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Indemnity as the Cause of Termination of Obligations
Termination of an obligation means termination of the parties' to the obligation rights and duties constituting the substance thereof. As soon as an obligation is terminated, it becomes invalid, and pursuant to the general rule legal relations between the parties to the obligation (sometimes one of the parties ceases to exist at all) are terminated.
Proper discharge of an obligation is the most natural way to terminate relationship of the parties to the obligation, although it is not the only cause thereof. Obligation relationship, regardless of fulfillment of the obligation, may be terminated by different causes. In some instances an obligation may be terminated by mutual agreement. In other cases the will of only one party is sufficient to terminate an obligation - an obligor declares about a set-off of a similar counterclaim. An obligation may be terminated as a result of a party's demise, impossibility to discharge the obligation, the obligor being at the same time the obligee. An obligation is deemed terminated also in other cases provided for by laws, other regulations, or contracts. Restrictions are provided only for cases when obligations are terminated by one of the parties' request, which is admissible in cases directly provided for by a law or a contract.
Chapter 26 of the Civil Code of the Russian Federation (hereinafter - "the CC of RF"), in particular, specifies the most common causes of obligations termination, which specification is extended as compared to that of the Civil Code of RSFSR of 1964 (hereinafter - "the CC of RSFSR"). One of the new causes of obligations termination is an indemnity. The practices of application of this legal institute have shown that in the conditions of real existence of freedom of agreement an indemnity is an effective instrument of civil relations regulation. At the same time, moot points have been revealed, which are connected with use of an indemnity in civil relations. First of all, this is the question of whether an indemnity may be claimed.
In principle, the answer to the question lies in the meaning of the word "indemnity". If a person gives an indemnity to another person for going back on his promise to discharge an obligation, he may not discharge it. But if the indemnity is not delivered, there can be no waiver of the obligation. Besides, this other person takes (consents to) the waiver only after receipt of the indemnity.
From the viewpoint of the civil law an answer to the question whether an indemnity may be claimed depends on whether an indemnity agreement is a real or consensual transaction. In our opinion, the legislator itself answers this question. Para. 2, Art. 433 of the CC of RF defines a real transaction as follows: "If a law requires that property be transferred in order to enter into a contract, the contract is deemed entered into as of transfer of the respective property (Art. 224)".
Is the construction of an indemnity in line with this definition? The answer is obviously positive, since pursuant to Art. 409 of the CC of RF "the parties may agree to terminate an obligation if an obligor delivers an indemnity (by money payment, property transfer, etc.) instead of discharging an obligation". The legislator connects commencement of definite legal consequences directly with the fact of an indemnity delivery, i.e. exactly with an actual transfer of an indemnity rather than with an obligation to deliver it.
Besides, inclusion of the words "may be terminated" in Art. 409 implies termination of an obligation by an indemnity delivery unless the obligation is terminated by discharge. If it is presumed that an indemnity delivery cannot terminate an obligation, the presumption will contradict positioning of an indemnity as a cause for an obligation termination. Even interpretation of these words as equivalent to the word "entitled" does not alter the substance of the rule whereby a party is entitled to waive discharge of its obligation by delivery of an agreed indemnity.
Another argument in favor of recognition of an indemnity agreement as a real transaction is a causa of an indemnity agreement. It is necessary to admit that an objective of an indemnity agreement is not a delivery of the indemnity per se but the obligor's waiver of its obligations under a contract and termination thereof. In this case the obligee's will is worded as follows: "I shall not claim discharge of the obligation if I receive an indemnity in the agreed form, amount, and within the agreed term". If his will were solely to receive an indemnity, it would be worded otherwise: "I do not require discharge of the obligation, my interest is to receive the indemnity". It would have actually meant a waiver of the initial obligation under the agreement with the obligor and accrual of a new obligation.
Under an indemnity agreement any party to an obligation, inasmuch it is an obligor, may, with the obligee's consent, waive its duties under the obligation and deliver an indemnity. The obligee, having received the indemnity, looses the right to claim that the obligor fulfill its obligation, which implies termination thereof. Besides, the indemnity must be delivered in full, partial indemnity entails neither complete nor partial termination of the initial obligation.
The institute of indemnity is more often used in case of an obligor's failure to discharge its obligation. However, proceeding from the construction of the article, an obligation may be terminated by an indemnity delivery even before the obligation maturity.
The fact that under an indemnity agreement the parties are willing to waive discharge of an obligation after an indemnity is delivered, is evidenced by other rules of the CC of RF. Pursuant to para. 3, Art. 396 of the CC of RF payment of a forfeit, as an indemnity, releases an obligor from discharge of its obligation in kind.
