Why and how do Ukrainian courts reduce monetary penalties? Case-law of the Supreme Court


Late performance of contractual obligation is an occasional part of the business. Moreover, in light of the COVID-19 pandemic and quarantine measures related to it, such cases are much more to come. While a quarantine is a directly designated force majeure in Ukrainian law, it is far from being a panacea for all cases and all contracts: it is not that easy to establish a causal link between the quarantine and the failure to perform in due time. At the same time, it is a core element when you are seeking an exemption from civil penalties in a Ukrainian court. The question arises: what the courts are looking at when deciding to reduce (if not to exempt from) monetary penalties?

Is a court empowered to reduce liquidated damages in Ukraine? 

Civil and Commercial Codes of Ukraine entitle parties to freely define liquated damages (monetary penalties) for the undue performance of a contract signed between them. Even more, the parties can agree upon a longer period during which the damages are accrued than the statutory period of six months envisaged in the Commercial Code. The only limit is established for the rate of the penalty interests: they cannot exceed the doubled interest rates established by the National Bank of Ukraine for the respective period. There is no similar limit for a lump-sum if applied.

Yet these two Codes reserve the right of the courts to reduce the amount of monetary penalties calculated on the basis of the contract. Thus, Article 233 of the Commercial Code says that the court may reduce the penalties if they are calculated in the amount significantly exceeding actual damages. Meanwhile, the court shall take into account:

  • the extent to which the debtor has fulfilled the obligation;
  • financial standing of the parties;
  • other interests of the parties that are worth taking into account.

Article 551 of the Civil Code prescribes for the similar rule: a court has the power to reduce the amount of monetary penalties (penalty interests or a lump-sum), if the latter significantly exceeds the damages or in light of other essential circumstances. 

In other words, the court is always entitled to reduce the penalties if their amount exceeds the amount of the damages.

In this regard, the list of circumstances or interests that the court shall take into account is inexhaustive. These circumstances shall have “considerable importance” (Civil Code), while the interests of the parties shall be “worth taking into account” (Commercial Code).

What do the courts pay attention to? 

First of all, reducing the amount of penalties is a right of the court and the exercise of this right does not depend on the outcomes of the pretrial settlement negotiation or the consent of the creditor to this reduce (Resolution of the Supreme Court of 19 September 2019).

Moreover, this is exactly a right, and not an obligation of the court, though the court shall always examine all the arguments of the debtor by which they substantiate their plea for reducing. (Resolution of the Supreme Court of 24 April 2019).

Also, the laws fail to determine either the maximum amount by which the courts can reduce the penalties, or the mechanism through which they shall do it – the fact that the courts underline themselves (Resolution of the Supreme Court of 07 November 2019).

As the result, the courts reduce the penalties in extremely different ways: by 25, 50, 70, 80, 90 percent from the amount claimed … to one UAH!

In this regard, the amount reduced does not depend on the amount for which the debtor pleads. The court can relieve their plea either in full or in part, which is happening much more frequently (for instance, instead of reducing by 90 percent as the debtor pleads, the court reduces the penalties by half (Resolution of the Supreme Court of 01 August 2019) or by a third).

Hence, one never can forecast the amount by which the court will reduce the penalties (if it will do it at all). Nevertheless, it is still possible to achieve the most favorable outcome if to pay attention to the factors which the courts take into account.

  • Damages incurred and the kind of penalty interests.

The very first things the courts address their attention in such cases are the types and the amount of the damages inflicted.

This is due to the fact that commercial laws generally prescribe for compensatory interests – where the damages are recovered in the amount not covered by the penalty interests. However, the laws or the contract may prescribe for the other type of penalty interests:

  • exclusive interests – when only penalty interests are due to be recovered;
  • punitive interests – when the damages are recovered fully and regardless of the penalty interests recovered;
  • alternative interests – when the creditor can choose either the actual damages or the liquidated damages to be recovered;

In general, recovering actual damages is a separate claim which a creditor may not bring before the court since it requires them to separately prove their amount and character. At the same time, recovering liquidated damages requires only to demonstrate the late performance of the contract, while it is for the debtor to prove the absence of guilt (Resolution of the Supreme Court of 31 March 2020).

In practice, however, the absence of the actual damages or failure to prove them is the basis for the court to reduce the liquidated damages. Thus, creditors willing to recover a full amount of the liquidated damages shall think ahead of proving the actual damages incurred, even if they do not intend to separately claim a recovery of such damages. 

  • Financial standing of the debtor and his ability to pay off the liquidated damages.

Secondly, the courts frequently take into account the financial standing of a debtor. For example, the courts reduce the amount of liquidated damages if the debtor suffers the loss of profits (Resolution of the Supreme Court of 21 October 2019), has salary arrears (Resolution of the Supreme Court of 10 December 2019), etc.

