Consequences of termination of public procurement contracts
The Code of Obligations is the general law applicable to contracts and contractual relations. When it comes to certain consultancy, procurement and construction works sought by public entities, specific and strict rules apply to contracts entered into with public entities in that regard. A pre-bid procedure must be conducted and bids must be received in accordance with the relevant tender rules. The relevant contract must then be concluded subject to the prescribed forms, procedures and restrictions. Generally, the Public Procurement Code 4734, the Public Procurement Contracts Code 4735 and the General Communique on Public Procurement 27327 apply to the procurement of services, work and materials from bidders. Accordingly, this set of laws plays an important role in sectors such as natural resources, energy, construction, engineering and intellectual property. This update examines the legal character of contracts subject to the Public Procurement Code and the Procurement Contracts Code. It also examines the termination structure of contracts, the reasons for termination and the legal implications of termination by the tendering entity – particularly, the outcomes regarding penalty clauses contained in public procurement contracts.
In general, when a public entity enters into a contract with a private party, it must follow the procedures and rules contained in the Public Procurement Code, the Procurement Contracts Code and the General Communique on Public Procurement, which contain special provisions regarding the tender preparation stage, the tender process and the contract itself. Public authorities cannot enter into contracts in the same way as private parties by simply negotiating and executing the contract. The question arises regarding the legal nature of procurement contracts, as one of the parties to these contracts is always a public entity and the relevant legislation contains clauses of a public nature. Determining the legal nature of procurement contracts will indicate the applicable set of rules and the type of liquidation structure, which is dependent on that determination.
A different structure for public procurement contracts exists to ensure that tendering public entities enter into contracts that provide the best conditions for them. This helps to ensure that state resources are used efficiently. Thus, at some level the public entity inevitably provides a public character to public procurement contracts with private parties. Likewise, some of the mandatory rules governing public procurement contracts are overwhelmingly of public character. For instance, under Article 4 of the Procurement Contracts Code, public procurement contracts cannot be amended unless specifically allowed by that contract. Conversely, under the freedom of will principle (a fundamental principle of the Law on Obligations), the parties to a contract may amend it whenever they want. Similarly, Article 10 sets out requirements regarding when the tendering entity considers an event to be force majeure. Although parties may impose clauses in their contract to clarify when and how an event amounts to force majeure, the Law on Obligations provides no such de jure limitation. In an ordinary contract, one party may not determine whether an event that affected its counterparty qualifies as a force majeure event, provided that any such limitation was validly incorporated into the contract between the parties.
The Procurement Contracts Code also stipulates that the Code on Obligations applies for any issue not covered by the former, supporting the idea that public procurement contracts are regarded as civil law contracts.
In most cases, Turkish doctrine and court decisions have taken the view that public procurement contracts should be regarded as civil law contracts. For example, in its May 16 2005 decision the Civil Division of the Court of Conflicts stated that this type of contract is governed by private law (E2005/16). Similarly, the 15th Civil Davison of the Appellate Court held that the exceptio non adimpleti contractus (defence of non-payment) also applies to public procurement contracts (E 2011/1338, 2011/8089). This exception is of a civil law character. According to the majority of legal scholars, transactions before the conclusion of a contract (eg, preparation for tender and the tender procedure itself) are administrative in nature. The contract then falls under the scope of civil law. The Appellate Court and the Council of State have also adopted this opinion in their decisions.(1) Clauses of a public nature do not prejudice the civil law character of public procurement contracts. The fact that the Procurement Contracts Code refers to the Code of Obligations for issues not governed by it illustrates that the legislature intends only to regulate certain procurement issues with mandatory rules to ensure that the public does not incur damages.(2) Likewise, Articles 19 and following of the Procurement Contracts Code provide that the Code of Obligations applies to the liquidation stage of public procurement contracts.
As per the principle of pacta sund servanda (ie, that agreements must be kept), declarations made with the intention of terminating a contract have legal effect only when their authority has been articulated in the applicable law or conferred by the contract. Otherwise, notice of termination has no legal effect. The only possible outcome of such a baseless termination notice would be to enable the other party to invoke the right to terminate the contract on the basis that its continuance cannot be reasonably expected.
