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In Both Germany And Turkey, Penalty Conditions Are Tools That Give Shape To A Contract.


Importance of Penalty Conditions

Often parties do not operate strictly within their contractual obligations. To achieve compliance, penalty conditions are included in contracts. Penalty conditions are not only for legal protections but are also a tool to shape behaviour. To ensure that the obligations are met, penalty conditions apply pressure to parties and motivate compliance. This kind of pressure is most commonly found in contracts involving elements of competition, confidentiality, contracts for service, contracts with specific time requirements, and in general in every contract where the obligation involving significant time or money. Therefore penalty conditions will always be found in commercial contracts.


Definition

A penalty condition is a clause in an agreement where one or more parties agrees to pay a certain sum of money or perform an action if he or she fails to fulfil their obligations under a contract. In general parties choose money as the most common form of penalty but the law leaves it open for parties to choose the most approprıate remedy, financial or otherwise. Paragraph 339 of the German Civil Code, contains similar provisions as found in the Turkish Civil Code concerning penalty conditions. Like in Turkey, in Germany penalty conditions are similarly understood to apply pressure to parties and act as a preventative measure to ensure contractual compliance. Should those conditions be breached, it is normal for financial penalties to be applied.


Benefit

The relationship between penalty and loss is regulated by Turkish Obligation law at paragraph 180. This regulation makes it clear that even if the claiming party has suffered no actual loss, they are able to enforce their rights with regard to penalty conditions. The advantage of these penalties is that loss does not need to be proved. This means penalty conditions provide more legal protection than indemnity clauses. In fact, it is often very difficult to prove a causal connection between the actions of one party and the loss. It can also be an expensive and time consuming exercise to prove loss. Therefore these penalty conditions provide effective protection in commercial contracts.


Fault

Turkey uses strict liability in penalty conditions, every degree of fault is sufficient to claim under a penalty condition clause. The law says that once the claiming party can prove breach, the burden of proof shifts to the other party to prove they had no fault. This differs from the German law in regard to the question of fault. Under paragraph 339 of the German Civil Code, the lower degree of fault is not sufficient to claim a penalty. The German law does not facilitate the shift in the burden of proof away from the claiming party, however it would of course be possible for parties to allow for such a shift in their contract. The German law requires the claiming party to prove noncompliance to the contractual obligation and also prove that there was an element of fault. While there is a difference in law, it is possible in both countries to contract penalty conditions without the need for fault. This freedom does not exist when using standard form contracts.


Financial Penalty Amount and its Reduction

In both countries the parties are able to choose any amount for contractual penalties. In Turkey the general rule is that a Court is able to reduce the amount using its sole discretion. In Germany a Court needs to receive a claim from the defendant before it can reduce the penalty amount, paragraph 343 German Civil Code. It is interesting that both systems have the discretion to reduce the amount of the financial penalty. However, in Turkey there is more protection of the defendant as a Court has the discretion to reduce the financial penalty without a claim being.
Importantly, in commercial law this rule does not exist, there is no ability of a Court to reduce the amount payable. This exception to the general rule exists in both jurisdictions, German Civil Code paragraph 348 and the New Turkish Commercial Code paragraph 22. This exception shows on the one hand that it is easy to use these penalties in commercial contract and also how important it is to draft these clauses as a Court cannot intervene.


Indemnity for actual loss

In both systems it is possible for the loss to be indemnified if the actual loss is higher than the penalty amount, German Civil Code paragraph 341 and 340 and Turkish Obligation Law 180. This makes it possible for a party to convince the other party to sign with a lower penalty amount but retain protection through the use of an indemnity. For the party that has to pay the penalty, it is often impossible to get them to sign a contract with high penalty amounts so it is a considerable advantage to also use an indemnity for worst case scenario. Finally, the claiming party can negotiate with very low payment amounts but while still protecting themselves against risk.


Conclusion

In both systems, penalty conditions should be used in every contact where the content has particular importance. Parties who use penalty conditions will have advantages under both systems despite the small differences under each jurisdiction. Contractual penalties that do not require loss, do not risk indemnity rights and that do not require a high level of fault, minimise the risk of doing business. Using these in unison with indemnity clauses creates a sound environment to conduct business.