Case No. 1
National company (Customer) entered into an agreement to construct an administrative (office) building on a turnkey basis (Contract) with a Kazakh construction company (Contractor) – our client – following the tender of 26 June, 2012.
The construction works had to be performed in full in 17 months from the date when the Customer performs the advance payment (clause 1.7. of the Contract). Additional agreement No. 3 prolonged this term until 15 November, 2014.
Additional Agreement No. 4 on the performance of the extra works for the sum of 188 million tenge was then signed by the parties introducing the sub-clauses 1.7.1. and 1.7.2. Pursuant to the sub-clause 1.7.1. “the term of the full completion of the works by the Contractor is extended to 28 February, 2015 according to the additional cost estimates of the construction” (sub-clause 1.7.1. of the Additional Agreement). That said, the sub-clause 1.7.2. runs as follows: “the extension term of the sub-clause 1.7.1. (until 28, February, 2015) covers the additional works”.
The last work completion certificates, pro-forma F-2, were signed by the Customer without any objections on 1 March, 2015. The Customer signed the Conclusion (Act) of the Provisional Commission on 2 March, 2015; and the Act of the State Acceptance Commission on the handover of the Unit was approved equally without any objections on 4 May, 2015.
A year after the completion of the construction and project commissioning the Customer filed a claim to a local court against the Contractor demanding the penalties for the delay in the construction works accrued in the amount of 89 million tenge.
The Claimant’s argumentation: The Defendant made a delay in performance of the construction works for which the agreement provides the penalties in the amount of 0.1 per cent from the total cost of the Contract for every day of the delay but no more than 3 per cent from the total Contract cost. The breach of the construction deadlines was based on the clause 5.10. of the Contract according to which “approval date by the State Acceptance Commission is the date of the performance by the Contractor of his contractual obligations”. The Claimant indicated that the Defendant had violated both the term of the completion of the main works which according to the Contract are to be done by 15 November, 2016 and the additional works to be completed by 28 February, 2015. The Claimant referred to the article 620 (1) of the RK Civil Code: “The contractor agreement provides the initial and final terms of the completion of work. The parties may agree on the terms of completion of particular stages of work (intermediate terms). Unless the contract provides otherwise the contractor bears all responsibility for the violation of the initial, final, and the intermediate terms of work completion”.
The Defendant’s response: The term of work completion in full (until 28 February, 2015) established by the Additional Agreement No. 4 was not violated which the last work completion certificates, pro-forma F-2, signed 01 March, 2015 (the first working day after 28 February, 2015) signed by the Customer without any abjections are the evidence. The claims about the penalty payments are, thus, ungrounded. The Claimant wrongly interpreted the terms of the Contract on the subject of the terms of work completion. The turnkey construction a priori cannot specify any particular terms for the main and additional works. The Claimant’s reference to the clause 5.10 is unsubstantiated because the Contractor’s obligations to perform the construction works cannot be attached to the date of the approval of the State Acceptance Commission’s Act. The Defendant’s line of argumentation lies in the article 651 (3) of the RK Civil Code: “In turnkey construction agreement the Constructor is responsible for the construction and must handover the unit ready for operation according to the contractual provisions”. Apart from that, the Defendant pointed on the inconsistency of the Contract’s provisions with the law regarding the penalties calculations based on the overall cost of the Contract for each day of delay whereas the article 296 of the RK Civil Code stipulates that “the amount of penalties is calculated either in a fixed sum or as a proportion to the amount of the unexecuted or the improperly executed obligation”. This norm is legally binding.
Courts of trial – Specialized Inter-district Economic Court (SIEC) of Mangistau region (2017), civil law judicial board of Mangistau regional court, civil law judicial board of the Supreme Court of the Republic of Kazakhstan.
Our firm became involved in the litigation at the cassation stage.
Judicial acts issued during the trial.
SIEC granted the claim in full. The Defendant was charged to pay the penalties to the Claimant in the amount of 89 million tenge for the violation of the construction terms.
- The Defendant undertook to perform the works in no later than 15 November, 2014, the additional works had to be done within the deadline of no later than 28 February, 2015, according to the Contract. However, both these terms were violated. The Defendant completed the works on 4 May, 2015 since the Act on the handover of the Unit was approved on this date. For these reasons the Claimant has a right to demand the penalties for the improperly executed obligations.
- The Defendant’s reasoning about the fact that the Additional Agreement No. 4 provided the performance of all works in full in no later than 28 February, 2015 is groundless because the parties had agreed that this term applies only on the additional works pursuant to the sub-clause 1.7.2. of the Contract.
