Regardless of the nature of the activities carried out by an economic operator, the drafting and conclusion of various types of contracts, as well as the negotiation of terms, are part of daily operations. Concluded contracts must be performed, obligations undertaken must be implemented, and the arising consequences must be managed. Contracts are the very legal tool used to create and regulate relations between both business entities and private individuals; however, even the interrelations of economic operators regulated by contracts, or the (non-)performance of contractual obligations, can lead to complex legal disputes, in the resolution of which law enforcement institutions are frequently involved or attempted to be involved.
Sham contracts can be very diverse. In certain cases, all parties to a contract agree to conclude a sham transaction (a “simulated transaction”), which aims to hide or mask a different type of transaction between the same parties, creating the appearance of a certain legal relationship. In other cases, only one of the parties concludes a transaction without intending to perform it, having no will to enter into it, but does not inform the other party, thereby misleading them.
Sham contracts can interest not only the counterparties but also state institutions
Contracts can be identified as sham if, although they meet formal requirements (concluded in writing or another form acceptable to the parties, confirmed by signatures, etc.), they contain information that does not correspond to reality, for example, regarding allegedly intended services, intended sales of goods, payment terms, or other performance conditions. In other words, the text of the contract records a situation or legal relationship that one or all parties have no intention of implementing in real life. The conclusion of such sham contracts—the deliberate recording of false information and a legal relationship not intended for implementation—can result not only in civil liability arising from non-performance but also, in certain cases, criminal liability for one or all parties to the sham contract.
In practice, cases are encountered where companies, seeking to “optimise” taxes related to wages, agree with highly paid employees that remuneration for their work functions will be paid not as a salary, but on the basis of service agreements. Such formal service agreements are concluded with other related companies, e.g., where the shareholder is that same highly paid employee. In such a case, two companies sign a service agreement that fictitiously states that certain services (usually consulting, “coaching”, management, or other services difficult to define and account for) will be provided, even though both parties know in advance that no services will be rendered, and the payment under the contract will actually represent the payment of a salary.
Practice shows that, in many cases, the “provision” of services is limited to the “service-providing company” issuing invoices and receiving payment. When it becomes necessary to substantiate the reality of the “rendered” services, both companies face difficulties. Agreements of this or a similar nature may also be concluded to fictitiously reduce company profits (e.g., by shifting profits to companies established in low-tax jurisdictions that allegedly provide certain services), to hide a different type of transaction, and so on. The conclusion of sham contracts and the imitation of their performance (issuing invoices, payment, entering accounting documents into the records, etc.) can lead to criminal and tax liability for the participating companies and their directors or employees. Legally, this can be assessed as fraudulent accounting, as an attempt to evade taxes related to wages, as a reduction of corporate income tax, and, in certain cases, as the squandering or misappropriation of company assets. If such a situation comes to the attention of law enforcement and criminal proceedings are initiated, they usually address not only the issue of criminal liability for legal and natural persons but also the recovery of the tax underpayment calculated by the State Tax Inspectorate (VMI), which is treated as damage caused by a crime.
Contracts that were never intended to be performed
When concluding contracts, it is possible that not both, but only one party acts maliciously, concealing its true intentions and deceiving or misleading the counterparty. This usually leads to losses and financial setbacks for the other party, which does not suspect the intent to default. The misled party, unaware of the other’s malicious intent or the fact that it does not intend to perform its contractual obligations, begins to perform the contract—for example, by paying for goods, services, or future works to be supplied, or by performing the works or delivering the goods itself—and, upon the other party’s avoidance of its obligations, suffers corresponding damage, while attempts to recover it can lead to additional costs.
If attempts to achieve compensation for damages through civil legal measures fail, the deceived party is left with the option of appealing to law enforcement institutions, hoping not only that the culprit will be identified and punished but also that compensation for damages will be achieved. Bearing in mind that criminal liability is considered the strictest form of legal liability and should only be applied as a last resort (ultima ratio) when protected legal interests cannot be defended by other legal means, law enforcement institutions are tasked with assessing whether a breach of contractual obligations has occurred that should be resolved by civil law measures, or whether it should be assessed as a criminal act.
In court practice, criteria have been established to assess when the non-performance or improper performance of contractual obligations should be considered a criminal act.
An essential element of fraud as a criminal act is the use of deception against the other party to the contract in order to acquire property or a property right by deceit, or to avoid a property obligation. In fraud, deception aims to mislead the owner, manager, or person in charge of the property. Deception may also manifest when one of the parties, clearly having no intention or even the capability to perform the contract, remains silent about or hides this information at the time of the contract’s conclusion. However, the deception used by the perpetrator must be essential, i.e., it must have a decisive influence on the person’s decision to carry out the aforementioned actions. Only essential, intentional deception can be considered criminal.
Another criterion is the possibility to defend violated rights through civil legal measures. Law enforcement institutions assess whether the party defaulting on the contract deliberately created a situation where the victim could not restore their violated right through civil legal measures or where such a method of defense would be significantly hampered. For example, if it is impossible to find or identify the person avoiding the obligation without the help of law enforcement, if the transaction was deliberately structured so that its true content could not later be proven, if a person borrowed money while concealing essential information about a heavy debt burden and insolvency, or if they deliberately became asset-less to avoid the claim, went into hiding, etc.
In one of the more recent cases of the Supreme Court of Lithuania, the cassation court upheld the decision of the lower courts regarding a crime committed within the framework of contractual relations. It was established that the convicted persons not only had a premeditated intent not to perform the concluded contracts and criminally misled foreign companies regarding their intentions but were also dishonest, presented themselves under false names, and used deception during the decision-making process of Chinese companies to enter into unfavorable transactions. Furthermore, once the buyers received the ordered goods—which did not correspond to the contract terms at all—and began to raise claims, the perpetrators ceased communication and failed to comply with demands to return the money paid. To defend their violated rights, the representatives of the foreign companies were forced to appeal to Lithuanian law enforcement. Thus, through their actions, the perpetrators created a situation where the method of defending the foreign companies’ violated rights was significantly hampered (Ruling of the Supreme Court of Lithuania in criminal case No. 2K-91-891/2025).
In such cases, an important criterion for distinguishing fraud from a civil law violation is the criterion of prudent, attentive, and diligent behavior of the victim, related to the victim’s characteristics and actions. The claim of deception may be refuted if the victim themselves acted with extreme negligence—for example, by transferring their property to another person while naively relying only on their goodwill, despite there being no basis or logical explanation for doing so.
Although the criteria for distinguishing criminal liability from civil legal relations are established, they are nevertheless not absolute and can be interpreted differently in every situation. Therefore, the boundary between these branches of law is not always clear, leaving significant room for interpretation. It is important to keep in mind that, quite often, the creation of civil legal relations is a cover to hide criminal intentions; thus, even what appears at first glance to be a classic civil law situation may hide criminal acts and consequences.
Prepared by dispute resolution experts and attorneys-at-law Dr Dovilė Murauskienė and Dr Linas Belevičius from the law firm Glimstedt.
