How to ensure payments under contracts

This short guide provides a general information on the possible effective methods of securing payments under contracts in Ukraine. This guide particularly addresses sales and supply contracts, yet the information herein can be useful with respect to other agreements.

Since one of the main purposes of application of the methods of securing payments under contracts is to protect oneself from bad faith conduct of the contract party, the most effective are those methods which allow to exclude the risk of such conduct by another party.

1. Advance payment

The simplest and one of the most effective methods to ensure for payments to be done in time is the advance payment as a condition of goods receipt. The prepayment is a common business practice and is widely used as a payment term in sales, supplies and services. There are no statutory limitations with respect to amount of a prepayment and its amount can be up to 100% of goods' cost. Of course, in cases when the prepayment is less than 100%, it allows to secure only that part of payment which is prepaid; the rest of the payment is not secured.

The prepayment can be especially recommended when a contract is concluded with a new customer and the level of trust between parties is therefore not high. In case when supply contracts are concluded, the prepayment can be done in installments in accordance with lots of goods delivered.

However, the prepayment, especially when it is done in significant amount, is the most risky form of settlements for a purchaser. Accordingly, a purchaser might expect the seller to provide him with corresponding collateral, i.e. bank guarantee, in order to secure his prepayment.

2. Letter of credit

Another method which can duly protect interests of both a seller and a purchaser, is an issuance of a letter of credit for the period of validity of the contract.
In case of settlements by means of a letter of credit, the purchaser's bank guarantees the payment or entrusts the executing bank to make a payment to the seller on the terms and conditions set out in the letter of credit. These conditions usually include submission of particular documents to confirm delivery of goods to the purchaser. When an uncovered letter of credit is issued, the emitting bank guarantees the payment even in cases if temporary there are no funds on the purchaser's account.

Since a letter of credit is a bank's obligation, not purchaser's one, it is a pretty reliable method to ensure payments. A confirmed letter of credit provides an additional obligation by another independent bank to pay under the documents named in the letter of credit.
Please note that a revocable letter of credit can be annulled by the emitting bank without prior notification given to the beneficiary upon the letter of credit, who is the seller under the contract. Therefore, only irrevocable letter of credit which can be annulled or changed only upon beneficiary's consent is a reliable method to ensure payments.

3. Pledge

A pledge is a sufficiently reliable method to secure obligations, however it can be used when a purchaser has an appropriate property which can be pledged. Besides, it should be taken into consideration that, although a pledge agreement for movable property does not require state registration, in cases when the same property is pledged under several pledge agreements, demands of the pledge holder under a registered pledge agreement shall be given priority.

Pledge is widely used when loan agreements are concluded in order to secure repayment of the loan. It is also applied to secure prepayments made by a purchaser under preliminary purchase agreements (e.g. real estate, corporate rights)

4. Other collateral

Bank warranties are usually provided against collateral (a pledge of property or deposit), at a charge. For this reasons, they are not commonly used.

Deposit is the payment made to secure an obligation. Deposit is to be returned by a creditor (a party who received a deposit) in double amount if he fails to fulfill its obligation; in case if an obligation is not fulfilled on at the debtor's fault, deposit shall be left with the creditor.
Deposit is often used when the preliminary contract is concluded in order to secure the conclusion of the principal contract in future. Deposit is usually used in sales contracts for immovable property or corporate rights and is not applied for current business transactions, i.e. supplies, whole sales or retail.  

Retention implies that a creditor who lawfully possesses a thing which is to be transferred to a debtor, in case when the debtor fails to fulfill his obligation (e.g. with respect to the payment) has the right to retain this thing until the obligation is fulfilled by the debtor. Retention clause does not need to be agreed by parties in a contract since the right for retention is expressly stipulated by law. The right for retention arises when the debtor delays the fulfillment of its obligation.
Retention clause is primarily used in construction. 

5. Other legal instruments

Although the Ukrainian civil legislation stipulates legal instruments which accelerate and simplify the process of possible future enforcement e.g. arbitration clause, a notarization of a contract which allows future enforcement even without court judgment on the basis of decision of the court of arbitration or notary's execution signature correspondingly, these methods still imply some level of cooperation by another party and cannot exclude the possibility of conscious delay by a contracting party. In fact, tools are available which can delay, prolong etc the procedure of debt recovering even if there are no valid reasons for that (appeal to the state court of a decision by arbitration court, objection to notary execution). Therefore, they cannot be considered as ones which secure creditor's interests to the full extent.

Furthermore, even in cases when beneficial arbitration decision or notary execution signature is received, the procedure of their enforcement can be long and not effective and where it is possible, is recommended to be avoided.  

A bill of exchange which can be issued only for actually delivered goods or services and should be stipulated by a contract as the term of payment, can also be enforced by a notary. However, bills of exchange are used as the kind of loan relationships, rather than the means of ensuring an obligation.



Karpov & Stifutin Attorneys at law, January 2012

This material does not constitute legal or other professional advice, should not be treated as such and is provided for general purposes only. We try to ensure that the content is accurate and up-to-date, but all users should seek appropriate legal advice before taking or holding back from any action. We accept no responsibility for loss which may arise from reliance on information contained herein.


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