We would like to ensure that you are still receiving content that you find useful – please confirm that you would like to continue to receive ILO newsletters.
18 February 2020
Is a penalty for delayed performance enforceable if the purchaser fails to reserve its rights immediately? Or is enforceability excluded only if the purchaser expressly waives its right? This article analyses the Supreme Court's judgment in a recent construction dispute, in which the court appears to have maintained its estoppel-based practice despite recent legislative changes.
A German company delivered building blocks to a Hungarian city (the purchaser) within the framework of a flood prevention project. According to the contract concluded in January 2013, under the temporal scope of the Hungarian Civil Code 1959 (the former Civil Code),(1) the German supplier undertook to use steel stocks to store the blocks. The parties stipulated a penalty in case of any delay in the supplier's performance of its contractual obligations.
As often happens in the construction industry, the supplier delivered the blocks late, in instalments. The purchaser accepted the delayed delivery and although it complained about the lack of steel stocks, it did not make a reservation of rights to enforce the penalty based on the delay.
The supplier eventually delivered the steel stocks, after which the purchaser filed a penalty claim for the delay.
The purchaser sought payment of the contractual penalty, referring to the missed deadline set out in the contract.
The supplier contested its obligation to provide steel stocks and highlighted that the delay had not impeded the project's completion. The supplier also argued that despite knowing of the delay, the purchaser had failed to make a reservation of rights; therefore, it could not claim payment of the penalty at a later date.
The Szeged Regional Court awarded the penalty claim, holding that the building permit submitted by the supplier, which formed part of the contract, stated that the building blocks would be delivered in steel stocks. Due to its failure to deliver these stocks, the supplier had breached the contract. Therefore, the penalty claim was justified.
The Szeged Regional Court of Appeal upheld the first-instance decision. It held that under the former Civil Code, the purchaser had not been required to make a reservation of rights to enforce the claim arising from the breach of contract at a later date.(2)
According to the Szeged Regional Court of Appeal, an inverse legal situation existed: in the absence of an express waiver of the right, the penalty could be enforced.
Notably, the Szeged Regional Court of Appeal classified the parties' relationship as a long-term contractual legal relationship, which had lasted for several months, after which they had settled their accounts with each other. As such, the fact that the purchaser had not made a reservation of rights at the takeover was insignificant.
The supplier pursued an extraordinary remedy against the second-instance decision by submitting a request for review to the Supreme Court.
The Supreme Court found the supplier's request for review to be well-founded. According to the court, in demanding a reservation of rights in the former Civil Code, the legislature had intended that only breaches of contract which are considered sufficiently substantial and serious by the parties would have detrimental legal consequences.
Therefore, in the absence of a prior reservation of rights, the purchaser could not refer to conduct of the other party which could formally be characterised as a breach of contract, but did not in fact impede the contract's fulfilment. Gaining an unfair advantage in this way would be contrary to the principles of mutual cooperation and good faith, which apply during the fulfilment of a contract.
In the present case, the purchaser has lost its opportunity to impose penalties against the supplier for the delay because it had failed to expressly reserve its right to do so, despite being aware of the delay.
The main issue in this case is closely related to the common law device of estoppel. Based on the principle of estoppel, the courts may prevent (or 'estop') a person from making assertions or going back on their word.
One of the leading English cases on promissory estoppel involved a contract of sale for coffee beans. The contract required the beans to be paid for in pound sterling, but the purchaser paid in Kenyan shillings due to a wrongly issued invoice. However, the English court ruled that the purchaser could not challenge the performance of the contract as it had failed to raise an objection immediately.(3)
Similarly to the principle of estoppel, the former Civil Code expressly required obligees to make a reservation of rights to enforce rights referring to a known breach of contract. However, the new Civil Code,(4) which entered into force in March 2014, is silent on this matter.
Despite the fact that the present case was governed by the former Civil Code due to the contract date, the first and second-instance courts tried to interpret the old provisions in light of the new Civil Code and did not require a reservation of rights from the purchaser to enforce the penalty.
However, the Supreme Court has drawn a sharp line of demarcation between the old and new regime, maintaining the case law relating to the former Civil Code, according to which a purchaser which is aware of a breach of contract, but accepts the performance, must make a reservation of rights in order to enforce any further claims arising from the breach.
This approach of the Supreme Court is more compatible with the requirements of foreseeability and business reasonableness as it favours transparent communication, which is a key feature of the estoppel principle under common law.
However, in cases where the new Civil Code applies, a new trend is developing in the first and second-instance courts which is contrary to the estoppel principle.
According to this trend, only an express waiver of rights – and not "accepting performance and remaining silent" – deprives a purchaser from submitting further claims in case of a breach of contract.(5)
The question remains as to whether the Supreme Court will – in cases in which the new Civil Code applies – maintain the sharp line of demarcation between the old and new regime by upholding the case law developing in the first and second-instance courts.
In such cases, foreseeability and business reasonableness would be undermined and the law would support non-transparent communication. Indeed, it would be unexpected for a party to enforce further claims if it had accepted the performance and remained silent on the consequences of a contractual breach.
For this reason, it is hoped that the Supreme Court will maintain its estoppel-based jurisprudence by providing a praeter legem (ie, outside the law) interpretation of the new Civil Code.
For further information on this topic please contact Péter Korózs or Richard Schmidt at SMARTLEGAL Schmidt & Partners by telephone (+36 1 490 09 49) or email (firstname.lastname@example.org or email@example.com). The SMARTLEGAL Schmidt & Partners website can be accessed at www.smartlegal.hu.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
ILO is a premium online legal update service for major companies and law firms worldwide. In-house corporate counsel and other users of legal services, as well as law firm partners, qualify for a free subscription.