Hardship Clauses and Modification of Contracts in Light of COVID-19
Recently, after the massive and rapid spread of the Corona Virus known as COVID-19 and the World Health Organization’s announcement of the whole situation as a pandemic, whether material changes to the terms of any contract that are beyond the parties’ control, should be sufficient for the adaptation or modification of contract terms continue to occupy legal professionals.
The situation has been on the legal agenda in Turkey for a time now, especially due to the unpredictable inflation and devaluation fluctuations that affect the Turkish Lira, and the risky consequences that it has brought along when combined with the novel pandemic, began showing its affects in almost every sector in the last few months. The need for contract modifications has increased significantly with the economic instability weighing in on myriad businesses by each passing day. This article aims to highlight the alternative solutions to modifications and contract amendments and focuses on the legal basis in Turkish Law that the legal entities and real persons have in order to revise their contracts in the situation we are all facing today.
Author’s Note: Before calling for modifications in any type of contract, the original contract should be carefully evaluated and the clauses referring to adaptation or modification, if any exist, should be analyzed in detail.
As a consequence of unforeseeable changes, performance may become unbearable for one of the parties to an agreement and cause inequity for the aggrieved party, even if the performance may sometimes be possible (at a much higher cost). This inequity may be eliminated by the adaptation or modification of the contract in light of the recent developments, when and if the conditions allow for such changes. This article provides legal recommendations on when and under which conditions the parties may adapt or modify their contract and the procedure to be followed in order to do so under Turkish local law.
Modification Claims and Bona Fides Principle Requirements
One of the main legal theories behind contract modifications according to the principle of equity is that applying the law strictly in a situation where the underlying conditions have changed drastically will create an even greater injustice. The idea of “In order for me to keep my promise, the circumstances must be the same as when I promised it” underlies the aforementioned doctrine.
On the other hand, the principle of bona fides underlines the necessity of providing reliable and true information regarding to the new cost of performance. Other terms and conditions also do factor in besides the cost of performance in the evaluation by the judge of the modification claim. A price increase at the time of performance that is higher then what any prediction could have revealed at the time of contract formation is never an adequate reason by itself to claim adaptation. For example, the price modification claim for a rental agreement of an apartment unit is much more agreeable for both parties compared to the bank loan agreements. However, in adaptation requests regarding loan agreements, the principle for the protection of the vulnerable party is at the forefront. A modification request by the vulnerable party is much more likely to be evaluated favorably by courts.
Another element that should be taken into consideration regarding contract modification is the time factor. Contracts that call for a single occasion of performance and contracts that call for continuous performance are not subject to the same assessment for the evaluation of modification requests. Due to the fact that the fulfillment of performance and the term of the contract spread to a longer period, in contracts of continuous performance the modification request do arise much more frequently and it is much more likely that the court will acknowledge a hardship in the performance expected of the affected party.
Generally, under the Turkish Code of the Law of Obligations (Borclar Kanunu) the modification claims due to hardship fall under the scope of Article 138. Under the scope of this article, the basic requirements that need to be met in order for a modification request to be granted are as follow;
- The conditions must have changed after the contract was formed
- The conditions under which the parties entered into agreement must be included in the four corners of contract
- If the subsequent conditions were to be foreseen by the affected party, the affected party requesting modification would never have entered into the contract
- When the distribution of risk is taken into consideration, it must truly be unjust to expect the aggrieved party to adhere to the contract and perform
Article 138 of the Law of Obligations and the Requirements for Implementation
There is a list of requirements that needs to occur in order to request a modification. Not every misfortune or unpleasant surprise that a party encounters prior to or during performance will allow that party to request a modification or revision to the contract. In order to be able to use Article 138, an unforeseeable change of circumstances must occur and because of this unforeseeable change it must truly become unjust to expect the obligor to perform. Pursuant to the principle of bona fides, the ability of one party to perform o must be significantly impaired, and an imbalance must have occurred between the obligations of the parties as a result of an extraordinary situation. Furthermore, this unforeseeable change in circumstances must not be attributable to the obligor and this situation must occur after the formation of the contract. Article 138 of the Law of Obligations must be used as a last resort (ultima ratio) and an the modification evaluation must be made objectively by the courts.
Requirements for Adaptation in scope of Article 138 can be summarized in a more inclusive way as follows;
1st Requirement: The unforeseen change of circumstances must have occurred after the formation of the contract and must cause material alterations in the events that form the foundation of the contract.
2ndRequirement: The change that occurs must be is unforeseeable. Such that, if the parties to the contract have foreseen the event, they would have not entered into the contract or would have entered into a contract with different terms.
3rdRequirement: It must be unjust under the principle of bona fides to expect the aggrieved party to perform its obligations under the changed conditions.
There must, of course, be a causal relation between the change in circumstances and the essential terms of the contract transaction in order for the contract to be modified. The change in circumstances should impair the existing risk sharing balance between the parties significantly. Additionally, the situation must not be induced by the obligor and the obligor, must either not yet have performed its obligation or must have performed by reserving its rights arising from hardship conditions. There are theories that suggest the weakness in any one of these factors can be counterbalanced by the strength of x5another.
The disproportion between the parties’ obligations and the scope injustice of what is claimed to be a hardship will create for one of the parties given the essential elements of the transaction is probably the two most important elements in the judges’ consideration of modification claims.
Although the High Court in Turkey deems inflation and exchange rate fluctuations as foreseeable changes in Turkey’s economy, how certain situations will be evaluated may vary depending on the time of contact formation. Any existing or cyclical changes and conditions will be taken into account in the foreseeability calculation of courts. In the precontractual phase, matters such as whether the change that occurred has happened before must be taken into consideration. The economic and social status of the parties as well as their level of education or their respective positions in the sectors they operate are further important in this assessment.
Conclusion and Recommendations
When an extraordinary and unforeseeable change occurs post-contract formation, or in other words when a hardship arises under Article 138 in Turkey, the first step in any modification discussion should be to remember that this provision is not imperative. Therefore, if there is an adaptation clause included in the contract that should be applied primarily. There might be a positive or negative adaptation clause in the contract, and it would never hurt to add a renegotiation clause in case of a change in circumstances. The provisions in the contract would usually have limited application compared to the general applicability of Article 138. Thus, in the case that the contract provisions are not sufficient to prevent the unfairness, Article 138 can always be referred to as a backup provision to fill in the blanks. It is essential to quality the right to modification as a formative right of the aggrieved party taking into account the basis of the given transaction.
Consequently, the steps to follow when a modification request arises should be as follows;
- The first step should be to invite the counterparty to renegotiations. This is more of a duty in contract modification and adaptation and it should be complied with in order for the right to be claimed
- Best efforts should be employed during the renegotiations
- If the renegotiations do not lead to a solution, the aggrieved party may file a claim with the courts for modification and if modification will not be reasonable or possible at all given the circumstances then contract termination should be the last resort.
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