This construction has stirred up a certain theoretical dispute. Thus, O.N.Sadikov[1] expresses his doubts as to recognition of such forfeit as an indemnity with reference to such peculiarities intrinsic to a forfeit as its written and monetary forms, the possibility to decrease the amount of a forfeit by a court.
M.I.Braginsky[2], on his part, considers that proceeding from the construction of this rule, an indemnity in this case must be regarded as a generic notion and a forfeit - as its variety. Besides, a forfeit as a variety of an indemnity may have its own peculiarities.
In fact, a forfeit has common features with an indemnity. A forfeit, like an indemnity, is determined by the parties' agreement. A forfeit has a monetary form. An indemnity may also be provided in the form of money payment. A forfeit is subject to payment in the event of a default on or improper discharge of obligations. An indemnity is also usually provided in the event of an obligor's default on its obligations.
However, a forfeit and an indemnity have essential differences. A forfeit is both a means of an obligation security and one of the forms of civil responsibility. An indemnity is neither. Besides, an obligee is entitled to claim a forfeit and cannot claim an indemnity by virtue of the real nature of an indemnity agreement. Pursuant to Art. 333 of the CC of RF a court may decrease a forfeit amount, but it cannot change an indemnity rate. A default on obligations always underlies payment of a forfeit, whereas an indemnity agreement may be concluded irrespective of a default on obligations. An indemnity payment always terminates an obligation, whereas a forfeit payment entails no termination of an obligation unless a law or a contract provides otherwise (para 1, Art. 396 of the CC of RF).
Hence, it may be inferred from the foregoing that the wording of para 3, Art. 36 of the CC of RF providing for payment of a forfeit as an indemnity means only that if a contract stipulates that a forfeit payment releases an obligor from an obligation in kind, a forfeit has "the property" of an indemnity in a sense that its payment results in termination of an obligation. In all other respects general rules on a forfeit are applicable to "a forfeit established as an indemnity". Therefore, there are no reasons to put a question whether a forfeit in this case is a variety of an indemnity with its own peculiarities.
However, to identify a legal nature of an indemnity it is very important to take into consideration that only an actual payment of a forfeit entails termination of an obligor's duty to discharge an obligation in kind. The fact that the legislator regards a forfeit in this case as an indemnity also attests to the real nature of an indemnity agreement.
It should be noted that from the practical viewpoint, establishment "of a forfeit as an indemnity" may have certain advantages, since a forfeit, as distinct from an indemnity, may be recovered. In our opinion, a court can have no grounds for its decrease because of its non-measurability, since, on the one hand, its rate has been agreed upon by the parties, and on the other hand, it entails termination of the obligation.
It is also necessary to consider an issue whether damages and forfeit payment in the event of default on obligations can be regarded as an indemnity. Pursuant to para. 2, Art. 236 of the CC of RF damages and a forfeit payment entails release of an obligor from discharge of an obligation in kind, i.e. provides a cause for termination of an obligation. However, in this event there is no agreement between the parties as required by the construction of an indemnity. Therefore, damages and a forfeit payment, as distinct from an indemnity, are a different cause of an obligation termination provided for by law, as well as a waiver of an obligation which no more presents an interest for the obligee because of the delay in discharge thereof (para 2, Art. 405 of the CC of RF).
A number of authors proving impossibility to recognize an indemnity agreement as a real transaction, advance the argument that if an indemnity agreement were recognized as a real transaction then, after its conclusion, there would exist two mutually exclusive obligations: one based on the initially agreed terms and conditions substitution of whose discharge has been agreed, and another based on an indemnity agreement aimed at termination of the initial obligation. One cannot but agree with this. As soon as an indemnity agreement is concluded, the initial obligation is in force, whereas rights and duties of the parties under the indemnity agreement arise only after the indemnity is delivered.
The aforesaid also demolishes the argument that "concurrent availability of both obligations would mean entitlement of the obligee to claim, at its discretion, discharge of the initial obligation as well as of the obligation to provide an indemnity"[3]. Such problem does not arise since pursuant to an indemnity agreement as a real transaction an obligee has no right to claim an indemnity. Before an indemnity is delivered an obligee is entitled to claim only discharge of the initial obligation.
In order to substantiate the consensual nature of an indemnity agreement, the following fact is advanced as well: "the fact that far from all the items of an indemnity may be provided, delivered at once (for example, performance of works, provision of services). Therefore, a time break is always necessary between an indemnity agreement conclusion and the indemnity delivery"[4]. Besides, it is pointed out that if the real nature of the respective transaction is recognized, it would deprive an obligor performing some work for an obligee instead of the initial obligation of any interest in the work performance, since at any time the obligee could claim the discharge of the initial obligation rather than the results of the work (indemnity).
