Penal Clause in Construction Contracts

A construction contract is a type of work contract in which the contractor constructs a building and transfers a fee or flat/land share to the employer. In practice, they are also referred to as construction contracts in return for flat or land share. Due to the size of the construction sector and the prevalence of construction contracts in Türkiye, many disputes arise in this area. What is expected in the concluded construction contracts is the timely fulfillment of the contractor’s obligation to “build the building and deliver it to the employer”. As a rule, if no delivery date has been determined, the contractor will be entitled to a fee when she/he delivers the building. However, this process does not always end as expected. The construction work itself is quite elaborate and complex. Sometimes due to reasons unforeseen by the parties and sometimes due to the fault of the parties, the obligations arising from the contract cannot be fulfilled or are fulfilled late. It is seen that foreseeing such risks in advance, they include the penalties to be paid in the event that one of the parties does not fulfill the debt arising from the contract at all or properly. Thus, the party that does not fulfill its contractual debt or is late in fulfilling it is obliged to pay or give the other party some amount of money or something of economic value as a penalty. Such conditions put into contracts are called penal clauses or penal clauses.

In this bulletin, explanations are given about the way the penal clause is regulated in construction contracts and the disputes that arise in practice in the light of judicial decisions.

1. The Concept of Penal Clause in General

A penalty clause is money or other economic benefits that the debtor agrees to pay if she/he does not fulfill her obligation at all or does not fulfill it in accordance with the agreed requirements. The purpose of penal clauses in contracts is to create an element of pressure for the debtor to fulfill her obligation. The debtor, who knows that she/he will pay a penalty if she/he does not fulfill her/his debt, will try not to act in this way and will pay more attention to fulfill her/his debt on time and properly.

The penal clause essentially has two main purposes (functions). One of them is to compel the debtor to perform and thus to secure the performance of the original debt; the other is to determine the compensation to be paid by the debtor in case of breach of the debt in advance and as a lump sum. Apart from these two main purposes, another purpose (condition) of the penal clause is to ensure that the debtor can easily withdraw from the contract by paying the penal clause in the penal clause that prevents performance (in the penalty of return and termination).

The penal clause is defined as a kind of secondary debt dependent on the main debt in the law of obligations. This means that the penal clause is dependent on the original debt, for which it is used as an element of pressure. The existence and validity of the penal clause depends on the existence and validity of the original debt. If the original debt exists and is valid, the penal clause also applies. However, if the original debt is invalid for any reason such as irregularity or impossibility, the penal clause cannot be valid either.

Even if there is no penal clause in the contract, when the debtor does not fulfill her/his debt at all or duly, the creditor may make demands from the debtor in accordance with the general provisions. For example, the creditor may still request the payment of the debt, the payment of delay compensation, the compensation of the loss by returning from the contract, or the compensation of all the losses by giving up the performance. However, in such cases, the creditor can claim compensation from the debtor only if she proves that she has suffered damage and the debtor’s fault. At this point, the advantage of penal clause is as follows; If the debtor does not pay his debt in the contract or does not pay it properly, the creditor may demand the amount of penal clause from the debtor without having to prove his loss. To put it more clearly, the creditor may demand the payment of the penal clause even if she/he has not suffered any damage. However, if the creditor has suffered more damage than the penal clause agreed in the contract, then she/he has to prove her loss and the fault of the debtor.

“Penal clause is an act that the debtor undertakes to perform against the creditor if she/he does not perform her original debt in the future, at all or properly. For this reason, penal clause is an auxiliary act that can only be born with the breach of this debt, depending on the main debt. If the debtor has committed to pay a penal clause, the creditor will now have the opportunity to obtain compensation without having to claim any damage or to prove the extent of the damage. The nature of the original debt is not important for the penal clause to be decided. As well as a debt of giving, a penal clause may be decided for debts of doing or not doing.” [1]

Penal clauses vary according to the way they are regulated in law and contracts. Accordingly, there are 3 types of penal clauses. These are;

  • Optional penal clause
  • Penal clause added to performance
  • Penal clause in lieu of performance

In the regulations included in the provisions of the Turkish Code of Obligations 179-182, it is emphasized that the types of penal clauses have different results. Which of the types listed in the Law falls within the scope of the penal clause agreed in a contract is determined by interpretation. If it is not agreed in the contract, the payment of penal clause cannot be demanded. Because the penal clause is different from the default interest.

