Penalties in Kind as a Security for Obligation Discharge
A joint-stock company (hereinafter - "the JSC") doing business in the sphere of farm production and an airline have entered into a contract of aircraft spraying. Payment for the work performed under the contract was to be effected with wheat grain rather than cash. The contract provided for penalties at the rate of 1% of the undelivered quantity of the grain per every day of delay in the grain delivery towards payment.
The aircraft spraying was carried out in full, but the grain in payment therefor was not delivered. Therefore, the airline filed an action with the arbitration court seeking recovery from the JSC of the grain to be paid for the work performed and penalties for delay in payment to be effected with the grain.
The arbitration court dismissed the claim for penalties to be paid with the grain for delay in payment for the aircraft spraying on the ground that pursuant to Art. 168 of the Civil Code of RF (the CC RF) the term of the contract providing for such penalties was void
In connection with the award rendered, there arises the question of compliance with current laws of the contractual provision to secure the client's discharge of the obligation by payment of penalties in the form of a certain quantity of the grain for every day of delay in payment for the aircraft spraying.
Dismissing recovery of the penalty, the arbitration court pointed out the following. Pursuant to Art. 330 of the CC RF a fine is a variety of a penalty which is a legally or contractually determined sum of money to be paid by a debtor to a creditor in case of the failure to discharge or improper discharge of an obligation by the former, in particular, for the delay in discharge. As appears from the foregoing that the contract term providing for penalties in the form of the grain delivery does not comply with the above law rule, hence, pursuant to Articles 168 and 180 of the CC RF the contract in this particular part is invalid (void). Therefore, the action for recovery of penalties filed against the airline is subject to dismissal as inconsistent with law.
It is our opinion that the award may be challenged on the following grounds.
First, pursuant to Art. 431 of the CC RF, when the court interprets the contract terms it should take into account the literal meaning of the words and expressions thereof. The word "penalties", and not "a fine", is used in the contract of aircraft spraying.
Second, a fine implies a lumpsum to be paid by the party which has defaulted on or improperly discharged its duty. The contract provided for penalties to be paid for every day of delay in the grain delivery towards payment without limitation of time. That is, the sanctions provided for by the contract had features of a penalty rather than of a fine (see: M.I. Braginsky, V.V. Vitryansky, Dogovornoye pravo. Obshchie polozheniya (The Contract Law. General Provisions), Moscow, Statut, 1997, pp. 387-388).
Third, pursuant to Art. 329 of the CC RF the obligations discharge may be secured not only with a forfeit, pledge, property retention, surety, bank guarantee, or a deposit, but also by other means provided for in the law or contract. Therefore, the parties to the contract concerned were entitled to agree on any kind of security of the grain delivery to the airline towards payment for the aircraft spraying, including payment of penalties in the form of the same grain delivery, i.e. the delivery of extra quantity of the grain for every day of delay in payment.
Forth, if the arbitration court failed to determine the legal essence of the sanction provided for by the contract on the basis of the literal meaning of the words and expressions used in the contract, it should have determined the implication of this term by comparing it with the other terms and the sense of the contract pursuant to part 1, Art. 431 of the CC RF.
In compliance with the contract 1% of the undelivered quantity of grain was to be recovered for every day of delay over and above the quantity to be paid for the work performed. Consequently, it was a measure of civil liability, i.e. a sanction.
The contract provided that the JSC, apart from this sanction, should fully compensate the airline for all the losses incurred as a result of the JSC default on its obligations. Hence, this sanction was of a penal nature.