• Contractual Penalty under Turkish Law
  • February 10, 2017
  • Law Firm: Erdem Erdem Law Office - Istanbul Office
  • The False Claims Act (FCA) has long been the United States Government most effective tool for dealing with fraud in government contracting, and that tool is now more powerful than ever. Originally enacted during the Civil War to combat war profiteers, it allows the government to seek criminal and civil penalties. As a reward to those who report fraud, it allows relators to recover between 15 and 30% of the amount recovered on behalf of the government, plus their attorney’s fees. A claim subject to the FCA is broadly interpreted to include just about any statement submitted to the government in order to obtain payment. Each false FCA violation is punishable with up to five years in prison, and 10 years if it involves a conspiracy. In addition, each violation is subject to civil penalties of treble damages, plus a fine. In each of the last four years, the Department of Justice recovered more than $3.5 Billion from FCA cases. [1]

    The Government’s recovery under the FCA is sure to rise as this summer, the Department of Justice published an interim rule effective August 1, 2016 nearly doubling the fine applicable for each false statement. [2] This rule adjusts the minimum per-claim penalty from $5,500 to $10,781, and the maximum per-claim penalty from $11,000 to $21,563. Anyone doing business with the Government is likely to make repeated statements to the government subject to the FCA during the course of a contract, making this increase a huge liability exposure for potential violators. While these increased fines may open the door to an argument that they violate the United States Constitution’s Eighth Amendment prohibition on excessive fines, in most situations it will give government investigators and private relators increased leverage in costly settlements discussions and criminal prosecutions.

    This summer, the United States Supreme Court also weighed in on the expansive scope of the False Claims Act. In Universal Health Services, Inc. v. United States, [3] a healthcare provider billed the government through the Medicaid program for providing specific mental health professional services. However, many of the individuals providing these services were not properly licensed. While the healthcare provider did not make an express statement to the government about the licensure of these individuals, the Supreme Court found under the “implied false certification theory” that the bills can be a basis for a violation under the FCA. A violation exists if a “claim” makes a specific representation about the goods or services provided, and the company fails to disclose noncompliance with material statutory, regulatory or contractual requirements. In other words, material omissions or half-truths can trigger FCA liability just as much as an affirmative false statement. Now that the Supreme Court has approved of the “implied false certification theory,” the Government has broadened powers to enforce the FCA in many situations involving government contracting.

    If increased fines and stricter interpretation is not enough to make companies take notice of the FCA, then increased enforcement activities should certainly get their attention. Contractors fraudulently using Disadvantaged Business Enterprise (DBE) programs have been the subject of numerous investigations and settlements over the last year. Contractors have been suspended, debarred, and convicted for using a DBE entity as a pass through scheme to flow money from government contracts to non-DBE entities. Granite Construction, Inc. will pay over $8.25 Million in fines and forfeitures where Granite conspired to make it look like a DBE company was performing work, when it was providing no commercially useful function. [4] Ahern Painting Contractors, Inc. was suspended by the U.S. Department of Transportation for using a DBE to pass through materials from a non-DBE supplier for a bridge maintenance, repair and painting contract in New York. [5] Sound Solutions Windows & Doors LLC was fined $5.8 million under the
    FCA and FCJ Real Estate Development Company was debarred for 3 years for using a pass-through entity “to obtain the appearance of DBE participation” on an FAA funded contract at Chicago’s O’Hare International Airport. [6] Also in Chicago, Elizabeth Perino was convicted in a DBE pass-through fraud scheme where she falsified certain documents to disguise that her company did not meet DBE requirements and conspired to make it appear that it had performed work really performed by the prime contractor. [7] In March, Philadelphia based contractor, Markias, Inc. was suspended for an alleged pass-through conspiracy on two federal funded bridge renovation projects. [8] In July, a DBE owner plead guilty to using her company to obtain kickbacks for herself, while not providing any services on a bridge project. [9] In Idaho, Elaine Martin was recently sentenced to 84 months in prison and her companies debarred for submitting false applications to participate in DBE programs. [10] Finally, The Department of Justice is now suing the CEO and CFO of a company that already paid a $50.6 million fine under the FCA for overbilling services on reconstruction contracts in Afghanistan, Iraq and other countries. [11]

    The False Claims Act is the Government’s most powerful tool used to combat fraud and abuse in contracting with the government. Contractors should beware that increased penalties, broad interpretation by courts and increased investigations have made the FCA even more powerful and a fearsome weapon to combat fraud that must be respected.