“In order for the penal clause, as expressed in the law, to be asked for the penal clause, there must be a provision regarding this in the contract. Even if it is not agreed in the contract, in case of default, the creditor may request delay compensation pursuant to Article 125/I of the TCO, but in order for the penalty clause to be requested, there must be a clear provision in the contract.

1.1. Optional penal clause

An optional penal clause is a penal clause decided to be paid by the debtor in case of non-performance or incomplete fulfillment of a debt arising from a contract. Here, the payment of the penal clause is substituted for the unfulfilled debt. The creditor may demand either the fulfillment of the debt or the payment of the penal clause. The creditor must choose one of them. She/He cannot demand both the payment of the debt and the payment of the penal clause at the same time. In this case, it can be said that the optional penal clause can only be demanded in cases where the contract is terminated.

“In an optional penal clause, the creditor will not be able to demand both the performance of the original act and the payment of the penal clause. For example, if it is decided that if the seller does not deliver the goods she/he sells, the buyer may demand a penalty of 100.000 TL instead of the goods, the buyer may either request the delivery of the goods or the penalty condition. As can be seen, there is an optional right here, and the creditor can only request either the performance of the original debt or the payment of the penalty clause. As a rule, the creditor cannot demand both the performance of the main debt and the payment of the penalty condition at the same time. However, it should be noted right away that this right of choice granted to the creditor does not make any sense if the possibility of performance of the original debt disappears due to subsequent impossibility. When the performance of the original debt is impossible, the creditor has the right to seek compensation only if the conditions exist. Accordingly, the creditor requests either compensation for the loss or payment of the penalty condition.”

1.2. Penal clause added to performance

If the penal clause in the contract is foreseen for the non-fulfillment of the debt arising from the contract at the agreed place or time, not for the case of non-fulfillment of the debt at all or as required, the penal clause is considered to be the penal clause added to the performance. Here, the creditor can demand the payment of both the debt and the penal clause at the same time. For example, the penal clause that the contractor is agreed to pay for each day of delay in delivery is a penal clause added to the performance. However, if the creditor accepts the performance of the debt without any objection, she loses her right to demand the penal clause. In order for the creditor to claim the penal clause, she must have reserved the right to demand a penal clause while accepting it.

 “Reserving the right to demand punishment (reservation, reservation) is a statement of will that creates innovation and must be made clearly at the time of performance. Retention may be made with a record to be recorded in the delivery-acceptance report, or with a written notification to be made before acceptance of performance, or with an action or transaction that indicates this, such as payment of the work cost by deducting a penalty.[2]

Unlike the optional penal clause, the penal clause added to the performance cannot be demanded in case of termination of the contract. Because this time, the penal clause added to the performance does not replace the debt arising from the contract, it functions as a kind of positive compensation for the losses incurred by the creditor.

1.3. Penal Clause Preventing Performance

The penal clause that prevents performance is also called withdrawal penalty.

“Here, the right to prove that the debtor has the right to unilaterally withdraw from the contract by paying the penal clause is reserved. Thus, in the agreement with the creditor, the debtor can decide to withdraw from the contract and pay only the penal clause to the creditor. In such a penal clause, the debtor may withdraw from the contract by paying the penalty, and the creditor may only demand the payment of the penal clause. In this case, the creditor will no longer be able to demand the performance of the original act from the debtor.”[3]

The rules regarding the penal clause briefly mentioned above are not regulated in an imperative manner in the Law. The parties can make contracts contrary to these regulations, if they do not, the rules described regarding the penal clause will be valid.  For example, the parties may decide on an optional penalty condition for non-performance of the debt at the specified time or place.