This may be argued as follows. Proceeding from the fact that one of the principles of an obligation discharge is the reality of the discharge, it should be admitted that in case of the obligor's default on its obligation, it is the obligee who should have the privilege in choosing the means of protection of its rights . Therefore, the obligee is entitled either to await maturity of the indemnity delivery or to claim discharge of the existing obligation. At the same time, even the obligee' filing of an action before the maturity of the indemnity delivery cannot hinder delivery of the indemnity by the obligor. In case the obligee accepts the indemnity before an award is rendered, it will entail termination of the initial obligation. Accordingly, there will be no cause of action, and the obligee will have to withdraw his action, or the court will have to dismiss its claim, since the indemnity delivery has entailed termination of the obligation which has given rise to the action. In the latter case it is possible to speak about the obligee's abuse of its right.
In the event the indemnity is not delivered before an award respecting the initial obligation is rendered by the court, the indemnity, respectively, cannot be delivered since the obligor's duty to discharge the obligation arisen from the award is not the subject of the indemnity agreement. This restrains, to a certain extent, the obligor's rights. However, the obligee's right to claim discharge of an obligation must be a priority.
Regarding the cases when an indemnity is delivered in the form of works performance or provision of services, it should be noted that if an obligor observes agreed dates of works performance or provision of services, the obligee cannot claim discharge of the initial obligation. However, if the terms stipulated by an indemnity agreement are violated the obligee may, in the statutory manner, waive execution of the agreement and claim discharge of the initial obligation. It is possible because the initial obligation is terminated only after an indemnity is delivered in full. Besides, pursuant to an indemnity agreement there arise legal consequences of its rescission stipulated by law for a respective type of contract.
In the event of delay in an indemnity delivery an obligee is entitled to waive the indemnity as of the moment of the maturity thereof and to claim discharge of the initial obligation, or to accept the late indemnity delivery which will entail termination of the initial obligation.
If to agree to the assertion that the initial obligation is terminated as soon as the obligation to deliver an indemnity arises, the principle of real nature of a discharge will be broken, and the obligee will be deprived of the right to claim proper discharge of the obligation. At the same time the obligee is not protected from bad faith actions of the obligor who does not deliver the indemnity. Besides, in case of conclusion of an agreement to deliver an indemnity instead of discharge of a pecuniary obligation the obligee will have no right to request sanctions for delay of the pecuniary obligation discharge.
In terms of its nature, the indemnity is close to a well-known legal institute of substitution of discharge when though the contract stipulates one subject of obligation, simultaneously the obligor is vested with the right of its novation. At the same time, the obligee is not entitled to demand execution of the novation even in the event of objective impossibility to discharge the initial obligation.
Such obligations are classified in the theory of civil law as optional ones. The position of M.I. Braginsky[5] that the absence of reference to optional obligations in the CC of RF cannot be the obstacle for their use by analogy with the above agreements seems to be correct. It is also necessary to agree with the fact that in absence of a special regulation of optional obligations their specific features should be defined in a concrete agreement.
The common feature of both indemnity and substitution of discharge is that the discharge of an optional obligation is the right rather than the obligation of the obligor. At the same time, the obligor's right corresponds to the obligee's obligation to accept the indemnity or substitution of discharge.
However, the right to substitute the discharge of an optional obligation principally differs from indemnity in that it does not constitute a cause for termination of the obligation, but is an additional means of its due discharge.
If the substitution is done outside the framework of an optional obligation, it will be a novation, i.e. termination of the obligation by agreement of the parties on its substitution by another obligation stipulating another subject of the obligation or means of its discharge.
In the event of an alternative obligation, already at the time the agreement is made there exist two or several options of the discharge of obligation: to transfer this or that property, to perform one of the two or several actions. The right to choose what action to perform normally belongs to the obligor (Art. 320 of the CC of RF). At the same time, any action performed in duly discharging the obligation entails termination of the obligation. Such feature of the indemnity as its granting instead of the discharge is missing from the alternative obligation. Also, in the event of an alternative obligation no consent of the obligee is required for the obligor to choose this or that discharge option.
