October 17, 2024

Legal Nature Of Penalty Clause And Claims For Compensation For Excessive Damages

INTRODUCTION

In the contracts concluded nowadays, the current economic uncertainties lead the parties to the contracts to add a penalty clause. In other words, the penalty clause is used to force the debtor to fulfill its contractual obligations as required. In this context, it is possible to agree on the penalty clause both within the contract and/or with a separate contract. Within the scope of this article, the legal nature of the penalty clause and its demand with compensation claims in case of failure to perform or termination of the contract will be explained.

CONCEPT, TYPES AND LEGAL NATURE OF PENALTY CLAUSE

The penalty clause is regulated between Articles 179 and 182 of the Turkish Code of Obligations No. 6098 (“Code of Obligations”) and secures the creditor in contractual obligations. The purpose of the creditor in the debt relationship is to ensure that the debt is fulfilled as agreed or contracted. The creditor may want to secure its receivable by taking into account the possibility that the debtor may not fulfill its obligation at all or as required. Since the penalty amounts agreed in the penalty clause are generally higher than the amount of compensation that may be requested in case of non-performance, the debtor will make more effort to fulfill its contractual obligation in order to avoid paying this penalty amount. Within the scope of Article 179 of the Code of Obligations, the penalty clause is regulated as follows: “If a penalty is agreed for the failure to perform a contract at all or properly, the creditor may demand either the performance of the debt or the penalty, unless otherwise understood from the contract”. In this context, the penalty clause is an ancillary performance that depends on the principal obligation but arises in case of breach or non-performance of the principal obligation. In the event that a penalty clause is agreed upon by the contract, the party in the position of the creditor will not be obliged to prove that it has suffered any damage or the amount of this damage. The penalty clause will arise in the event of non-performance of the obligation.

Under the Law of Obligations, penalty clauses appear in three forms: (i) optional penalty clauses, (ii), penalty clauses instead of performance and (iii) penalty clauses included in performance.

(i) Optional Penalty Clause

The optional penalty clause appears in the first paragraph of Article 179 of the Code of Obligations. Within the scope of the relevant article, in the event that the contract is not performed at all or as required, the agreed fixed amount is paid to the creditor. It should be noted that this optional right does not give the debtor the opportunity to discharge the obligation by paying the penalty clause, but gives the creditor the authority or the optional right to discharge the obligation. The creditor also has the right to request the performance of the performance in kind as agreed in the contract. Since the creditor is given the right to choose, it is called an optional penalty clause.

(ii) Penalty Clauses Instead of Performance

Penalty clause instead of performance appears in the third paragraph of Article 179 of the Code of Obligations. Although the penalty clause, as a rule, forces the debtor to fulfill its obligation, the optional right that appears in the first paragraph of the relevant article belongs to the debtor this time. The debtor may refrain from performance by paying the penalty clause, without the debtor having to violate the obligation or the contract. In the doctrine, this form of penalty clause is also referred to as the penalty of withdrawal, since it saves the debtor from performance.

(iii) Penalty Clause Included in Performance

This type of penalty clause is not explicitly included by the legislator. In the doctrine, expressions such as penalty clause added to the performance, contractual penalty that may be requested together with the performance are used. In the second paragraph of Article 179 of the Code of Obligations, in summary, in the event that the debtor violates the obligation imposed on the debtor by the contract, the creditor may demand from the debtor both the performance in kind and the payment of the penalty clause agreed in the contract. Compared to the optional penalty clause, the creditor is not obliged to make a choice in this case. Due to the legal structure of the penalty clause, the creditor can demand both the performance and the payment of the price agreed with the penalty clause without having to prove that he has suffered damage.  The purpose of the penalty clause added to the performance is to compensate the damages that will occur before the creditor due to the debtor’s failure to fulfill its obligation as required. This type of penalty clause is the most common type of penalty clause in practice, especially in the late performance of the debt, and finds application especially in the prohibition of competition. The penalty clause attached to the performance is dependent on the principal debt until it becomes due. In this context, the creditor may demand the penalty clause added to the performance if the debtor fails to perform at the time or place agreed upon by the contract.

PENALTY CLAUSE AND COMPENSATION OF DAMAGES

Under the Code of Obligations, in case a penalty clause is agreed, as a rule, the creditor is not obliged to prove that the damage has occurred or that the debtor is at fault in order to claim the penalty clause. This is stipulated in the first paragraph of Article 180 of the Code of Obligations. In the event of non-performance or non-performance of the obligation as agreed between the parties, the debtor shall be obliged to pay the penalty amount to the creditor. At this point, it is necessary to discuss the compensation of damages exceeding the penalty amount and the reduction of exorbitant penalty amounts.

