Section 1 of the Latvian Civil Law enunciates the general principle that rights are to be exercised and duties performed in good faith. 'In good faith' is also taken to mean 'in fairness.' Since the restoration of Latvian statehood, this principle of civil law has often been cited but relatively rarely used in practice. The gradual development of Latvian jurisprudence has however brought with it a tendency to more frequently invoke a duty of good faith or fairness. A trend toward giving it life has made its way not only into the Latvian court system, but thanks in part to the heightened court supervision of arbitral awards, into the arbitration system as well.
One area where 'good faith' and 'fairness' considerations are becoming increasing relevant is in penalty evaluation in debt recovery cases. Under Latvian Civil Law, it is possible to stipulate in a contract a penalty for failure to perform or failure to perform within a stipulated time period. In the case of failure to perform on a timely basis, the penalty is usually set at some amount of money per day until such time as performance is achieved. When it comes to cumulative interest payments, a limit to their sum total is set by law. Total interest is not permitted to exceed total principal. This is legally not so when it comes to the cumulative total of penalty payments, for which, on a strict interpretation of the law, the sky is the limit. But that is not the end of the story. Despite an absence of supporting black letter law, Latvian courts are not accepting the 'sky is the limit' approach, regardless of the content of the law.
What this means is that at least in some cases, Latvian courts are reading into the law a reasonableness requirement. One of those cases is the case of assessing the fairness of the scope of a contractual penalty for failure to perform on a timely basis. The courts are conceding that fairness may trump the content of a contract. This may be good news for the debtor in applicable cases. It is not great news for laissez faire purists, who would like to see upheld the rights of parties to set their own terms of contract without subsequent judicially imposed content revision. Nevertheless, the practice of judicial refusal to enforce what is considered to be an unconscionable provision is hardly unique to Latvia. What is more striking is that Latvian courts are now more frequently tending to depart from a strictly legalistic approach and delving into the question of fairness.
As a result, we see judicial intervention in the scope of penalties, finding that, for example, 1 percent of delayed payment amount is disproportionately high. In some cases, even a penalty of 0.5 percent of an unpaid amount for each day of delay is recognised as disproportionately high.
Courts are now also frowning upon the practice of a creditor sitting on its rights, waiting for late payment penalty amounts to accumulate and reach disproportionately high levels. If, for example, a court has ascertained that a requested penalty recovery is disproportionate to the amount of principal debt or if a creditor has wilfully delayed recovery of debt, the court is likely to consider not satisfying a claim for payment of penalty to the full extent requested by the creditor. The courts have no strict formula in such cases, and apply their discretion. Courts have been known to refuse to grant penalty payments in their full amount due to considerations of the bank interest rate amounts stipulated in the contract, or delay of a creditor in bringing a claim, or in consideration of the amount of the penalty stated in the loan agreement, or in consideration of the amount from which the penalty is requested.
In such cases, we see the courts increasingly willing to apply a fairness test. Where this will lead to is unclear. With the development of such case law, it is within the realm of possibilities that in debtor-creditor cases the 'penalty' as an institution of law may eventually disappear, at least within its classical meaning.
Martin Mezinskis is an associate at Kronbergs & Cukste, a member of Baltic Legal Solutions, a pan-Baltic integrated legal network of law firms which includes Glikman & Partnerid in Estonia and Jurevicius, Balciunas & Bartkus in Lithuania, dedicated to providing a quality 'one-stop shop' approach to clients'
needs in the Baltics.
