Russian Federation arbitration proceeding 155/2003 of 16 March 2005

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1 Russian Federation arbitration proceeding 155/2003 of 16 March SUMMARY OF RULING Translation [*] by Sophie Tkemaladze [**] 1.1 The decision is made in respect of the Respondent [Seller], which at the time of dispute resolution was registered at the state agency of registration of its place of business, however, was not conducting economic activities. 1.2 Although places of business of the parties to the international sales contract are in Contracting States of the Vienna Convention 1980, it is ruled that the Convention is not applicable to the relationships of the parties since the contract provided for application of the law of the Russian Federation, which has been interpreted as their recourse to article 6 of Vienna Convention, enabling parties to opt out of the Convention. Thereby, it is established that relationships of the parties are regulated by the internal legislation of the Russian Federation, i.e., the Civil Code of the Russian Federation. 1.3 Finding that [Buyer]'s claims are related to latent faults of the product revealed in the process of refinement, the Tribunal found unjustified [Seller]'s contentions that [Buyer] has missed time for notice of lack of conformity, which has been presented after expiry of the six months period fixed by the contract. Referring to section 5 art. 477 of the Civil Code of the Russian Federation, the Tribunal notes that [Buyer] had a two-year period from the moment of passage of goods to him and thus [Buyer] has not missed this period. 1.4 In the absence of remarks and objections of the [Seller] in relation to the revealed defects, the Acts regarding defect of the goods compiled without presence of [Seller]'s representatives have been given evidential force, although the [Buyer] failed to present proof of sending the notice of defect to [Seller]. 1.5 Based on section 2 art. 475 of the Civil Code of the Russian Federation, [Buyer]'s claim for repayment of the price for defective goods (having unrecoverable failure) has been satisfied. 1.6 In considering the claim of [Buyer] in relation to reimbursement of damages caused as a result of delivery of defective goods, each of the claims presented has been evaluated and the decision was made taking into account the terms of the contract and proof of the amount of the relevant claim. 2. FACTS AND PLEADING An action has been filed by a Russian organization [Buyer] against a Ukrainian organization [Seller] regarding alleged defects of goods meant for refinement, shipped under an international sales contract concluded between the parties on 20 September [Buyer]'s requests included: repayment of the cost of defective goods, reimbursement of losses incurred by the [Buyer] as a result of defectiveness of the goods, as well as reimbursement of arbitration fees. The Contract, particularly, provided for the following terms: - Delivery of the goods shall be on DAF terms (Ukrainian-Russian border, border crossing

2 point "Red Grave" station - station Gukovo) as per INCOTERMS 2000 (sec.1.1.); - Payment shall be made via direct bank transfer with 30% pre-payment for each shipment and balance payment not later than 10 days after completion of customs get-up of the goods on the territory of the Russian Federation (part 3); - Quantitative or qualitative non-conformity of goods shall be rectified by drawing up of an act where parties shall fix deadline for elimination of defects of the product (sec. 4.3.); - A six-months warranty period is fixed for the goods commencing from delivery date; - Acceptance of the goods in terms of quality and quantity shall be done by [Buyer] or consignee not later than within 15 days from the moment of acceptance of the goods from carrier at the final point of destination (section 9.1); - In case of flaw in product quantity or quality, the [Buyer] (consignee) shall inform the [Seller] by telegraph within two days after finding such deficiency. The supplier's representative must come for acceptance within 36 hours after such notice is given. [Buyer] may carry out acceptance in a unilateral way. Results of the acceptance are fixed in an act to be signed by representatives of [Seller] and [Buyer] or only [Buyer] (sec.9.4.); - On identification of qualitative and/or quantitative defects [Buyer] shall send a claim to [Seller] attaching the act, waybills and other documents, proving inconsistencies (sec.9.5.) Handling over the claim papers to [Seller] was not possible because of the finding that [Seller] no longer carried out economic activities, although [Seller] still remained registered at the address noted in the contract and statement of claim. Thus, [Seller] did not present a response to the claim and its representative did not participate in the arbitral hearing. Meantime, from the correspondence of the parties provided by the [Buyer], it was evidenced that [Seller] did not admit the requests of [Buyer] in particular referring to the fact that defects were revealed after termination of the warranty period provided for in the contract. In the course of oral hearings, [Buyer]'s representative stated that the position of [Seller] noted in response to the claim is not acceptable since [Buyer] contends that the defects in the goods were latent and thus, based on sec. 5 art. 477 of the Civil Code of the Russian Federation, the period for notice of claims had not elapsed by the time [Buyer]'s claim was filed. On the issue of invitation of [Seller]'s representatives for drawing up the act of nonconformity of goods [Buyer]'s representative stated that the [Buyer] attempted to get in touch with [Seller], but in vain. [Buyer]'s representative noted that the absence of [Seller]'s representatives did not affect objectivity of the committee composed by the factory where refinement works were carried out in establishing non-conforming quality of the goods. 3. TRIBUNAL'S REASONING The award of the MKAC Arbitral Tribunal (hereinafter: the Tribunal) contained following main provisions:

