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This summer, the Russian Supreme Arbitration Court drew a line under a promissory note dispute that had dragged on since 2009. By its Resolution No. 16623/10 dated 21 June 2011 [1] in case No. A40-120754/09-55-921, it corrected the lower courts which had considered the only lawful basis for issuing a promissory note to be, in essence, a loan relationship and which had stated that a promissory note may not be paid if issued to secure a third party’s obligation.
Until now, there was no case law of the highest Russian courts relating to the legal force of so-called ‘accommodation promissory notes’, which are issued not in exchange for goods or money but as security.
Therefore, when hearing a case of this nature, the courts proceeded on the basis that the sole legal ground (cause) according to which a promissory note may be issued was a monetary obligation of the promissory note holder itself, in other words, a loan. Under this approach, a loan included a delay of a payment which the promissory note issuer itself had to make.
The courts established that a claimant was the holder of five simple promissory notes issued by the defendant, an individual entrepreneur, to a third party. On the date on which they were issued, the promissory notes in question were assigned by the third party to the plaintiff and endorsed with the inscription “currency in pledge”. When the deadline for payment of the promissory note arrived, they were presented to the issuer, but the latter did not pay them.
In rejecting the claim, the courts classified the promissory notes in question as having been issued without proper grounds since the issuer (the defendant) had no monetary obligations to the third party (the first promissory note holder) and the claimant was allegedly aware of this.
The lower courts applied to the disputed legal relationship articles 17 and 19 of the Regulations for bills of exchange and promissory notes, brought into force by Resolution No. 104/1341 of the Central Executive Committee and the Council of Peoples’ Commissars of the USSR dated 7 August 1937. The courts pointed to the fact that the lack of a monetary assignment to the promissory note holder when the promissory note was issued means that the promissory note should be considered to have been issued without proper grounds and the claimant’s actions should be classified as being performed with the intention of causing harm to the issuer of the promissory note.
However, the Supreme Arbitration Court ruled that this interpretation by the court of article 17 of the above Regulations was incorrect. Clause 15 of Resolution No. 33/14 of the Plenum of the Russian Supreme Court and the Plenum of the Russian Supreme Arbitration Court dated 4 December 2000 On certain issues concerning the practice of examining cases associated with the circulation of promissory notes clarified that a party against whom a claim was made under a promissory note is entitled to rely on the objections that result fr om its relationship with the lawful promissory note holder who brought the claim in question. Thus a party with an obligation under the promissory note is exempted from payment if that party can show that the creditor making the claim knew or should have known when it acquired the promissory note that such promissory note was issued on the basis of an invalid obligation or no obligation at all, or that the creditor obtained the promissory note through theft, or that the creditor knew or should have known of such circumstances before, or when, it acquired the promissory note.
In addition, the Supreme Arbitration Court agreed with the claimant’s argument that from the standpoint of Russian legislation, the lack of a lawful basis for a promissory note to be issued is intended to refer to: the obligation that is the underlying basis for the promissory note to be issued being invalid or does not exist; or there being fraudulent actions on the part of the promissory note holder.
Based on the case materials, the Supreme Arbitration Court ruled that the defendant had more than once issued promissory notes to the third party, whose general director and founder was the defendant’s wife. These promissory notes were then assigned, endorsed with a notice of pledge, to the claimant, which was supplying the third party company with goods on delayed payment terms. The third party and the defendant had concluded an agreement by virtue of which the latter expressed its intention to provide security under the contracts concluded by that company. The Supreme Arbitration Court assessed the information relating to the case and concluded that the lawful basis for the promissory notes in question to be issued was a security transaction under which the defendant assumed the obligation to be answerable to the claimant for the third party’s performance of payment obligations in relation to goods received by such third party.
In addition, the Presidium indicated that the law does not lim it the basis for a promissory note to be issued; in itself, the fact that the first promissory note holder has no money or other property granted to it does not signal that there are no grounds for the promissory note to be issued or that such promissory note holder has acted fraudulently. To this end, the lower courts did not reach a legitimate conclusion in terms of the lack of an underlying obligation as a basis for the promissory note to be issued, as the expression of the will of the issuer of the promissory note pointed to its intention to assume an unconditional payment obligation under such promissory notes by way of guaranteeing payment under sale and purchase contracts.
The case was referred back to be reheard by the first instance court to allow it to find that the amount secured by the promissory notes should be paid.
This Resolution of the Supreme Arbitration Court is of major legal and economic significance. The lower courts’ incorrect approach to the legal classification of promissory notes issued as security for an obligation to pay for goods that have been supplied violated the law as well as the lawful rights and interests of a wide range of members of the business community. Issuing a promissory note may be a good way for small and medium sized businesses to give security for their obligations: it is necessary to pay – sometimes quite handsomely – for a bank guarantee to be issued and the guarantee depends on how the principal obligation is performed, while a promissory note is an unconditional obligation to pay but costs nothing to issue. The only risk for a promissory note holder is the insolvency of the debtor under the promissory note. However, this risk also exists in the case of a guarantee, and is not so much legal as economic in nature.
The position of the Supreme Arbitration Court on the question of accommodation promissory notes issued as security will be interesting for lawyers and businessmen from countries that are signatories of the Convention Providing a Uniform Law For Bills of Exchange and Promissory Notes (Geneva, 7 June 1930). This is because the highest Russian court has, in essence, given its interpretation of the Uniform Law For Bills of Exchange and Promissory Notes, which is mirrored in Russia by the Regulations for bills of exchange and promissory notes, brought into force by Resolution No. 104/1341 of the Central Executive Committee and the Council of Peoples’ Commissars of the USSR dated 7 August 1937.
[1] On 21 June 2011, the operative part of the Resolution of the Supreme Arbitration Court was published; the full text of the Resolution was published at the end of August 2011.
