The Supreme Court Distinguishes Between Penalty and Interest on Advance Payment in a Case Concerning Supply of Goods for the Armed Forces of Ukraine

Commercial Court Case: State Contract for Defence Goods

The Commercial Cassation Court considered case No. 910/2097/25, which concerned the non-fulfilment of a state contract for the supply of defence goods. The court partially upheld the cassation appeal lodged by the state enterprise.

Case Circumstances

The dispute originated from a state contract for the supply of defence goods, intended to support the Armed Forces of Ukraine during the full-scale war. The contract stipulated an advance payment of up to 97% of the goods' cost: up to 50% upon obtaining necessary permits, a further 47% upon notification of the batch's readiness for shipment, and the remaining 3% upon signing the acceptance-transfer act.

The state enterprise made the advance payment as per the contract; however, the supplier failed to meet the delivery deadlines. Of the 4,976 units ordered, 2,000 were delivered 13 days late, and the remaining 2,976 units were never delivered.

The customer initiated legal proceedings, seeking to recover over UAH 31.9 million from the supplier in penalties, fines, and interest for the use of advance payment funds. The supplier, conversely, attributed the delay to force majeure circumstances involving its foreign contractor and requested the contract be terminated for the unfulfilled obligations.

The Commercial Court of Kyiv partially granted the initial claim, ordering the supplier to pay penalties and fines, albeit reduced by 80%. It also upheld the counterclaim, terminating the contract in respect of the outstanding obligations.

The court reasoned that while the supplier had violated delivery deadlines, the partial performance of the contract, the absence of proven damages, and the principles of fairness, good faith, and proportionality justified a reduction in the penalty amount. Furthermore, the court declined to award interest for the use of advance payment funds, deeming them effectively a form of penalty, and arguing that simultaneous recovery would constitute double liability. The court also concluded that further contract performance was impossible and, therefore, terminated it.

The Northern Commercial Court of Appeal concurred with these conclusions, upholding the first instance court's decision.

Reasons Considered by the Supreme Court

The Supreme Court reiterated that, according to Article 233 of the Commercial Code of Ukraine and part three of Article 551 of the Civil Code of Ukraine, the reduction of penalty sanctions falls within the discretionary powers of the court. It is imperative to consider the financial standing of both parties, the extent of obligation fulfilment, the ratio of the penalty size to potential creditor damages, the nature of the violation, other case circumstances, and to ensure a balance of interests between the parties.

The courts also found no evidence that the customer had suffered actual damages or incurred additional financial costs due to the delivery delay. The Supreme Court agreed that, in such circumstances, recovering the full penalty amount would impose an excessive and disproportionate burden on the defendant relative to the consequences of the violation. Consequently, the 80% reduction in penalty sanctions was deemed within judicial discretion and consistent with the Supreme Court's established practice.

Regarding contract termination, the Supreme Court noted that the appellant had failed to provide any Supreme Court conclusions on the application of Articles 607 and 651 of the Civil Code of Ukraine in similar legal relations that had not been considered by lower courts. Instead, the arguments presented in the cassation appeal largely amounted to a disagreement with the facts established by the courts and a demand for their reassessment, which exceeds the powers of a cassation court.

However, the Supreme Court found the lower courts' conclusions regarding the refusal to recover interest for the use of advance payment funds to be erroneous.

The court observed that lower courts had mistakenly applied an outdated legal approach, as set out in the decision of the united chamber of the Commercial Cassation Court dated 5 June 2020. Conversely, in its decision of 3 December 2021, in case No. 910/14180/18, the Supreme Court had departed from that conclusion, clarifying that the provisions of Article 536 and part three of Article 693 of the Civil Code of Ukraine are dispositive in nature.

The Supreme Court emphasised that interest for the use of advance payment funds possesses a distinct legal nature from penalties or fines. They represent payment for the use of money, and the contracting parties are entitled to independently determine both the amount of such interest and its calculation method, including by applying double the National Bank of Ukraine's discount rate.

Nevertheless, the lower courts had not verified the actual value of the delayed goods, the accuracy of determining the delay period, the application of double the NBU discount rate, or the reasonableness of the calculation performed. As the cassation court lacks the authority to independently establish such facts, the Supreme Court annulled the decision on this point and remitted the case for a new hearing to the Commercial Court of Kyiv.

In conclusion, the Supreme Court partially upheld the cassation appeal: it left the previous courts' decisions unchanged regarding the reduction of penalties and contract termination but annulled them concerning the refusal to recover interest for the use of advance payment funds, remitting the case for a new hearing on this specific matter.

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