    Introduction

    A contractual penalty, or penal clause, is used as a mechanism to force a debtor to duly fulfil its obligations under a contract. Whereas a creditor may claim its damages in accordance with the general provisions of the law of obligations, having a contractual penalty provision set forth under a contract eliminates the obligation to prove the damages, and enables the creditor to claim a pre-determined and precise penalty amount. Contractual penalties are widely used in practice, especially in contracts with high values. The following sections of this newsletter article explain the legal characteristics and types of contractual penalties, as well as the amount, invalidity, and reduction of penalty.

    Legal Characteristic and Features of Contractual Penalty

    Although a contractual penalty is a type of performance obligation that is subject to a dilatory condition, since it is specifically regulated under Turkish Code of Obligations numbered 6098[1] (“TCO”), it is primarily subject to these provisions, instead of the provisions regulating the conditions[2].

    Parties to an agreement consent to a penalty in cases where the primary obligation is not fulfilled; therefore, a penal clause is not a stand-alone clause. A penalty obligation is subject to a primary obligation, and can be regulated for any type of obligation, except for the obligations that are explicitly prohibited from being subject to a penalty, such as the obligation of rental payment for residential and enclosed workplaces, or penal clauses that are to the detriment of the consumer in consumer contracts. Further, agreements stipulating that the guarantor shall also be liable under contractual penalty are null and void. As per Article 182/2 of the TCO, if a primary obligation is invalid for any reason or, unless otherwise agreed, later becomes impossible to fulfil due to a reason not attributable to the debtor, the creditor cannot claim the fulfilment of the penalty. The invalidity of the primary obligation may be due to, among other things, violation of the law, ethics and personal rights, as well as non-compliance with its formal requirements, or lack of legal competence. If the contract for the primary obligation is subject to a formal requirement, a penal clause must be also agreed to through following the same formal requirement.

    Similar to the primary obligation, any type of penalty can be regulated under a contract. Although the majority of the time monetary penalties are preferred, in practice, other forms of penalties, such as the obligations to give, to do, or not to do are also possible, save for obligations that are in violation of the law, ethics and personal rights. Notwithstanding, Article 182/2 of the TCO sets forth that the penal clause being rendered invalid, or later becoming impossible to fulfill due to a reason not attributable to the debtor shall not affect the validity of the primary obligation.

    Relationship of Contractual Penalty with the Fault of the Debtor and Damages of the Creditor

    If an obligation is not duly fulfilled, or not fulfilled at all, the debtor is responsible to recover the damages of the creditor, unless it proves that no fault can be attributed to it. In accordance with this general principle of the Turkish law of obligations, claiming the contractual penalty is subject to the existence of debtor’s fault. Article 182/2 of the TCO explicitly clarifies this by regulating that the debtor shall not be liable for the contractual penalty if its obligation becomes impossible to fulfil without its fault yet allows the parties to agree otherwise under the contract. Following the evidentiary rule, it is sufficient for the creditor to prove that the obligation has not been duly fulfilled, but not the fault of the debtor.

    The most distinctive characteristic of penal clauses is that unlike the debtor being at fault, the creditor does not have to suffer damages in order to enjoy compensation through the penalty clause. As per Article 180/1 of the TCO, even if the creditor has not suffered any losses, the penalty obligation must be fulfilled. Similarly, the degree of damages does not affect the penalty obligation; therefore, having a penal clause under a contract releases the creditor from the burden to prove its damages. Elimination of the possibility of confronting difficulties in evidencing damages, and the prevention of any possible disputes that may arise in relation to the calculation of the damages are the main reasons for using penal clauses, in practice. A debtor who would not hesitate to incur a compensation obligation with an undetermined amount and calculation method, and therefore procrastinating to fulfil its obligations, might feel the necessity to act cautiously and prudently in the event of the existence of an agreed, certain and accurate penalty that would accrue, irrespective of the occurrence of the creditor’s damages[3].

    The creditor is entitled to claim damages in addition to the penalty only if its damages exceed the penalty amount, and only for the exceeding portion. However, the burden of proof to evidence the debtor’s fault passes to the creditor, and the creditor must prove that the debtor is at fault in the non-fulfilment of its obligation in order to claim the exceeding damages.

