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REPRESENTATIONS OF CIRCUMSTANCES

REPRESENTATIONS OF CIRCUMSTANCES

PUBLICATIONS \ 07.08.2020

When drawing up and concluding a contract, it is important to make the most of the tools provided by legislation to protect the interests of the company. One of these tools is to record representations that may subsequently turn out to be false. Marina Potsabei, Acsour’s lawyer, told us how to include representations of circumstances in the contract especially for the “Raschet” magazine

Representations of circumstances consist in the fact that the person who provided false information to the contractor have to compensate him of her for the losses he or she took owing to inaccurate information. At the same time, it does not matter whether false information concerned past or present events, the main thing is whether it affected the decision of a potential or current contractor to perform certain actions.

SUBJECT OF REPRESENTATION

In order to protect yourself, any representations should be enounced explicitly and unambiguously (clause 34 of the Resolution No. 49 “On certain issues of application of the general provisions of the Civil Code of the Russian Federation on the conclusion and interpretation of a contract” of the Plenum of the Supreme Court of the Russian Federation dated December 25, 2018), and even better to indicate them in the contract or accept them in writing, rather than orally.

Please note: the representation may also be provided by a third party if they have an interest in concluding, changing, or terminating a contract between the parties. In the event of fraud, the third party is responsible before the company to which this representation was provided.

The legislation does not specify that article 431.2 of the Civil Code of the Russian Federation will be applied only in the case of the conclusion of a contract. This means that if losses are caused by providing false information at the stage of the approval of a contract, you can claim compensation for losses regardless of whether the parties eventually signed the contract.

There are no restrictions in the Civil Code of the Russian Federation on which representations may be provided, but theoretically they can be divided into several categories.

The first group of data is information about the subject of the contract and its characteristics. For example, the seller assures the buyer that the dog he wants to sell has won exhibitions, is healthy and trained for further participation in them, and so on.

The second category of information is data about the party to the contract, information about participants (shareholders), financial stability, tax residence, applicable VAT rates, possession of a license, etc. For example, a foreign contractor can assure a Russian company that it is a tax resident of the Republic of Cyprus, with which the Russian Federation has concluded a Double Taxation Avoidance Agreement, and that it has no beneficiaries in other countries.

And another group of data: information about the availability of approvals required by law. Here are some examples of such representations: the party of the contract informs that all the necessary procedures associated with the approval of a major transaction are met; or refers to obtaining any necessary consent of a third party (for example, spouse’s consent for a sale of joint property); another example is the representation of compliance with the procedure of preferential purchase right when selling a share in the tenancy in common.

RELEVANCE OF THE PROBLEM

The introduction in the Civil Code of the Russian Federation of an article dedicated to representations of circumstances is largely owing to the striving of the state to fix the idea of prudence in doing business. If economic agents inform the company with which they would like to enter into a transaction, and later it turns out that this data is false, they should be prepared to compensate for the losses associated with providing such representations. In other words, if you lied you would have to pay.

The existing problem of unfair practice could be overcame by applying by courts of the existing articles dedicated to the invalidity of transactions made under the influence of delusion or fraud (articles 178, 179 of the Civil Code of the Russian Federation), as well as by extending article 475 of the Civil Code of the Russian Federation on the quality of goods to relationships on the alienation of shares. However, the courts did not interpret the above rules in a broad way, in fact, they did not work when providing false representations. Therefore, the state decided to continue to carry out the idea in the Civil Code of the Russian Federation that the parties, especially business participants, should act without fraud.

There is a danger in this policy of the authorities. It consists in the fact that the introduction of new rules does not always lead to their effective work, i.e., new laws may not work as well as the old ones. It is too early to draw conclusions about the representations of circumstances, since, over a space of three years of existence, the judicial practice of applying article 431.2 of the Civil Code is relatively small.

FOREIGN EXPERIENCE

I would like to note that the Russian norm is similar to the representations and warranties known to English law, but it cannot be said that it duplicates them.

The legislator decided to borrow the very idea of responsibility for false information. The introduction of the law is of practical interest for companies that do not want to spend a large amount of money on conducting the due diligence procedure (in choosing a contractor).

The application of representations of circumstances is particularly relevant if you would like to conclude a contract with a foreign contractor. For example, it is possible to take a representation from a foreign company that the company does not include shareholders who fall under the list of Russian sanctions. If later it turns out that this information is false and it influenced your decision to conclude the contract, the foreign company should compensate for the losses incurred in this regard.

It is interesting that article 431.2 of the Civil Code of the Russian Federation allows to recover the losses regardless of the rescission of a contract, i.e., if the interest in the transaction remains, it is possible to charge for the losses for false information and continue cooperation.

Please note: another advantage of the introduction of the article 431.2 in the Civil Code of the Russian Federation is to save time when concluding contracts. It is easier to take a representation than to independently conduct a check against the contractor, moreover when understanding that there is a “safety net” in the form of recovering losses or paying a penalty under the contract.

FIGHT AGAINST UNCONSCIENTIOUS CONTRACTORS

Upon identifying false representations, you can apply to the court with an action for damages or for payment of a penalty, if it is provided for in the contract. Only a conscientious contractor who did not know and should not have known that the information provided was false will have the right to claim damages. In accordance with clause 5 of article 10 of the Civil Code of the Russian Federation, all economic agents initially have good faith and reasonableness, therefore bad faith should be proved to the party that presumably provided false representations.

That is, the principle of “if you think otherwise, prove it” is applied. However, it should be understood that a party cannot be considered as an unconscientious one if it could only find out some information during the conduction of due diligence, otherwise the purpose of providing interpretations of circumstances in Russian legislation, consisting in the cost saving, is lost.

The party claiming that the requirements are false, consequently, should prove the circumstances on which it bases the claim to recover the losses or to pay a penalty, namely the presence of representations and their inaccuracy.

Please note: the fact that the representation and its content are available cannot be confirmed by witness testimony, but it is possible to use written and other evidence (clause 1 of article 162 of the Civil Code of the Russian Federation), for example, by providing email correspondence between the parties.

ABOUT THE BENEFITS OF PROMISES

Representations help the parties to distribute risks between themselves. It is useful for companies to take representations, since they help shift the risk of consequences to the contractor. For example, the seller can assure the buyer that all transactions for the purchase of goods from the supplier are reflected in the primary documentation and that all basic source documents will be transferred to the buyer.

If the seller does not transfer the documents and consequently the buyer does not exercise his or her right to deduction, the seller is obliged to compensate for these losses (Resolution No. F08-2428/2017 with regard to case No. A53-22858/2016 of the Commercial (‘Arbitration’) court of the North Caucasus District dated June 5, 2017).

The risk of providing false representations in the course of business activities is that a party is responsible for them, regardless of whether it intentionally provided them. Moreover, it is supposed that the other party relied on these representations (clause 4 of article 431.2 of the Civil Code of the Russian Federation), therefore before providing information to the contractor, it is necessary to check everything and understand what information to provide on your part.

Another risk is that the representations do not depend on the validity of the contract, i.e., the contract may be considered as unconcluded or invalid, but it is still possible to recover the losses under article 431.2 of the Civil Code of the Russian Federation.

It should be noted that the defrauded party has a number of rights along with recovery of losses or payment of a penalty: it can withdraw from the contract and declare it invalid in accordance with articles 178-179 of the Civil Code of the Russian Federation. As previously stated, it may also require only the recovery of losses or the payment of a penalty, remaining the contract in force.

Marina Potsabey

Lawyer