Termination based on contractor negligence
Termination as a result of negligence on the part of the contractor is stipulated under the Procurement Contracts Code. A contract may be terminated if:
- the contractor goes bankrupt;
- the contractor fails to comply with a notice expressly stating that breaches have been committed and a 10-day extension is granted in which the contractor fails to perform its obligations;
- the contractor commits acts prohibited under Article 25 of the Procurement Code; and
- following the completion of the tendering process, the contractor commits acts prohibited under the Procurement Code.
Article 20(a) is a catch-all article which covers all kinds of breaches. It states that a contract may be terminated by the tendering entity after granting an extension to the contractor if the contractor fails to perform its obligations as required by the procurement documents or the contract, or on time. The fact that some of the acts prohibited under Article 25 (c to f) constitute a breach of contract creates ambiguity regarding whether a tendering entity should base its termination on Article 20(a) or on the relevant subsections of Article 25. Termination of contract pursuant to Article 20(a) requires at least a 10-day extension, while no such requirement exists under Article 25.
There are two kinds of termination notice under Turkish law: prospective and retrospective. If the obligations are continuous, the notification of termination is deemed as having a prospective effect, and vice versa. The fact that performing a contract obligation consumes a certain amount of time for the contractor does not make that obligation continuous. The criterion in this regard is whether the benefit of the contracting party on that particular obligation has been satisfied suddenly or over time. The terminology used in the Procurement Contracts Code corresponds to a prospective effect. If a termination notice with a prospective effect has been served, the contract is deemed to be invalidated from the receipt of the notice. However, the termination notice does not prejudice the legal existence of the contract and the resulting legal implications prior to the receipt of the termination notice.
Article 22 of the Procurement Contracts Code deviates from this principle. If the contractor declares bankruptcy and an inability to perform its duties, the contract is deemed to have been terminated on notification. Further, if the contractor fails to perform its duties as required by the procurement documents and contract or on time, and those breaches have not been rectified within the 10-day minimum extension given by the tendering entity, the contract is deemed to have been terminated when the extension period expires. If termination is based on Articles 20(b) or 21, the termination is deemed to have occurred from the discovery of the prohibited acts.
If a literal interpretation is applied, these articles arguably do not stipulate that a termination notice must be served by the tendering entity. Instead, they articulate situations in which the contract is annulled ipso jure (ie, by the operation of law) if certain events occur. At that point, the role of the tendering entity is to complete the terms set out in the Procurement Contracts Code (eg, the detection of prohibited acts), as it would be inaccurate to classify the tendering entity’s action as a termination despite the fact that the contract had already been invalidated. The declaration made by the tendering entity is thus declaratory rather than constitutive. This interpretation has been explained in a dissenting vote in a decision by the 15th Civil Division of the Appellate Court.(3)
However, under Article 21(2) a tendering entity cannot terminate a contract if 80% of the contractor’s work has been completed. In such case, if a tendering entity discovers that a contractor has committed a prohibited act the contract is deemed to be terminated from that point forward. However, Article 21(2) stipulates that the tendering entity may prefer not to terminate a contract if the article’s requirements are met and that it may request the contractor to continue to perform its obligations under the contract. Thus, the tendering entity has discretion over whether to retain the contract, as it cannot terminate a contract which has already been terminated – that would be contrary to the fundamental principles governing the Law on Obligations. The wording of Article 22 contradicts Article 21(2). For this reason, the majority of judges in the Appellate Court’s abovementioned decision have established their reasoning in compliance with the general principles of the Law on Obligations and decided that the declaration to be served by the tendering entity was a notice of termination with legal effect. Despite the fact that the legal effect of termination comes into existence at the time stipulated in Article 22 of the Procurement Contracts Code, the declaration made by the tendering entity pursuant to that article is not a declaration without legal implications; it constitutes a notice of termination. Thus, Article 22 is regarded as a sui generis regulation regarding the effective date of termination notice. This interpretation agrees with a 13th Civil Division of Appellate Court decision (HD E 2006/8713 K 2006/13605) holding that a declaration made by the tendering entity after 51 days of delay constitutes a notice of termination. However, damages for delay in performance of the contract will accrue only following the completion of the 20-day extension (the effective date of termination under the previous wording of Article 22) given by the tendering entity.
