Under Hungarian Law, liquidated damages (penalties) are governed in the Sixth Book of the new Hungarian Civil Code (Articles 6:186-189) and are contractual i.e. voluntarily undertaken monetary sanctions by the contracting party (or both parties) to pay a lump sum as liquidated damages for delayed or failed delivery, or for the breach of contract; such contractual penalties serve as an immediately available remedy. Any agreement on liquidated damages is only valid in writing.
Claiming liquidated damages rules out claiming certain other remedies of similar effect that may be otherwise claimed on the same factual basis: claiming liquidated damages agreed for failed performance rules out the right to demand performance, and similarly, liquidated damages agreed for faulty performance rules out warranty claims for the said faulty performance; agreeing on an interest rate after liquidated damages is null and void by law, however, if the party fails to pay liquidated damages on time, late interests are applied to late payment. Penalties agreed for late monetary payment shall be considered under the rules of late interest, rather than as a penalty. Claiming liquidated damages does not rule out claiming damages that exceed the amount received as penalties for the breach of contract. Contractual Penalties for delayed performance are commonly used.
Under Hungarian law and construction contract practice, the calculation of liquidated damages for breach of contract can be agreed freely by the parties, i.e. either as a fixed lump sum or as a percentage of the contract sum or a combination of both, with or without cap on the specific or for all kinds of contractual penalties. As the full amount of liquidated damages are claimable regardless of any actual damages occurring, and, as any damage exceeding the received sum as liquidated damages may be also claimed, and as the sum of the penalty may be freely agreed by the contracting parties, they are likely to agree in an amount that is sufficient to compensate for losses suffered, but generally no more than the expected profits of the contractor.
It is common contractual practice in Hungary that the contracting parties agree in a cap for the penalties, usually at 10% to 20% of the total contractual sum, which is usually accepted in the practice of Hungarian Courts. However, if the amount penalty is considered excessive, the Court – on the request of the party obliged to pay the penalty – may decide to reduce its amount. Regardless of the amount of penalty set in the contract or the amount ultimately upheld by the Court, provable damages that have occurred and which exceed the amount the penalty may be still claimed in civil litigation. In case of multinational corporations, it is common practice to consider the maximum agreed penalty as a revenue-decreasing factor, until the contract is fulfilled, and therefore, it has an effect of limiting the negotiable maximum amount of penalties if it exceeds the corporate policy for maximum penalties.
Under Hungarian law, suffering a loss in order to claim liquidated damages is not required, if the conditions agreed for the payment of penalties for the breach of contract are otherwise met. Where penalties are already claimed for the breach of contract, only damages that exceed the claimed and received penalties may be also claimed.
Under Article 6:188 of the Hungarian Civil Code, a tribunal may reduce the amount of liquidated damages upon which parties had previously agreed in the contract the obligor so requests, and provided that the amount of the liquidated damages is considered excessive. However, in Hungarian judicial practice, rulings lowering the pre-agreed amount of liquidated damages are an exception, although they might be applied to cases where the actual damages were very marginal or did not occur at all, and where the circumstances of the breach of contract support such a lenient decision, such as a marginal breach of contract, or the presence of ‘national economic interest’. Otherwise, and especially if the liquidated damages were agreed as a one-time fixed amount, such rulings are unlikely to occur.
As a case law example for reducing excessive liquidated damages, in a recent ruling of 2017, the Court has ruled in a case that concerned undertaking the upgrade of electrical systems in a condominium for a contractor’s fee of HUF 2.4 million (cc. EUR 7,750). The Parties mutually agreed in a late penalty of HUF 5,000 (cc. EUR 16) per every half a day for late delivery/payment, however, it was neither limited by time or amount in the contract, and thus the claimant (the contractor) has ultimately accumulated a late penalty claim of HUF 22.5 million through several years, which was subsequently litigated.
The Court of First Instance has ruled that the amount of the penalty was excessive, and was reduced to 50% of the agreed amount. The Court of Appeal, however, awarded (limited) the claim for liquidated damages to approximately 20% of the original contractual fee, based on the reasoning that the amount was excessive and disproportionate to the obligation, but also that liquidated damages for late payment are to be considered and limited by the rules applicable for late interest. The Supreme Court upheld the Court of Appeal’s reasoning in the ruling and emphasised that such rulings are exceptional and are only applicable where the amount of liquidated damages are severely disproportionate and/or where the claimant did not suffer considerable damages itself. The fact that claimant enforced its claim for liquidated damages several years later had no bearing on the decision.
The main rules for liquidated damages are governed by Articles 6:186 through 189. § of the Hungarian Civil Code.
1. Article 6:155. §, Section 4. In contracts between enterprises, the payment of late interest may not be ruled out, unless the defaulting party would be obliged to pay late penalties (liquidated damages)
2. Article 6:185. §, Section 4. The amount of earnest money to be paid is to be deducted from the payable penalties (liquidated damages).
3. Article 6:186. §, Section 2. Penalties (liquidated damages) can be stipulated only in writing.
4. Article 6:187. §, Section 1 thorough 3. Claiming penalties (liquidated damages) for default performance rules out claiming performance of the obligation; claiming penalties (liquidated damages) for late delivery, however, does not rule out claiming delivery. Claiming penalties (liquidated damages) for faulty delivery rules out any warranty claims; damages that occurred in excess of the agreed liquidated damages may be still claimed. Damages from the breach of contract may be claimed even if the penalties (liquidated damages) were not claimed.
5. Article 6:188. §. Excessive amount of penalties (liquidated damages) may be reduced by the Court on the request of the party obliged to pay the penalties (liquidated damages).
6. Article 6:189. §. Stipulating late interest after penalties (liquidated damages) is null and void, late interest, however, may be claimed after unpaid penalties (liquidated damages) that were not paid in due time.
The aforementioned provisions are mandatory, however, the employer and contractor are otherwise free to govern their contractual will, including the structure of penalties (liquidated damages) or other securities freely, within the guidelines outlined by general clauses of the Hungarian Civil Code.
Liquidated damages provisions are widely used in Hungarian construction projects, mostly for loss sustained as a result of late or default performance by a contractor. Several legal limitations apply, i.e. regarding the connection between late interest and liquidated damages, and claiming liquidated damages may rule other rights of similar reparation intent and effect.
The employer does not have to have suffered actual loss before claiming contractually agreed damages, although tribunals sometimes do take into account his complete absence of loss. Excessive liquidated damages may be changed by the Court or Tribune. As a general rule, however, the Courts and Tribunes tend to uphold the liquidated damages agreed by the parties. The type of contract used determines how liquidated damages are calculated, and the amounts can vary, but generally limited by amount to 10 to 20 percent of the contract sum, or the individual works contractual value.
Hungarian law makes distinction between liquidated damages provisions and other possible penalty provisions, such as Loss of Right, or Earnest Money (deposit). In the Hungarian Civil Code’s structure, these are all considered as securities to enforce the performance of the contract that the parties are free to employ in securing the integrity of their contracts.
BALÁZS & KOVÁTSITS Legal Partnership