Possible effects of covid-19 on contracts: hardship

The Covid-19 virus, which has affected the whole world, has brought our daily lives to a halt because of the danger it poses and it is expected to do so in the months ahead. As the virus keeps spreading faster and at higher rates compared to previous pandemics the world had faced, and due to the length of the treatment process, millions of people are encouraged to stay at their homes to prevent a possible collapse of the health sector. There is no doubt that the lack of active participation of millions to the economic life either because of illness or simply as a result of preventive measures for weeks or even months will have short and long-term effects on the supply chains, and the national and international trade relations. As a consequence, it is inevitable that many natural and legal persons will have a hard time fulfilling their contractual obligations, or will simply not be able to do so.

Under these difficult circumstances, which are expected to adversely affect the economies and especially trade relations, we have prepared this article to provide our readers with brief and essential information on the concept of hardship under the Turkish Code of Obligations and the rights of the contracting parties in such cases.

The Concept of Hardship

Firstly, we should note that the prevailing principle of the contracts law is pacta sundt servanda, which means that the parties are bound by their contract provisions and have to perform their obligations accordingly. However, in some cases, strict application of this principle has caused injustice and the legal systems have adopted different approaches in order to eliminate these, one of those being the concept of hardship regulated under article 138 of Turkish Code of Obligations (“TCO”), which provides:

• “If an extraordinary event occurs, that was not foreseen and could not be expected to have been foreseen by the parties at the time of the conclusion of the contract, due to reasons that are not attributable to the debtor and which alters the facts that existed at the time of the conclusion of the contract to the disadvantage of the debtor, to the extent that requesting performance would be contrary to the rule of good faith and if the debtor has not fulfilled its obligation or fulfilled its obligation by reserving its rights arising from the undue hardship caused in such performance, it may request from the court adaptation of the contract to the new circumstances and, if this is not possible, cancellation of the contract. For long-term contracts, the debtor shall be entitled to terminate the contract instead of cancellation.                                                This article shall also be applicable to foreign currency debts.”

In line with this article, in order for a situation to be deemed as hardship the following conditions should exist together:

• Occurrence of an extraordinary event that is not foreseen and could not be expected to have been foreseen by the parties at the time of the conclusion of the contract,

• The occurrence of this extraordinary event should not be attributable to the debtor,

• Alteration of the facts that existed at the time of the conclusion of the contract to the disadvantage of the debtor, to the extent that requesting performance would be contrary to the rule of good faith, and

• The obligation of the debtor should not have been performed or performed under reservation of rights arising from the undue hardship caused in such performance

There exists vast doctrine on this concept in the Continental European legal system to which Turkey belongs. However, to simplify the subject for our non-jurist readers, we intend to avoid complicated and conflicting legal arguments and instead focus on the explanation and application of the concept in light of the commonly supported views.

The first issue to be clarified is that hardship is different from the impossibility of performance that results in partial or total release from contractual obligations. As a matter of fact, although in case of impossibility, the debtor’s ability to perform is partially or completely eliminated; under hardship, the performance is still possible, it has however aggravated to the extent that requesting performance would be contrary to the rule of good faith and it would be appropriate to say that this aggravated situation has become a heavy burden on the obligated party, let alone providing the benefits expected from the relevant contract at the time of its conclusion.

In the current system, where the freedom of contract is fundamental, the parties may always amend their contracts as per the adaptation clauses included therein or re-negotiate their obligations in the absence of such clauses.¹ We recommend to our readers that, in order to eliminate any inconsistencies that may occur while amending contracts and any relevant future conflicts, these amendments should be dealt with by a legal professional by determination and amendment of all affected contract clauses.

In case where the parties fail to amend the contract through negotiations, the obligated party for which the performance has become a heavy burden, may apply to the Court and request the contract’s adaptation.²

Intervention of the Judge to the Contract

Upon request and in the event the conditions cited above are met, the judge may decide on the (i) adaptation and, if this is not possible, (ii) termination of the contract.

In the first option, the judge will decide on the adaptation based on the contract and/or any applicable provisions of law³. However, in the absence of any contract clause or provision or if the application of these fails to eliminate the imbalance between the parties, the judge, as a last resort, may adapt the contract based on his/her own interpretation of the parties’ will⁴. It should be kept in mind that the adaptation method is at the discretion of the judge⁵ and it may be a change in the quantity of the goods to be delivered, place of delivery, payment terms, payment amount etc., depending on the specifics of each case.⁶

On the other hand, where adaptation is not possible or would have no effect on the elimination of the imbalance between the parties, the judge would rule for the termination of the contract.⁷ For the contracts requiring instant performance (e.g. work, sales, etc.), the termination will have a retrospective effect and the parties’ obligations will come to an end, and the already performed obligations e.g. bank guarantee, performance guarantee etc. shall be returned; whereas for the contracts requiring continuous performance (e.g., lease, labour, insurance, etc.), termination shall only take effect in respect of future obligations but shall not affect obligations already performed.⁸

As always, we will be happy address and assist with any questions and queries you may have about this article or about the effects of the Covid-19 pandemic on your contracts generally.

¹ Başak Baysal, Sözleşmenin Uyarlanması BK m.138 Aşırı İfa Güçlüğü, güncellenmiş ve gözden geçirilmiş 3. bası, On İki Levha Yayıncılık, Ocak 2019, s.388.

² As per paragraph 1 of article 5/A of the Turkish Commercial Code, commercial cases related to the payment of a receivable or compensation are subject to mandatory mediation. To read our client alert dated 28 December 2018, please click here.

³ TCO provides several adaptation clauses for certain types of contracts: Art. 296, 344, 363, 480, 599.

⁴ Baysal, s.308; Gülmelahat Doğan, Aşırı İfa Güçlüğü Nedeniyle Sözleşmenin Değişen Koşullara Uyarlanması, Türkiye Barolar Birliği Dergisi, 111. Sayı, 2014 Mart- Nisan, s. 12; Elif Pak, Türk Borçlar Kanunu’nda Aşırı İfa Güçlüğü, Seçkin Yayıncılık, Ocak 2020, s.113.

⁵ Kemal Oğuzman, Turgut Öz, Borçlar Hukuku Genel Hükümler, gözden geçirilmiş 16. Bası, Vedat Kitapevi, Şubat 2018, para. 624, Baysal, s. 404.

⁶ Oğuzman, Öz, para. 625.

⁷ Oğuzman, Öz, para. 627, 628; Baysal, s. 408.

⁸ Baysal, s. 409, 410,411.