The Court of appeal changed the SIECS’ decision. While agreeing with the conclusions of the court of the first instance, it lowered the amount of the penalties to 10 million tenge considering the amount of penalties to be disproportionately high compared to the creditor’s loss.
Court of appeal’s conclusions:
- The board accepts the SIECS’ conclusion about the Defendant’s violation of the contractual deadlines.
- The arguments of the Defendant’s appeal in relation to the inconsistency of the clause 5.10. of the Contract with the other terms of the Contract and the article 651 (3) of the RK Civil Code have no grounds since “this contractual provision has neither been contested nor invalidated by the court”.
- The penalties are disproportionately high compared to the creditor’s loss and must be lowered pursuant to the article 297 of the RK Civil Code and based on the principles of reasonableness and equity.
The RK Supreme Court (cassation instance) by the Claimant’s petition cancelled the decision of the court of appeal leaving the SIEC’s decision in force.
Court of cassation’s conclusions:
- Court of appeal ignored the Claimant’s interests judging the amount of penalties disproportionately high compared to the creditor’s loss. It did not establish any grounds for this conclusion which led to the debtor’s continuing avoidance of the execution of his responsibilities.
- In violation of the article 297 of the RK Civil Code, according to which the court per a debtor’s request has a right to lower the amount of penalties, the court of appeal exceeded the scope of the Claimant’s requests. For the latter had not asked to lower the amount of penalties but merely requested to cancel the decision of the court of the first instance as illegal and unjustified, and demanded to issue a new decision.
- The parties amended the Contract on their own accord and the Defendant did not duly dispute the changes being introduced at that time, which provided the deadlines for the execution of the main works on 15 November, 2014 and the addition works on 28 February, 2015.
The Defendant addressed the petition to the Chairman of the RK Supreme Court to initiate the review of the judicial act issued by the cassation instance due to the violation of uniformity of interpretation and application of law by the courts, article 438.6 (3) of the RK Code of Civil Procedure. The Chairman obliged the Defendant to pay the state duty for filling the petition in the amount of 1.5 per cent from the disputed sum, even though neither the RK Code of Civil Procedure nor the RK Tax Code do not provide any direct provision in this respect.
Grounds of the petition (Defendant’s argumentation):
- Pursuant to the article 434.5 of the RK Code of Civil Procedure the acts of the courts of cassation may be reviewed when the grounds provided by the article 438.6 of the Code are established (including the violation of the uniformity in the interpretation and application of law by the courts, article 438.6 (3) of the RK Code of Civil Procedure).
- Act of the cassation instance contradicts the legal precedent law formed by the RK Supreme Court for this category of cases with the purpose to ensure legality, reasonability, and, main of all, justice.
The petition cites two civil law cases as examples of such court practice formed by the RK Supreme Court.
1) Department of the Customs Control of the Mangistau Region State Administration Body (Department) vs Actau Inzhstroy Industia Limited Liability Company (Company) re recognition as the malevolent participant of the state procurement.
The case brief: on 20 December, 2011 the Department (costumer) and the Company (supplier) entered into an agreement on the state procurement No. 199 to construct the administrative residential houses in Beineu village, Mangistau region, with the inside engineering networks and necessary utilities as well as outside engineering networks for the costumer. According to the article 7 of the agreement the Company undertook to finish the construction until 30 September, 2012. The parties agreed that the date of the works completion must be the date of the Act signed by the Provisional Commission.
On 18 February, 2013 SIEC of Mangistau region granted the claim and the Company was considered as malevolent participant of the state procurement due to the violation of the construction deadlines.
Judicial act of the court of appeal of Mangistau region dated 09 August 2013, civil and administrative board, left the decision without change.
The cassation judicial board of Mangistau regional court ruled on 2 October, 2013 to leave the judicial acts equally without change.
The act of the judicial board of review for the civil and administrative cases of the RK Supreme Court dated 22 January 2014 No. 3гп-34-14 cancelled all the judicial acts issued thought the entire proceedings and ruled to dismiss the Department’s claim on merits.
Supreme Court’s Argumentation:
The court of the first instance while recognizing the Company as malevolent participant of the state procurement indicated about the delay in the execution of the contractual obligations only on 21 December, 2012 which is the date of the State Acceptance Commission on the acceptance of the objects constructed into operation. The court of appeal, apart from that, invoked the clause 73 of the agreement which stipulates that the date of the Act of the Provisional Commission must be the date of work completion. Acts of the Provisional Commission are signed after 30 November 2012. Court of cassation agreed with the conclusion of the two courts down the ladder.