3 3.1 In deciding the issue of its competence to consider the [Buyer]'s claims against the [Seller], the Tribunal reasoned as follows. The [Buyer] in the present case is a public corporation, the legal successor of a federal government enterprise. [Buyer] and its predecessor are legal entities, established and operating in the Russian Federation. [Seller] in this case is a legal entity in the form of a limited liability company having its place of business in Ukraine. In view of the abovementioned and given that the place of arbitration is the Russian Federation, in determining the issue of its competence to resolve the present dispute the Law of Russian Federation "On International Commercial Arbitration" shall be applied, which is based on the UNCITRAL Model Law on International Commercial Arbitration adopted by the United Nations Commission on International Trade Law on 21 June 1985 and approved by the General Assembly of the UN. Contents of the statement of claim as well as the documents attached to it point this as a dispute arising out of the delivery of defective goods to [Buyer] (its predecessor) by the contract dated 20 September 2001 with additional agreement to it No. 4 dated 19 October At the arbitral hearing, [Buyer]'s representative presented the original copy of the contract which is in case files. Art of the contract states that: "If the parties do not come to agreement, all disputes and controversies shall be settled by the International Commercial Arbitration Court attached to the Chamber of Commerce and Industry of the Russian Federation, the City of Moscow... The arbitral award shall be final and binding on both parties." According to sec. 1 and 2 of the Rules of the Tribunal (Attachment No. 1 to the Law of the Russian Federation "On International Commercial Arbitration"), the Tribunal is an independent permanent arbitral body (arbitration court) where disputes may be referred to by agreement of the parties, namely contractual or other disputes arising out of civil law relationships from foreign trade or other type of international economic activities, if the place of business of at least one of the parties is abroad. Similar provisions are recited in section 1 1 of the Rules of the Tribunal. Analyzing the materials of the case, it is established that the parties have made a written agreement on settlement of potential disputes between them in relation to the contract dated 20 September 2001 which is in line with requirements of art. II of the UN Convention on Recognition and Enforcement of Arbitral Awards (New York, 1958) which was in force for the relationships of Ukraine and the Russian Federation at the time of conclusion of the contract. The requirement of written form of arbitration agreement is as well envisaged in section 2 art. 7 of the Law of the Russian Federation on "International Commercial Arbitration" and sec. 3 1 of the Rules of the Tribunal attached to the Chamber of Commerce and Industry of the Russian Federation. There is no evidence in the case materials and the parties have not presented any data or information which could challenge the validity of the parties' agreement granting the Tribunal attached to the Chamber of Commerce and Industry of the Russian Federation competence to consider disputes related to the performance of the contract.

4 In view of the abovementioned and given that no challenge of arbitrators has been lodged, the Tribunal, based on sec. 5 1 of the Rules of the Tribunal, has found that it has competence to resolve the dispute between [Buyer] and [Seller] to the full extent of the claims lodged. 3.2 The dispute between [Buyer] and [Seller] arose out of the relationships based on the contract dated 20 September 2001 and Additional agreement to it No. 4 dated 19 October The Tribunal considered the issue regarding the substantive law of which country is to be applied in considering and regulating rights and obligations of the parties under the contract. In art of the contract, the parties have noted that in execution of contractual obligations they shall be guided by legislation of the Russian Federation and in they provided that liabilities of the parties not regulated by the present contract are to be settled by acting legislation of the Russian Federation. At the hearing, [Buyer]'s representative stated that the parties have chosen the internal legislation of the Russian Federation to apply, excluding thereby applicability of the Vienna Convention According to art. 28 of the Law of the Russian Federation "On International Commercial Arbitration" and sec of the Rules of the Tribunal, the Tribunal resolves disputes based on the applicable substantive law chosen by agreement of the parties; where no such agreement is made - guided by law determined by the Tribunal in accordance with the conflict-of-law norms which it deems applicable. In any case, the Tribunal makes its decision considering the terms of the contract and taking into account trade usages applicable to the dealing at hand. The Tribunal notes that the international sales contract has been concluded between [Buyer], whose place of business is in the Russian Federation and [Seller], whose place of business is in Ukraine, and that both the Russian Federation and Ukraine are parties to the Vienna Convention of By virtue of article 1(1)(a) of the Convention, the Convention is applicable to sales contracts between parties, whose places of business are in different countries when these countries are signatories of the Convention. And, according to section 4 article 15 of the Constitution of the Russian Federation, if international agreements of the Russian Federation set different rules than internal laws provide, then such international agreements shall be applied. The Vienna Convention of 1980 is an international agreement that provides unifying rules applicable to contracts for the international sale of goods. At the same time, art. 6 of the Convention grants the parties the right to opt out the Convention or, provided art. 12 is adhered to, derogate from any of its provision or alter its operation. In view of this, the Tribunal believes that in designating the applicable law to be the acting legislation of the Russian Federation, the parties' intent was to opt out from application of the Convention. Based on this, the Tribunal concludes that law applicable to the rights and obligations of the parties from this international commercial transaction -- the contract dated 20 September 2001 and additional agreement to it No. 4 dated 19 October is the internal legislation of the Russian Federation.