2. Penal Conditions and Application in Construction Contracts

As a rule, it is possible to stipulate penal clauses in construction contracts, as in all types of contracts. In the construction contracts, it is foreseen that the contractor will pay a penal clause to the employer, especially if the contractor does not perform the construction and delivery debt of the building at all or does not perform it on time. In such contracts, there are more penal clauses added to the performance. For example, if it is decided to pay 20,000 TL to the employer for each month of delay in delivery, there is a penal clause added to the performance, and in practice this type of penal clause is usually imposed. In this case, the employer can demand from the contractor both the completion and delivery of the construction and the payment of the penalty stipulated in the contract at the same time. The point to be noted here is that:

If a penal clause has been agreed in the contract for the possibility that the contractor will not deliver the construction on time, this condition is a penal clause added to the performance unless otherwise agreed by the parties. In this case, the employer may demand both the completion of the construction and the payment of the penal clause from the contractor.

If a penal clause is stipulated in the contract for the contractor to make no or incomplete work, this penal clause is accepted as an optional penal clause unless otherwise agreed by the parties to the contract. In this case, the employer may demand either the completion and delivery of the construction or the payment of the penal clause, but not both at the same time. In the contract, it can be decided that if the contractor does not complete the construction, she/he will both fulfill this debt and pay a penal clause. In this case, the employer is entitled to direct both requests to the contractor at the same time.

In order for the employer to request a penal clause from the contractor, the contractor must be defective in failing to fulfill its construction and delivery debt. But this rule can be decided otherwise. Another consequence from this is that if the contractor’s delay in delivering the construction is based on a reason, no penal clause can be demanded. For example, if the contractor has not been able to perform her/his debt due to the employer’s failure to fulfill her/his obligations, it is not possible to demand a penal clause from the contractor.

One of the most important issues for the employer who wants to request a penal clause is to reserve the right to demand a penal clause when receiving the construction. If the employer receives the construction from the contractor without any objection, it is deemed to have waived the penalty clause implicitly. For this reason, the employer must notify the contractor that she/he wants a penal clause before the delivery of the construction or at the latest during the delivery. The notification does not have to be made in writing. The important thing is that the notification is clear.

Below are examples of Supreme Court decisions on the subject;

“The compensation agreed to be paid in case of non-performance or incomplete performance of the contract is an optional penalty regulated in Article 179/1 of the TCO. When the optional penalty becomes demandable, the creditor will either demand performance or demand the optional penalty that replaces the performance benefit. If the creditor demands performance, it is not possible for her to demand an optional penalty. Again, in the event that the work is not completed and delivered within the time agreed in the contract, the creditor who does not terminate the contract may request the damages arising from the delay by waiting for the performance according to Article 125/I of the TCO.”[4]

In the 5th article of the “amendment contract in the form of arrangement” signed between the parties on 11.04.2002, it is written as follows: “On 30.08.2002 (except for force majeure), the elevator in the A block will operate, a temporary occupancy report will be obtained, the roof will be insulated, all the conditions in the previous contract will be fulfilled, the landscaping will be done, the heater will be in a state of fire, the property will be taken over, and it will be removed from the construction view. Otherwise, the cooperative is obliged to pay compensation of 30.000,00 TL to the land owners.” This penalty in the contract is not an optional penalty, but a penalty added to the performance. According to Article 179/II of the TCO, if the parties have decided to pay a penalty to be paid in case the contract is not executed at a certain time or at the agreed place, there is a penal clause added to the performance. The scope of the file, which the plaintiff received before the time stipulated in article 5 of the amendment agreement and rented it to third parties, is fixed by the evidence. Since the plaintiff could not claim and prove that she/he made a reservation (reserving the right to demand penal clause) while receiving her/his apartments (while accepting the performance), her/his right to demand a penal clause was dropped. ”[5]