Differentiation of the indemnity from the discharge of obligation under the conditional transactions (Art. 157 of the CC of RF) is more complicated. For instance, the parties provided in the contract of delivery of fuels and lubricants for the delivery of petroleum to the buyer. Concurrently the parties set forth that in case the buyer acquires vehicles working on diesel fuel, the supplier will deliver to the buyer diesel fuel for the amount equaling the cost of petroleum delivery. In this case it seems that there are all features of an indemnity. There is an initial obligation, i.e. petroleum delivery. There is an agreement of the parties to substitute this obligation with the delivery of another product - diesel fuel. Delivery of diesel fuel results in termination of the obligation to deliver petroleum. However, the delivery of diesel fuel is not an indemnity, since the cause of termination of the obligation is not the delivery of diesel fuel, but occurrence of the condition which, as the parties have agreed, governs the obligation to deliver diesel fuel, on the one hand, and termination of the obligation to deliver petroleum, on the other hand. After occurrence of the condition agreed upon by the parties - acquisition by the buyer of vehicles working on diesel fuel - the obligee is entitled to demand, and the obligor is obliged to deliver diesel fuel.
Another case frequently encountered in business practices is when the parties stipulate as the condition for accrual or termination of the rights and obligations a non-fulfillment or improper fulfillment of the obligation by the obligor. For example, if the obligor fails to fulfill the obligation, he should pay to the obligee a certain amount of money or transfer certain property. At the same time, the agreement may or may not stipulate that the above amount or property is the indemnity. However, the question is whether in this particular case there is an indemnity or the arising legal relation should be regulated by the rules other than Art. 409 of the CC of RF.
First, there are doubts as regards compliance with the law of such condition as non-fulfillment of obligation. A non-fulfillment of obligation cannot be considered as a good-faith behavior, nor can it be regarded as rightful, i.e. an action corresponding to rules of law. Respectively, in the event of the obligor's bad-faith actions, paragraph 2, sub-Article 3, Article 157 of the CC of RF should be applied which stipulates that in such case the condition is deemed as having not occurred.
Second, by stipulating in the agreement the obligor's obligation to pay to the obligee a certain amount of money in the event of the failure to discharge the obligation, the parties actually set forth the indemnity as a measure of property responsibility in order to compensate the obligee's losses.
Thus, the Presidium of the High Arbitration Court of RF (hereinafter - "the HAC") has entertained the case of the claim to compel to discharge in kind the obligation to deliver products and to recover the incomplete delivery fine (Ruling No. 2411/96 dated 15 October 1996[6]) The first instance court upheld the claim as regards recovery of the fine. The court of cassation upheld the claim in full.
The HAC set aside the previous judgements and referred the case for retrial on the grounds that it was necessary, on the one part, to make an additional study of the matter of the fine amount to be recovered and, on the other part, the judgement obligating the obligor to discharge the obligation in kind rendered by the court of cassation runs contrary to the law and the terms and conditions of the parties' agreement, since the contract stipulated that in the event of the obligor's failure to discharge the obligations to deliver, he was to pay back to the obligee the amount equaling the cost of undelivered products. The HAC has made a conclusion that in essence the parties stipulated in the contract an indemnity instead of the discharge of obligations in compliance with Art. 409 of the CC of RF.
However, it seems that the contract did not stipulate the indemnity. In fact, by agreement of the parties the cost of undelivered products was to be paid instead of the discharge of obligation and its payment entailed termination of the obligation, i.e. as regards this part, the features of an indemnity are evident. But the HAC itself has acknowledged that the obligor's contractual obligation to pay to the obligee a certain amount in the event of the failure to discharge the obligation is the obligation to pay a forfeit, since it has pointed out the necessity of an additional study of the matter of the fine amount to be recovered. Hence, the reference to Art. 409 of the CC of RF is substantiated only inasmuch the forfeit concerned has the features of an indemnity and its payment results in termination of the obligation.
Simultaneously the HAC has pointed out that the initial obligation has been terminated and the obligee is not entitled to demand that the obligation be discharged in kind. It seems that with due regard for the above, this conclusion cannot be based on Art. 409 of the CC of RF.
In the case under review the payment of a forfeit under the contract exempted the obligor from the discharge of obligation in kind; hence the claimant could not simultaneously request additional delivery of the products in full and payment of the forfeit in the amount equaling the cost of undelivered products. Filing a claim requesting payment of the forfeit, the obligee in so doing refused to accept the discharge, which is his right pursuant to para 2, Art. 405 of the CC of RF in connection with the obligor's default. Correspondingly, the claim to discharge the obligation in kind was unfounded.