(i) Compensation for Damages in Excess of the Penalty Clause Amount

Although the creditor has the right to claim the penalty clause due to the debtor’s non-performance, in practice, in certain cases, the damage caused to the creditor may exceed the amount of the penalty clause in question. As a rule, the creditor is not obliged to prove the damage or defect caused by the non-performance of the contract. The legislator has not accepted the principle of absolute combination of penalty and compensation. In case of excessive damage, the creditor may claim compensation in proportion to the part exceeding the penalty clause amount. However, in this context, the creditor must prove that the debtor is at fault in not proving its debt for the excessive damage.

A controversial issue in the doctrine in the context of compensation for damages exceeding the amount of the penalty clause is whether the compensation exceeding the amount of the penalty can be claimed in the rescission penalty. According to the established jurisprudence of the Court of Cassation, the debtor may exercise the right of rescission by paying the penalty amount agreed upon in the contract. Therefore, the creditor will not have the right to compensate for the excess damage. 

“In the practices of our Chamber, it has been accepted that in the event of termination of the contract, the other party can only claim the negative damages and cannot claim the positive damages, and if a return penalty is agreed in the contract for the damages to be incurred in case of termination, it can claim the agreed penalty, and cannot claim the damages exceeding the penalty. (Example: Court of Cassation 15th HD 28.09.2010 T. 2010/4150 E. 2010/4834 K.) This acceptance is the result of the idea that all the damages of the other party are covered by the return penalty.” [Decision of the 6th Civil Chamber of the Court of Appeal dated 25.04.2022 and numbered 2022/578E. 2022/2390K.]

Another controversial issue is related to default interest. Default interest is an obligation directly related to the failure to perform in a timely manner, which starts to run automatically due to the default of the debtor in money debts and continues to exist during the default period. Default interest arises from the law and arises when the debtor fails to fulfill its debt on time. In the event that the penalty clause is agreed upon by the parties in the contract, the penalty fee may be claimed by the creditor, but the fault must be proved for the part exceeding and belonging to the default interest.

(ii) Request for Reduction of Excessive Penalty Charge

The parties may determine their obligations under the contract in accordance with the principles of contract and freedom of will. However, in practice, considering the principle of pacta sunt servanda, it is not possible to make changes unilaterally after the conclusion of the contract. Considering economic fluctuations, market conditions and similar reasons, the penalty clause may be requested to be reduced by the judge. If there is a clear injustice against one party to the contract, the penalty clause agreed by the judge may be reduced to a reasonable extent. Pursuant to the last provision of Article 182 of the Code of Obligations, the judge shall automatically reduce the penalty clause that the judge deems excessive, but there is no regulation regarding the criteria to be applied. In determining the excessive penalty clause; the economic situation of the parties, the solvency of the debtor as the principal, the reasonable and fair measure between the creditor’s interest in the performance of the principal obligation and the interest of the creditor in the payment of the penalty clause, the damage suffered by the creditor due to the breach of the contract, the benefit provided by the debtor due to the failure of the debtor to fulfill their debt, the degree of fault of the debtor.

CONCLUSION

Penalty clauses appear in practice in order to ensure the fulfillment of the obligation as agreed or contracted and to provide assurance to the creditor. Basically, the Code of Obligations includes three types of this assurance, which are optional penalty clause, penalty clause instead of performance and penalty clause included in the performance. The creditor may choose the fulfillment of the penalty clause or the performance of the main performance agreed in the contract by using their optional rights, or he/she may demand the fulfillment of both within the freedom of contract. In the penalty clause instead of performance, the right to refrain from the performance of the performance agreed in the contract in return for the fulfillment of the penalty clause, in other words, the right to return. In our law, the legislator has not accepted the cumulative claims for penalty clause and compensation. In this context, in the event that there are damages exceeding the penalty clause agreed by the parties within the scope of the contract, the creditor will be able to eliminate the excessive damage to the extent that the debtor proves the fault of the debtor and the damage incurred. Although there are debates in the doctrine in terms of the penalty for rescission, the opinion predominantly accepted by the Court of Appeal is that the creditor cannot claim compensation due to the debtor’s exercise of the right of rescission. Even if a penalty clause has been agreed between the parties in order to force the debtor to perform and to secure the creditor within the scope of the contract and freedom of will, in case of exorbitant penalty clauses, it may be possible for the judge to reduce these clauses. In this context, although the legislator has not drawn a clear framework in terms of the discretion of the judge, it is possible to reduce the penalty clause to reasonable measures by evaluating the conditions of the concrete event.

Authors

Nigar Guliyeva

Nigar Guliyeva

Senior Lawyer

Elif Akman

Elif Akman

Lawyer