3. Penal Condition-Delay Compensation Difference

The penal clause in the contract and the cash compensation are different from each other. There is no need to register a reservation for a claim for cash compensation. This point is emphasized in the Supreme Court decisions as follows;

“The lawsuit has arisen from the contract of work and is related to the cancellation of the objection made to the execution proceeding without judgment and the request for the continuation of the proceeding made for the collection of the delay compensation due to the fact that the work was not completed and delivered on the date agreed in the contract. In the ‘D’ article of the contract, it is stated that the monthly amount that the plaintiff may request in case of delay is the rent, and the amount to be paid by the defendant is the delay penalty. At first glance, although there is hesitation about whether it is a delay compensation or a delay penalty; since the judge will automatically apply the Turkish Laws (law) according to the 76 of the HUMK no. 1086 and the 33rd article of the HMK no. 6100, it is up to the parties to assert and prove the material facts, since the legal qualification belongs to the judge, It has been accepted by the majority of the General Assembly of the Law that what is agreed in the ‘D’ article of the contract is not the penalty clause attached to the performance regulated in Article 158/II of the UK No. 818 in force at the date of the contract and the lawsuit but delay compensation, which is stipulated in Article 106/II of the same Law and is also called rent loss-rent compensation in practice. As explained above, there is no need to register a reservation in delivery in order to claim delay compensation. Even if the work is received without making a reservation, delay compensation may be requested during the statute of limitations.

In cases where the occupancy permit (occupation permit) is left to the contractor, as in the concrete case, since the owner cannot be forced to actually use the independent section for which the occupancy permit is not obtained even if it is actually received, the contractor’s responsibility for delay compensation continues as long as it is not actually used by him/her or economic benefit is obtained by leasing it. Although it is understood from the documents in the file that the plaintiff actually took delivery of the villa, it could not be proven that she/he provided economic benefit by living or renting out. For this reason, since the occupancy permit was not obtained, the plaintiff employer is right to demand the agreed delay compensation from the defendant contractor as of December 2005.”[6]

Conclusion

There are frequent disputes about the penal clause in construction contracts. Some of these are due to the fact that there is not enough clear provision when drawing up the contract, and some of them arise from the fact that the performance has been accepted without any reservation. At this point, it is important to know the legal regulations regarding the penal clause. Arranging contracts by taking into account the legal regulations and the comments made by the courts in judicial decisions is effective in preventing disputes that may arise later.

You can contact our team to learn more about penal clauses in construction contracts or to request consultancy.

Best Regards.

References

Erhan GÜNAY, (2021), Arsa Payı Karşılığı İnşaat Yapım Sözleşmesinden Kaynaklanan Uyuşmazlıklar, Seçkin Yayıncılık, Ankara.

İlker Hasan DUMAN, (2021), İnşaat Hukuku, Seçkin Yayıncılık, Ankara.

Numan TEKELİOĞLU, “İnşaat Sözleşmelerinde Cezai Şart Ve Götürü Tazminat”, YBHD, Yıl:2, Sayı: 2017/2, s. 159–186.

Supreme court assembly of civil chambers, 2017/2245 E., 2021/880 K.

Supreme court assembly of civil chambers,  27.04.2011, 118/234.

15th Civil Chamber of the Supreme Court, 28.10.2004, 1465/5468.

Supreme court assembly of civil chambers, 2013/1140 E., 2014/905 K. 

[1] Supreme court assembly of civil chambers, 2017/2245 E., 2021/880 K.

[2] Supreme court assembly of civil chambers, 2017/2245 E., 2021/880 K.

[3] Supreme court assembly of civil chambers, 2017/2245 E., 2021/880 K.

[4] Supreme court assembly of civil chambers,  27.04.2011, 118/234.

[5] 15th Civil Chamber of the Supreme Court, 28.10.2004, 1465/5468.

[6]Supreme court assembly of civil chambers, 2013/1140 E., 2014/905 K.

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