5 3.3 In relation to the non-appearance of [Seller]'s representatives at the arbitral hearing of 1 February 2005 at which time the case was tried on the merits, the Tribunal stated that the notice on the hearing of 1 February 2005 was sent to the Respondent [Seller] by the Secretariat of the Tribunal on 1 November 2004 by registered letter. No acknowledgement of receipt of the above notice was received by the Secretariat. The case materials sent to Respondent [Seller] earlier were returned to the Tribunal with the following notice of the UPS courier: "Recipient does not reside at the given address. Notice has not been delivered (deleted)." The Tribunal considered the application of the [Buyer]'s representative, who in executing the Tribunal's Resolution dated 28 October 2004 tried to determine the whereabouts of [Seller] with the help of the organs of internal affairs of Ukraine and has presented to the Tribunal explanations of the director of [Seller]'s organization given to the official of the Ministry of Internal Affairs of Ukraine. It is evident from the explanations that the [Seller] is registered at the address noted in the case papers, however, at present it does not carry out economic activities and is represented solely by a director, residing in Kiev. According to sec. 2 2 of the Rules of the Tribunal, statements of claim, explanations, notices, arbitral awards, resolutions and references are sent by registered mail with notification on delivery or otherwise providing for registration of the endeavor of delivery of the relevant notification. Under sec and sec of the Rules of the Tribunal, non-appearance of a party, duly notified of the date, time and place of the hearing, shall not hinder adjudication and rendering an award, so long as the defaulting party has not filed a written motion on remand for good reason. Under such circumstances, the Tribunal found that [Seller] was duly notified at his address on the date, time and place of arbitral hearing. Moreover, the Tribunal states that no written motion on remand of the case has been filed by the [Seller] and the available case materials are enough in order to fully resolve the case and render an award. In view of the above and given the [Buyer]'s motion to hear the case in the absence of the [Seller], the Tribunal, guided by art. 25 of the Law of the Russian Federation "On International Commercial Arbitration" held that the non-appearance of the [Seller] does not hinder adjudication and rendering of an award and deemed it possible to hold the hearing in the absence of Respondent's representatives. 3.4 The Tribunal examined the issue of the status of the [Buyer] in relation to the relevant Resolution of the Government of the Russian Federation, which provides that rights and obligations of an organization, concluding a contract or an additional agreement to it, shall pass by succession to another Russian organization. Taking into account the abovementioned and the resolution of the Tribunal Representative dated 10 October 2003 on satisfaction of [Buyer]'s request of its substitution by a successor, the Tribunal considers the successor organization to be the appropriate Claimant in the present case With the knowledge of the contents of the contract dated 20 September 2001 and an additional agreement to it No. 4 dated 19 October 2001, the Tribunal finds that there is no evidence of invalidity of the contract and it is reasonable to qualify the contract as an

