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Note: To pay for a shipment of 1000 MT of Indian long grain polished rice, Moscow based OOO Patriot (Buyer/Applicant) obtained a commercial LC issued by Joint Stock Commercial Bank AVTOBANK (Issuer) in favor of Phulchand Exports Ltd. of India (Seller/Beneficiary) for INR 12,450,000. The contract provided that the goods were to be shipped on a CIF (INCOTERMS 1990) basis and delivered to Novorossiysk, Russia. The contract also provided that Buyer/Applicant had the right to cancel if the shipment of goods by Seller/Beneficiary was delayed by more than 15 days. Under Clause 4 of the contract, Seller/Beneficiary was obligated utilize a vessel that was departing for Novorossiysk as its first port of discharge and that "[i]n case the goods do not arrive to the customs area of Russian Federation within 180 days from the date of payment the transferred amount is to be reimbursed to the Buyers' account."

Seller/Beneficiary presented shipping documents to Issuer and was paid by Issuer. However, Seller/Beneficiary subsequently shipped the goods 16 days after the agreed date and did not use a vessel that was sailing directly to Novorossiysk. While en route, the freighter suffered engine failure and had to be salvaged and towed to port by another vessel. In order to compensate its owner for the rescue efforts, the freighter was detained and its cargo sold.

Pursuant to the CIF contract, Buyer/Applicant sought compensation for the lost goods from United India Insurance Company Ltd. (Insurer). Insurer denied liability for the loss of the goods on the basis that the risk of detention was not covered. Insurer advised Buyer/Applicant and Seller/Beneficiary to proceed as though the goods were uninsured.

Buyer/Applicant subsequently filed a claim against Seller/Beneficiary to recover USD 285,569.53 in the International Court of Commercial Arbitration at the Chamber of Commerce and Industry of the Russian Federation. Seller/Beneficiary contended that the risk of loss passed to Buyer/Applicant on shipment of goods per the CIF contract. The Arbitration Tribunal ruled that, because Seller/Beneficiary had breached the CIF contract by shipping the goods late and not on a vessel whose first destination was Novorossiysk, Seller/Beneficiary retained liability for the loss of the goods. However, the tribunal also held that Buyer/Applicant delayed acting in accord with Clause 4 by not providing insurance certificate and cargo documents to Seller/Beneficiary and not demanding reimbursement from Seller/Beneficiary immediately after expiration of the 180 days. As a result, the Tribunal ruled that losses should be split between the parties.

Buyer/Applicant then filed a claim in the High Court of Bombay, India to enforce the Arbitral Tribunal's award. Seller/Beneficiary resisted on the grounds that the provisions that provided for reimbursement in the event of non-arrival after 180 days "amounted to a penalty" making it unenforceable under Indian public policy. The Bombay High Court found no merit in Seller/Beneficiary's contentions and ordered enforcement of the award. The Division Bench dismissed Seller/Beneficiary's appeal. On appeal, the Supreme Court of India, in an opinion by R.M. Lodha, J., modified the decision of the Division Bench but ruled that the arbitration award should nonetheless be enforced.

Seller/Beneficiary argued that the Division Bench had applied a flawed test of public policy which was too narrow. The Supreme Court agreed that an arbitration award could be set aside for patent illegality under Indian law but, instead of remanding, addressed the question of whether the award was patently illegal.

The Supreme Court opinion stated that "the sellers breached the terms of the contract at the very threshold by late shipment of goods and by loading on board the vessel which was no longer to reach the port of Novorossiysk as the first port of discharge. ...[Therefore] it is very difficult to hold that property in the goods got transferred out and out to the buyers on shipment of the goods or when the shipping documents were handed over to the bank for negotiations of L/C. ... Even if the property in the goods is deemed to have transferred to the buyers, since there was no delivery of goods due to the fault of the sellers in shipment of the goods, firstly belatedly and then by a vessel that was not on way to Novorossiysk as the first port of discharge, the goods continued to be at risk of the sellers as they were in fault." (¶22-23)

The Supreme Court rejected Seller/Beneficiary's claim that Clause 4 of the contract was unconscionable and noted that
"[w]here experienced businessmen are involved in a commercial contract and the parties are not of unequal bargaining power, the agreed terms must ordinarily be respected as the parties may be taken to have had regard to the matters known to them. The sellers and the buyers in the present case are business persons having no unequal bargaining powers." (¶31)

[JEB/dm]

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