In principle, the problems with application of Art. 409 of the CC of RF are apparently connected with the fact that the parties to the civil relations urgently need regulation of the situation when the obligor is unable to discharge the obligation and the obligee proceeds from impossibility to receive the discharge from the obligor and in fact refuses to accept it. Of course, the obligee may refuse to accept the discharge in connection with the obligor's default and claim compensation of losses in court. However, this is a long and not always eventually fruitful way. Therefore, frequently a situation develops when the interest of both parties is aimed at termination of the initial obligation and hence the parties sign an agreement stipulating the obligor's obligation to provide a certain amount of money or other property instead of the discharge of obligation. Such agreement is structurally similar to the agreement of indemnity. However, it is not such, since it results in termination of the initial obligation as of the moment it is signed and it is a consensus transaction. The legal basis of such agreement will differ from the legal basis of the indemnity agreement. Essentially, such agreement is the agreement on compensation of the obligee's losses in connection with the latter's acceptance of the obligor's refusal to discharge the obligation.
Such agreement may be considered as a novation if the possibility to stipulate another subject or means of discharge of the new obligation is interpreted broadly. However, recognition of an independent legal nature of such agreement, as was specified in Art. 233 of the CC of RSFSR of 1964, seems to be more correct. The rule concerned set forth that the obligation is terminated by agreement of the parties, in particular, by agreement on substitution of an obligation for another one signed by the same parties. The legislator has made this rule more concrete in the CC of RF by introducing the institutes of novation and indemnity. However, by virtue of para 2, Art. 421 of the CC of RF the parties are not restricted in their right to sign an agreement which is not directly stipulated by law.
This may be exemplified by the case entertained by the HAC (Ruling No. 7508/99 dated 27 June 2000[7]). The claimant and the respondent signed the contract under which the claimant was to deliver to the respondent fuel oil and the respondent was to deliver tank-wagons.
As a result of improper discharge of the contractual obligation by the respondent, the parties signed an agreement stipulating indemnity in a pecuniary form instead of discharge of the contractual obligation.
The claimant filed with the arbitration court a lawsuit seeking recovery of the debt resulting from the respondent's failure to execute the indemnity agreement, and the interest for using his money.
The Presidium of the HAC has acknowledged the claimant's right to request both the discharge of obligation under the indemnity agreement and the application of sanctions for the breach of the said agreement
It seems that the case concerned was about the agreement on compensation of losses called the indemnity agreement. This is attested by the fact that the obligee's will, also manifested in filing of the claim, is aimed at receipt of money rather than at the discharge of obligation in kind. Having signed the indemnity agreement, the obligee has refused to accept the discharge. It is through the obligee's refusal to accept the discharge that the losses compensation agreement may be differentiated from the indemnity agreement wherein the obligee accepts the obligor's refusal to discharge only if the indemnity is paid.
The above conclusion may be illustrated with the following case (Ruling of the HAC No. 2569/99 dated 14 November 2000[8]). The claimant filed a claim seeking obligation of the respondent to transfer real estate as an indemnity. The first instance court upheld the claim with reference to Art. 307, 309 of the CC of RF and the clause of the contract which stipulated that in the event of the default in payment exceeding six months and the absence of money the respondent undertakes to transfer as an indemnity the real estate he owns for the amount of the debt and penalties within 10 days following the request to transfer such real estate.
Hence, the first instance court has come to the conclusion that after the obligee requested the obligor to transfer real estate as an indemnity, the obligee waived the initial obligation, which, subject to the contract and Art. 307 of the CC of RF, resulted in origination of a new obligation to transfer real estate.
The Presidium of HAC set aside the above judgement on the grounds unrelated to challenging of the claimant's rights to request transfer of real estate. At the same time, the HAC reasonably refrained from considering incorrect enforcement of law by the first instance court and from pointing out the necessity to apply in the case under review Art. 409 of the CC of RF.
It seems that in the case under review no indemnity agreement as such was signed by the parties, since having provided for the obligee's right to request transfer of real estate in the event the obligor fails to discharge his obligations, the parties actually entered into a preliminary agreement on losses compensation by transfer of real estate for the amount of the debt and penalties.
Finally, therefore, a conclusion can be made that it is impossible to demand the indemnity according to the general rule, unless the indemnity agreement is in terms of its legal nature an agreement on substitution of the initial obligation by another one signed by the same parties and its conclusion has not resulted in termination of the initial obligation due to the obligee's refusal to accept the discharge. In the latter case signing of the agreement entails origination of a new obligation under which the obligee is entitled to request its discharge and application of sanctions for the failure to discharge or improper discharge of obligations by the obligor. Concurrently, in order to determine a legal nature of the indemnity agreement, it is necessary to proceed from whereat the obligee's will was aimed when signing the indemnity agreement - at acceptance of the obligor's refusal to discharge the obligation provided the indemnity is granted, i.e. at signing the indemnity agreement subject to Art. 409 of the CC of RF, or at the refusal to accept the discharge and, respectively, at signing the agreement on substitution of the initial obligation.
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