The RK Supreme Court affirmed that the conclusions of the local courts are not legally grounded and contradict with the factual circumstances of the case. The total amount of the evidence in the case indicates that the Company did not violate its obligations. Both the Act of the Provisional Commission and State Acceptance Commission mention the undertaking of the construction works within the deadlines provided by the agreement. The moment of completion or incompletion of works must be established by the factual data on the fulfilment of the particular construction works to be reflected in the corresponding acts singed by the authorized representatives of the parties to the agreement.
2) Nur LLC vs Construction Managing Body of the Kyzylorda Region SAB re debt recovery in the amount of 803,141 tenge.
The claim was based on the premise that while paying for the works completed the defendant withheld 803, 141 tenge as penalties for the delay in the handover of the unit.
SIEC of Kyzylorda region of 17 January, 2011 granted the claim in part. The court ruled to charge Construction Managing Body of the Kyzylorda Region SAB with 568,001 tenge in favor of Nur LLC.
The decision of the court of appeal of Kyzylorda region No. 2 a – 92/11 dated 23 February, 2011 left the SIEC’s ruling without change.
It is clear from the judicial acts that the claimant did the contactor’s work for the building of the medical station in the residential area Kosuenki of Shiliski district, Kuzulorda region according to the contracts of 3 December, 2008 and 11 March, 2009. The deadline for the performance of works was set on 31 May, 2009. The last work completion certificate F-2 was signed in November, 2009. The defendant withheld 803, 141 tenge from the payment as penalties according to the contract because of the delay in the handover of the unit. The costumer charged the interest for the undue handover of works to the State Acceptance Commission for 194 days starting from 31 May, 2009 and ending with 15 December, 2009 (the approval date of the State Acceptance Commission’s Act) in the amount of 0.1 per cent for every day of the delay.
SIEC reached the conclusion that “the defendant is deemed to have performed his obligations from the moment when he signs work completion certificates; the claimant’s demands with regard to the defendant’s obligation to provide State Acceptance Commission’s Act of the unit are illegal”.
SIEC also indicated that “the claimant is mistaken assuming that the defendant is deemed to have performed his obligations only after he provides the State Acceptance Commission’s Act of the unit. Pursuant to the article 663 (1) of the RK Civil Code the customer who received a notice from the contractor on the readiness to handover the work performed under a construction contract, or if it is stipulated in the contract, of a stage of work, must be obliged to immediately begin their acceptance”.
Court of appeal accepted these conclusions. The claimant filed a petition to the RK Supreme Court. According to the official website of the RK judicial system “Sudebnyi Cabinet” the RK Supreme Court dismissed the case without hearing on merits. It, thus, accepted the rulings the local courts had previously made on the case.
Back to our case, the Defendant, after four months from the date when the petition had been addressed to the Chairman of the RK Supreme Court, received a regular letter, unregistered and undated (which means there was not any procedural act taken in response to the petition for which, we note, state duty had been paid), and signed by a judge of the Supreme Court. The letter informs the Defendant that “the conclusions of the cassation instance on both the legality of the penalty charges by the court of first instance and the absence of the grounds for their reduction by the court of appeal are justified; and there is no basis for the review of the judicial acts according to the article 438 (6) of the RK Code of Civil Procedure”.
Case No. 2
The dispute arose between the same parties as were in the previous case and followed from the same construction Contract. Only in present situation the Costumer filed a claim to the (SIEC) court against the Contractor demanding penalty charges provided by the clause 7.2. of the Contract for the violation of the deadlines for the elimination of construction defects provided by the clause 6.4. of the Contract occurred within the guarantee period of the operation of the unit constructed in the amount of 83 million tenge.
Defendant denied the claim and filed a counter-claim to declare the conditions of the Contact which had formed the basis of the Claimant’s legal action as invalid and against the law. Thus, clause 7.2 of the Contract setting the penalties in the amount of 0.1 per cent from the total cost of the Contract for every day of the delay but no more than 3 per cent from the cost of the Contract contradicts the article 296 of the RK Civil Code which states that “the amount of penalties is calculated either in a fixed sum or as a proportion to the amount of the unexecuted or the improperly executed obligation”. This norm is legally binding. The deadline term for the elimination of construction defects and flaws within the guarantee period, which makes 10 working days upon the receipt of the corresponding notice by the Costumer, does not conform to the technological standards regulating the deadlines of the relevant types and scope of works; it equally contradicts the article 635 (1) of the RK Civil Code which stipulates the reasonable time period for the elimination of defects.
