplied. The Customer was released from the take-or-pay obligation with respect to coal that was not supplied for transshipment other than through its fault. A penalty, at the transshipment rate, was to be accrued on the volume of coal that was not supplied through the Customer’s fault.
The Customer had the right to withdraw from the Contract only if the Operator defaulted on a number of its obligations (such as an obligation to accept the cargo by the deadline). In that case the Customer was to be released from the obligation under the take-or-pay condition.
By citing article 782 of the Russian Civil Code[3], the Company notified the Operator of its withdrawal from the Contract.
The Operator, in turn, challenged the above withdrawal in court by arguing that the withdrawal was unlawful.
Position of the first instance court
The court of first instance sustained the Operator’s claim having found that the parties had concluded a mixed-type contract. In the court’s opinion, this precludes the application of chapter 39 of the Civil Code concerning a fee-based contract and, specifically, of article 782 of the Civil Code, to the relationship of the parties to the Contract.Positions of the courts of appeal and of cassation
The court of appeal reversed the above decision and dismissed the claim.The court held that, by its legal nature, the Contract in dispute was a fee-based contract for services. Therefore, the Customer lawfully used its right to unilaterally withdraw from the Contract for no cause, where such right was granted to it under the imperative rule in article 782 of the Civil Code. No restriction of such right by the agreement of parties is allowed.
Citing the provisions of articles 421(3), 806(1), 904 and 782(1) of the Civil Code, the court pointed out that, even if the Contract is classified as a mixed-type contract containing elements of freight forwarding, storage and other contracts, the statutory regulation of each of the elements allowed the Customer to unilaterally withdraw from the Contract for no cause.
Russian legislation does not regulate a ‘take-or-pay’ contractual structure which stipulates that one party has an obligation to accept a service and pay for it a minimum established amount, or pay a penalty for breaching the extent of performance. It is aimed at reducing the risks and financial losses of a service provider.
This contractual structure does not limit the Customer’s right to withdraw from the Contract.
The adverse consequences the Operator may face as a result of the Customer’s withdrawal from the Contract are to be eliminated by other methods for which legislation provides, specifically, by the reimbursement of the actual costs incurred for the purpose of fulfilling the Contract rather than by declaring the unilateral withdrawal to be unlawful.
The court of cassation agreed with the above conclusions.
Position of the Supreme Court’s Economic Board
It is arguably for the first time in court practice that a court has considered somewhat in detail the elements of a ‘take-or-pay’ condition having stressed the following, among other things:- In its legal nature a ‘take-or-pay’ condition consists of two separate but intertwined obligations:
- The first obligation (‘take’) implies that the Customer has the right to receive from the Operator certain performance for a certain period of time, and the Operator must provide such performance.
- Under the second obligation (‘pay’) the Customer must make a payment even if it has not received any performance from the Operator. In that case the Customer receives consideration in the form of additional benefits of a separate value, such as the reservation of production capacities for the customer’s needs, priority and guaranteed servicing at any moment, or the removal from the market of certain volumes of services (goods or work) of the service provider specifically for the customer, among others.
- The Customer's withdrawal from the Contract is a declaration of the Customer’s intent (i) to terminate, for the future, its right under the ‘take’ obligation, and (ii) to release the service provider from its obligation. No restriction is allowed on the Customer’s right to withdraw from the Contract without cause. This contradicts statutory regulation (article 782(1) of the Civil Code) as well as the essence of the parties’ legal relationships, because neither the law nor the Contract can force the Customer, against its will, to receive services from the Operator.
- The Customer’s refusal to receive a service (the ‘take’ obligation) in itself does not terminate the Customer’s monetary obligations to the Operator (the ‘pay’ obligation). Otherwise, this would allow the approach of ‘I will pay if I want’.
- Under the ‘take-or-pay’ contractual model, if a Customer refuses to receive a specific supply (under the ‘take’ obligation), the performance by it of the obligation within the scope of the ‘pay’ obligation can be viewed as a payment for withdrawal from the contract (articles 6(1) and 310(3) of the Civil Code).
- The Customer’s withdrawal from the Contract did not violate the Operator’s property rights and, hence, there were no grounds for recognising the withdrawal to be unlawful.
- Compensation of the Operator’s actual costs incurred in performing the Contract, as article 782(1) of the Civil Code provides for, is not the only possible method for eliminating the adverse consequences for the Operator as a result of the Contract being terminated. Such an approach does not take account of the parties’ arrangements and the model of relationship they have agreed upon (the ‘take-or-pay’ condition).