6 international contract for the sale of goods, i.e., as a foreign-economic transaction, defining relevant rights and obligations of the parties. 3.6 In considering [Buyer]'s request to collect from [Seller] the cost of 600 units of goods, the Tribunal found the following: In performing payment obligations of the contract, [Buyer] has transferred to the [Seller]'s account monetary means for delivered goods, which is evidenced by payment orders and abstracts from [Buyer]'s bank account, certified copies of which have been presented by the [Buyer]. [Seller] did not dispute the fact of payment in its letter dated 5 June [Buyer] received goods shipped by [Seller] on 28 March 2002 in April of 2002; deficiencies of the goods were revealed at the time of its refinement on 23 October 2002, 11 December 2002, 10 February 2003 and 13 March Under art. 4.4 of the contract, the goods had a six-months period of warranty from the date of their delivery. In accordance with sec. 5 art. 477 Civil Code of the Russian Federation, in cases where the warranty period fixed by the contract is less than two years and deficiencies are revealed by Buyer upon expiration of the warranty period but within two years from the date of transfer of the product to the Buyer, Seller shall be held liable if the Buyer proves that defects were present before delivery of the goods to him or by reasons occurring before such delivery. Under sec. 2 art. 475 of Civil Code of the Russian Federation, in cases of material breach of the requirements to the quality of goods (detection of unrecoverable failure, defects which cannot be repaired without disproportionate expenses or loss of time or which emerge repeatedly or appear again after their removal or other similar defects) Buyer at its discretion has the right to: - Refuse performance of the sales contract and request repayment of the cost of the product paid by him; - Demand substitution of the defective goods with goods complying with contractual requirements. In these circumstances, the Tribunal considers [Buyer]'s request for reimbursement of the price of defective goods to be well founded and recoverable. 3.7 Regarding the issue of imposition on the [Seller] of 20% VAT paid by the [Buyer] upon Customs clearance of the goods as well as [Buyer]'s expenses related to payment of brokerage fees, transportation expenses for sending the goods back to the factory, refining the goods, and return of the defective goods, the Tribunal states that under sec of the contract [Buyer] was obliged to "carry all expenses relating to the goods from the moment of transfer of the goods to the Buyer at the designated place on the border as well as expenses related to payment of taxes, customs dues, other duties, customs formalities, necessary for import of the goods in the country of destination." The Tribunal found that expenses presented by the [Buyer] calculated based on 600 units of defective goods were in fact carried by the [Buyer] which is proved by payment

7 documentation, invoices and other documents presented to the arbitration court, copies of which are available in the case files. 3.8 Under sec. 1 art. 15 of the Civil Code of the Russian Federation, a person whose right is violated is entitled to claim full reimbursement of damages, if reimbursement in less amount is not determined by the law or by the contract. According to sec. 2 art. 15 of the Civil Code of the Russian Federation, damages include expenses which the person, whose right is violated has incurred or shall have to incur for restitution of violated right, loss or damage to his property (real damage) as well as nonderived income, which this person would have received in ordinary circumstances of civil circulation, if his right had not been violated (loss of profit). The Tribunal finds that since the [Seller] in its letter dated 5 June 2003 did not accept [Buyer]'s complaints in relation to the quality of goods and refused to deliver substitutes for defective goods and pay the penalty fixed by the contract, and by the time of rendering the present award has ceased economic activities, [Buyer] is entitled to claim full monetary reimbursement of losses incurred. Satisfying [Buyer]'s requests, the Tribunal also took into account that [Seller] did not file a response to the claim and did not disputed the claim neither in its essence nor in its amount. Based on the abovementioned, the Tribunal finds [Buyer]'s request for collection of the cited amount of damages from [Seller] essentially well founded and recoverable. At the same time, part of the claimed amount of damages the Tribunal finds to be excessive and unjustified. From calculations presented by the [Buyer], it follows that manufacturing costs and factory overheads in the factory where refinement of [Buyer]'s goods took place amount to 543 and 235% accordingly. No basis for such calculations is present in the case papers and no explanations were given on this by [Buyer]'s representative. Under these circumstances, [Buyer]'s request for reimbursement of these expenses has to be denied. 3.9 In making this decision, the Tribunal also considered the following: Product deficiencies were revealed and placed on record in acts compiled by competent persons. [Seller] did not point to any remark or objection in relation to the revealed deficiencies as well as in relation to the data evidencing inappropriate examination of the quality of production in the process of their refinement. In this respect, the Tribunal considers that non-notification of the [Seller] of the deficiency of the product and composition of the acts without presence of its representatives do not influence proof of the fact of delivery of defective goods In considering the request of the [Buyer] on collection of arbitration fees from [Seller], the Tribunal, guided by sec. 2 6 of the Regulation on Arbitral Fees and Expenses (Attachment to Rules of the Tribunal) has levied on the [Seller] reimbursement of arbitration fees paid by the [Buyer] in proportion to the amount of satisfied claims. FOOTNOTES

8 * All translations should be verified by cross-checking against the original text. For purposes of this translation, Claimant of the Russian Federation is referred to as [Buyer] and Respondent of the Ukraine is referred to as [Seller]. ** Sophie Tkemaladze, LL.M. Central European University, Budapest, Hungary; Lecturer at Tbilisi State University; Coach of the TSU team for the Willem C. Vis International Commercial Arbitration Moot.

Tribunal of International Commercial Arbitration of the Ukrainian Chamber Commerce and Trade

Tribunal of International Commercial Arbitration of the Ukrainian Chamber Commerce and Trade - Particulars of the case - Position of the Parties - Opinion of the Tribunal - Award PARTICULARS OF THE CASE