Courts of trial – SIEC of Mangistau region (2017), civil law judicial board of Mangistau regional court, civil law judicial board of the Supreme Court of the Republic of Kazakhstan.
Our firm became involved in the litigation at the cassation stage.
Judicial acts issued during the trial.
SIEC granted the claim in part. The Defendant was charged to pay the penalties to the Claimant in the amount of 73 million tenge for the violation of the deadlines for the elimination of construction defects and flaws within the guarantee period of the building operation. The counter-claim was denied.
- The argumentation in the counter-claim of the Defendant is unfounded because pursuant to the article 380 of the RK Civil Code individuals and legal entities are free to enter into an agreement, according to the article 393 (1) of the RK Civil Code, provided that the parties have agreed on all the essential conditions including the amount and calculation of penalties and the terms for the elimination of defects, there are no grounds to declare these contractual conditions as invalid.
- The requirements of the articles 157-159 of the RK Civil Code define the exhausting list of the grounds for declaration of a contract as invalid. During the trial, however, the Contract, or its certain conditions, was not found nonconforming to the law. In particular, the Contract is made in written form and regarded as a voluntary deed where parties take corresponding obligations which have led to the consequences for the parties by virtue of the Contract or the legislation provisions.
Court of appeal changed the SIECS’ decision reducing the amount of penalties to 10 million tenge.
Court of Appeal’s Conclusions:
- The board accepts the SIECS’ conclusion about the Defendant’s violation of the deadlines for the elimination of construction defects.
- The board agrees with the court decision to deny the counter-claim because according to the article 380 of the RK Civil Code individuals and legal entities are free to enter into an agreement, and in this case the parties have signed the Contract based on their own free will; it does not violate the law, there are no legal grounds to declare the Contract as invalid in the part contested by the Defendant.
The board considers that the penalties charged by the court are disproportionately high and does not conform to the criteria of reasonability and equity. SIEC did not take into account the Defendant’s attempts to repair the defects; it inadequately estimated the extent of the both parties’ fault as well as it did not consider the absence of the Claimant’s loss.
The RK Supreme Court (cassation instance) by Claimant’s petition cancelled the decision of the court of appeal leaving the SIEC’s decision in force.
Court of Cassation’s Conclusions:
- It follows from the meaning of the article 297 of the RK Civil Code that the amount of penalties charged is subject to reduction only by a debtor’s request. However, in violation of the norm of the material law the board of appeal going beyond the scope of the appeal unlawfully reduced the amount of penalties charged by the court of first instance notwithstanding the fact that the Defendant had not made such request, he had asked to cancel the decision of the court of first instance as illegal and groundless.
Lessons drawn from the cases and recommendations:
- Improve contractual negotiations in order to protect your own rights and interests, to be persistent and assertive while negotiating the terms bearing in mind that it may be difficult, if not impossible, to remedy the blunders in the conditions (provisions) of a contract made not in your favor.
- Be ready that the courts are still not good at cases related to contractor agreements, i.e. there is no uniformity in the interpretation and application of law in this category of cases. The RK Supreme Court who by constitutional authority is supposed to ensure such uniformity of interpretation and application of law does not promote this neither at cassation stage of review of the acts came into force nor by adopting a regulatory resolution which would clarify the court precedents accumulated for these cases. To our knowledge such regulatory resolution has not been issued by the RK Supreme Court. Moreover, there are no conclusions or any analysis of court cases in this area.
- Be ready that the court practice which have already been formed for such cases does not always conform to the criteria of reasonableness and equity provided in the article 6 (5) of the RK Code of Civil Procedure.
- Every means must be employed to protect your rights and interests, including a counter-claim, which will make it possible to settle the dispute though reconciliation procedures (settlement agreement, mediation, etc.).
- Be ready that your counterparties operate in bad faith, act more swiftly and be proactive both before filing a claim and during a trial; expand the wording of your response to a claim and of your appeal in order not to be blamed that you have not previously asked or mentioned that.
- Evaluate the judicial acts of your case, including those in your favor, considering the possible perspective of an appeal by the counterparty and forming a right strategy and tactics of your actions during the trial and be ready to reconsider your tactics at any moment including all the possible instances the case might go through.
- Be ready for long-term court trials and have all the resources necessary for them considering now that the address (petition) to the court of cassation (the RK Supreme Court), to the Chairman of RK SC, is charged with the state duty.
- Take all measures to settle your disputes outside the courtroom through negotiations and finding compromise solutions.
Prepared by Gulnar Ospanova, Partner “Artyushenko and Partners” Law Firm. June, 2018