However, we saw also counterexamples, where the courts rejected the arguments of the debtor regarding the dire financial situation and noted that the entrepreneurship is risky in nature (Resolution of the Supreme Court of 09 October 2019).

  • Debtor’s approach and behavior regarding settling the debt.

Thirdly, the courts pay attention to the actions taken by the debtor to retire the debt in good faith. They often emphasize that reducing of the liquidated damages is acceptable if the debtor’s failure has exceptional character. Also, they appreciate if the debtor is gradually paying off their debt by periodic payments (Resolution of the Supreme Court of 26 September 2019) or even if the debtor has already paid off the principal of debt before the creditor brings their claim (Resolution of the Supreme Court of 19 June 2019).

Conversely, if the debtor fails to even partially clear the debt, the courts may dismiss the motion to reduce the liquidated damages (Resolution of the Supreme Court of 18 February 2020).

Also, the courts take into consideration the actions of the debtor concerning pretrial dispute resolution – for instance, if the debtor addressed the creditor with proposals to restructure the debt and to reduce the liquidated damages by 50 percent (Resolution of the Supreme Court of 19 February 2020). Plus, the court may also examine the period of delay in performance: in one case, the period of 33 days was declared to be insignificant (Resolution of the Supreme Court of 22 May 2019).

  • Correlation between the debt and the liquidated damages.

The proportion between the debt amount and the amount of liquidated damages calculated plays also a significant role.

Thus, the courts estimate that the liquidated damages constituting a half (Resolution of the Supreme Court of 23 September 2019) or even a third (Resolution of the Supreme Court of 26 March 2020) of the contract price is disproportional, let alone the case where these damages are double the amount of debt (Resolution of the Grand Chamber of the Supreme Court of 18 March 2020).

Sometimes, the courts do the calculations and reduce the liquidated damages in exact proportion to the amount of the outstanding debt. For example, in the case where the amount of undelivered goods constituted one ninth of the overall amount, the court reduced the amount of liquidated damages to 10 percent (Resolution of the Supreme Court of 27 January 2020).

In the other case the courts take into account the profitability of the contract and concluded that the liquidated damages exceeding potential profits of the contracts are unfair and should be reduced (Resolution of the Supreme Court of 22 May 2019).

Similarly, the courts note if the parties has agreed upon the extension of the period during which the liquidated damages are calculated (Resolution of the Supreme Court of 19 June 2019).

  • Other circumstances.

The courts also consider other circumstances which may reflect an objective inability to perform the obligation in due time. In one case, the court recognized the malicious activity of the computer virus in the network system of the debtor as such circumstances. (Resolution of the Supreme Court of 19 September 2019). At the same time, one need to demonstrate that these very circumstances were a direct cause of the late performance (Resolution of the Supreme Court of 18 February 2020). 

However, contrary to the case with force majeure concept, which serves as a basis for the full exemption from the liquidated damages, the party petitioning for reducing the liquidated damages does not have to produce a special certificate issued by the Chamber of Commerce and Industry (Resolution of the Supreme Court of 21 October 2019).

Notably, the courts refuse to treat high volume of the contractual orders or tough deadline of the performance as such circumstances, since the debtor has freely agreed upon such terms while signing the contract. This is even more the case, where the contract is a result of the public procurement procedure (Resolution of the Supreme Court of 20 February 2020).

Finally, the courts bear in mind the special position of the creditor or of the debtor. For example, the courts often reduce the liquidated damages where the debtor is a municipal entity (see Resolution of the Supreme Court of 26 September 2019). The other example is the case where the subject of the contract was the special equipment ordered by the State Emergency Service of Ukraine and designed for rescuing of human lives. In that case, the court refused to reduce the liquidated damages for the late delivery of the equipment (Resolution of the Supreme Court of 24 July 2019).

The approach matters, not the amount.

The analysis of the case-law shows that the contractual clause regarding the liquidated damages is not a rule of the highest order. More and more frequently the courts employ their power to reduce an amount of such damages.

The desirable outcome for the creditor or the debtor rests upon many factors. Above all, the parties should be able to prove the rightness of their cause in all essential considerations. Creditors shall take care of proving not only the correctness of its calculations, but also the actual damages incurred – even if they do not claim them separately. On the other hand, debtors may achieve a significant reduce of the amount of liquidated damages recovered if they are capable of proving that the amount of these damages are disproportional to the debt or to the contract price or that their behavior was in good faith. If impartial circumstances barred the debtor from performing their obligations in due time, this debtor should dully prove their existence and the causal link between them and the late performance.

The right comprehension of the legal norms, knowledge of the judicial peculiarities and the points the courts take into account have utmost importance for recovering and reducing of the liquidated damages. This importance is much higher than the amount of the liquidated damages established by the contract.

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