    Types of Contractual Penalties

    Penalty in Lieu of Performance

    Article 179/1 of the TCO regulates the penalty in lieu of performance, which means that the creditor is entitled to claim the performance of either the obligation or the penalty. This is when a penalty has been agreed upon between the parties for cases where the obligation is not duly fulfilled, or not fulfilled at all. In such a case, unless otherwise explicitly understood from the contract, the creditor must choose between the two options, unless the primary obligation becomes impossible to fulfil due to a reason attributable to the debtor, in which case the creditor will be entitled to claim the penalty, only. On the other hand, the wording of Article 179/1 allows the parties to agree in the contact on the performance of both the obligation and the penalty.

    Penalty together with Performance

    As per Article 179/2 of the TCO, if the penalty has been agreed upon in cases where the obligation is unfulfilled by the determined time, or at the determined place, the creditor is, in principle, entitled to request non-performance of the penalty, together with the primary obligation, unless it has explicitly waived its right, or has accepted the performance without any reservations. For example, the 19th Civil Chamber of the Turkish Court of Cassation rendered a judgment in this regard, and stated that in the event of contracts containing a minimum order commitments, including periodic performances, continuing to supply products following the end of a period without making a reservation or a notification, shall be deemed as a tacit waiver of the penalty claim pertaining to the previous period[4].

    Whereas it is also possible to agree on a penalty in lieu of performance, unless otherwise understood from the contract, the debtor is liable for both the performance (delayed or at the right place) and the penalty.

    Amount and Reduction of Penalty

    Whereas the parties are free to determine the penalty amount as per Article 182/1 of the TCO, Article 182/3 authorizes the court to ex officio reduce the amount if it deems it to be excessive. Although the court is entitled to decide whether or not to reduce the amount and determine the new amount, according to the Turkish Court of Cassation, “whether or not the contractual penalty amount is excessive should be determined based on the economic status of the parties, specifically the payment capacity of the debtor, as well as the benefits gained by the debtor due to non-fulfillment of its obligation, degree of fault and the gravity of the behaviour in violation of the obligation and in accordance with the principles of justice and equity”[5]. The court must also consider the indemnification and penalty functions of the penal clause[6] and strike a balance between the facts of the specific case and the effectiveness of the penalty amount so as to force the debtor to fulfil its obligation. The court is authorized to reduce the amount only, not to eliminate it completely, or replace it with another type of penalty.

    An exception to this rule is the contractual penalty agreed to against the merchant debtor in commercial agreements. Article 22 of Turkish Commercial Code numbered 6102[7] sets forth that a merchant debtor cannot request the court to reduce the penalty due to its excessiveness.

    Conclusion

    A contractual penalty, or penal clause, eliminates the creditor’s obligation to prove its damages, and enables it to claim a pre-determined and precise penalty amount. Claiming the contractual penalty is subject to the existence of debtor’s fault, but does not require the occurrence of damages to the creditor. A penalty obligation is subject to the primary obligation, and can be regulated for any type of obligation, except for the obligations that are explicitly prohibited from being subject to a penalty. Similarly, any type of penalty can be regulated under a contract. In principle, in the event the obligation is not duly fulfilled, or not fulfilled at all, the creditor shall be entitled to claim either the performance of the obligation or the penalty; whereas, it can claim both at the same time in the event the obligation is not fulfilled by the determined time, or at the determined place. The parties are free to determine the penalty amount under the contract, yet the court is authorized to reduce the amount if it deems excessive.



    [1] The TCO (Official Gazette, 04.02.2011, No. 27836) entered into force on 01.07.2012.

    [2] Oǧuzman, Öz, Law of Obligations General Provisions Volume 2, 9th Edition Updated and Extended in accordance with the New Turkish Code of Obligations No. 6098, Vedat Kitapçilik, Istanbul 2012, p. 504.

    [3] Oǧuzman, Öz, Law of Obligations General Provisions Volume 2, 9th Edition Updated and Extended in accordance with the New Turkish Code of Obligations No. 6098, Vedat Kitapçilik, Istanbul 2012, p. 504.

    [4] Turkish Court of Cassation 19th Civil Chamber, File No. 2014/3953, Decision No. 2014/7865, Date: 24.04.2014 (www.kazanci.com).

    [5] Turkish Court of Cassation 13th Civil Chamber, File No. 2015/504, Decision No. 2016/5643, Date: 23.02.2016 (www.kazanci.com).

    [6] Turkish Court of Cassation 6th Civil Chamber, File No. 2013/679, Decision No. 2013/12298, Date: 12.09.2013 (www.kazanci.com).

    [7] The TCC (Official Gazette, 14.02.2011, No. 27846) entered into force on 01.07.2012.