Main conclusions
- The position has been reinstated that a right to unilaterally withdraw from a fee-based contract for services, as provided for by article 782(1) of the Civil Code, is an imperative right and cannot be restricted by an agreement of the parties to a contract.
- Parties to a fee-based contract for services can agree upon other consequences of a withdrawal from the contract. Compensation of the Operator’s actual costs incurred in performing the Contract, as article 782(1) of the Civil Code provides for, is not the only possible method for eliminating the adverse consequences for the Operator as a result of the Contract being terminated.
- Parties can stipulate a condition that a customer makes a payment for withdrawal from the contract (article 310(3) of the Civil Code) that is in line with the clarifications set out in clause 4(3) of Resolution No. 16 of the Plenum of the Supreme Commercial Court “On freedom of contract and its boundaries” dated 14 March 2014.
- The ‘take-or-pay’ condition, which provides for a customer (buyer) to have an obligation to pay to the service provider (supplier) a set amount of money even if the former does not avail itself of the services ordered from the service provider, does not contravene legislation but is a payment for withdrawal from the contract.
- This condition does not restrict the right, for which article 782(1) of the Civil Code provides, to unilateral withdrawal from a fee-based contract for services.
- An essential element of the ‘take-or-pay’ condition is the receipt by the customer of a set consideration in the form of certain benefits that have a separate value in addition to the services (goods) as such from the service provider (supplier)[4].
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If no such consideration is available, this in turn, as we see it[5], may imply that the parties have not reached any agreement on the ‘take-or-pay’ condition. |
What to think about and what to do
Please be reminded that the above Resolution (clause 15(2)) clarifies that no condition can be included in a contract that a monetary sum is to be paid if either party exercises its right to unilaterally withdraw from it when such a right is established by an imperative provision. Such a condition in a contract contravenes the essence of the statutory regulation of the corresponding type of obligation (articles 168(2) and 180 of the Civil Code) and, therefore, it is void. The Judicial Board has not considered this aspect.
Although the Supreme Court virtually admitted that ‘take-or-pay’ conditions can be included in fee-based contracts for services and provided its view of the legal nature and main elements of the contractual structure, questions remain as to how these conditions can be applied in practice. These questions do not boil solely down to the divergence of the current position of the Judicial Board and the Supreme Court’s Plenum No. 54 dated 22 November 2016[6].
In our view, the court ruling at hand does not eliminate difficulties as regards legal protection with respect to the conditions obliging a customer to make a payment for a unilateral withdrawal from a contract for no cause based on article 782(1) of the Civil Code. In agreeing upon provisions to this effect in contracts, various scenarios should be calculated to the fullest degree in long-term contractual relationships.
Help from your adviser
Pepeliaev Group’s lawyers are ready to provide integrated legal support to companies and individual entrepreneurs on matters related to drafting contracts, assessing whether terms of contracts are valid, and to devise the optimal legal structures on a case-by-case basis.We are also ready to provide other legal support, including in the context of settling disputes and pre-trial dispute resolution, during negotiations with contracting parties, in drafting contracts and agreements, and within proceedings in commercial courts of all levels. We will also provide recommendations on selecting the optimal business solutions for any commercial and corporate law matters.
[1] A take-or-pay condition stipulates that a customer has an obligation to make a certain payment even if the customer decides not to use the services he has ordered from the service provider.
[2] The Ruling of the Supreme Court’s Judicial Board for Economic Disputes dated 20 August 2021 in case No. А40-328885/2019.
[3] According to article 782(1) of the Civil Code, a customer may withdraw from a fee-based contract for services if it has paid to the service provider the expenses the latter has actually incurred.
[4] These, specifically, may include a guaranteed reservation of production facilities for the customer’s needs, its priority and guaranteed servicing at any moment, the removal from markets of certain volumes of services (goods or work) of the service provider specifically for the customer, a reduction of prices as compared with ordinary customers, fixing the price for a long period of time, adjusting the service provider’s production base for the customer's needs, including by making capital investments in its reconstruction, and others.
[5] The Supreme Court’s Judicial Board for Economic Disputes did not comment on this matter.
[6] For example, if an obligation to pay (even if there are no requested services) is viewed as a payment for withdrawal from a contract and it has been proven that the size of the payment is disproportionate to the adverse consequences triggered by the withdrawal from the contract and the other party deliberately abused its right when it requested such payment to be made in such amount, the collection of the amount can be denied in full or in part (article 10(2) of the Civil Code and clause 16(2) of Resolution No. 54 of the Supreme Court’s Plenum dated 22 November 2016).