The contradiction between Article 22 and Article 21(2) creates ambiguity that cannot be resolved without contravening the Law on Obligations, particularly regarding the legal implications of the use of constitutive rights. These two articles will need to be revised as they clearly contradict the rulemaking technique. The legislature should take the general principles of law into consideration and calculate how these articles will interact with each other. This, revision is essential to establish legal security regarding the liquidation structure of public procurement contracts.
Another question in this regard is whether the termination mentioned above will have a prospective or retrospective effect. Under the Procurement Contracts Code, it is possible to make purchase agreements, construction agreements and service agreements. In that context, retrospective termination will apply to purchase agreements and prospective termination will apply to service procurement agreements. Construction contracts have resulted in doctrinal dispute, as they are not continuous, despite the fact that they contain certain features of continuous agreements. A contractor’s performance is spread out over time, but the contracting party’s benefits are fulfilled suddenly; thus construction agreements are classified as non-continuous. However, the Appellate Court has made numerous decisions suggesting that notice of termination will have a prospective effect on the fulfilment of certain requirements.(4)
These decisions show that if 90% of work have been completed, a notice of termination have a prospective effect according to the Appellate Court. Thus, the same principles apply to contracts entered into under the Procurement Contracts Code, as it has no clause covering the status of notices of termination and refers to the Code of Obligations for all other issues.
Article 17 of the Procurement Contracts Code regulates how contracts are affected by the death, serious illness, arrest or conviction of a contractor:
“If the contractor dies, the contract shall be terminated and liquidated under general principles and performance guarantees and other receivables (if any) shall be given to the contractor’s successor. However, if the tendering entity approves so, the contract may be maintained in effect upon application by the contractor’s successor who has the same qualifications as the contractor, provided that a performance guarantee covering all of the obligations, including additional assurances, has been submitted within 30 days as of the death of the contractor.
If severe sickness, arrest and conviction precludes the contractor form performing his obligations, the contract may be maintained in effect with a nominee who has been recommended by the contractor within 30 days of the occurrence of the aforementioned events and if the tendering entity approves such an appointment. However, if the contractor is unable to wilfully appoint a nominee, the appointment of a legal representative may be requested by those concerned and within the same limitation on time. If these terms do not apply, the contract shall be terminated and Article 20 and 22 shall apply except for the terms as to prohibition from public tenders.”
These articles stipulate termination despite the general principles of the Law on Obligations, under which the aforementioned events will result in the contract being annulled ipso jure (ie, by the law itself) rather than being terminated.
Article 10 of the Procurement Contracts Code lists events which may qualify as force majeure, including:
- natural disasters;
- lawful strikes;
- epidemic diseases;
- declaration of partial or mass mobilisation; and
- other events specified by the tendering entity.
The article sets out additional requirements for an event to qualify as force majeure:
“In order for the events mentioned above to be accepted as force majeure by the tendering entity; (1) it should not be caused by negligence attributable to the contractor, (2) it should preclude the performance, (3) the contractor should not be able to eliminate the obstacle caused by that event, (4) the contractor should notify in writing the tendering entity within 20 days as of the occurrence of the event, (5) the event should be certified by the authorities.”
Despite the fact that some of the requirements conform to the Law on Obligations, there are certain formal requirements for an event to qualify as force majeure that are unusual from a private law perspective. Under the Law on Contracts, the issue of whether an event is force majeure is determined on the basis of its character and consequences. Unlike Article 10 of the Public Procurement Contracts Code, this determination excludes the parties’ opinion.
The contractor’s default, other actions or omissions which amount to a breach of obligations may give the contracting party the right to terminate the contract under the Code of Obligations. The contractor is responsible for its breaches unless it is proven that it did not act negligently (as per the presumption of negligence in Article 112 of the Code of Obligations). It is also responsible for indemnifying damages resulting from its actions and omissions that led to the termination of contract. There are two kinds of damages to be indemnified in that regard: positive and negative. Negative damages are those which would not have been incurred had the contract not been entered into, while positive damages are those which would not have been incurred had the contract been performed as required.(5) In cases of retrospective termination, the terminating party cannot claim positive damages. Retrospective termination removes all contractual implications from its entry into force. As those implications have been removed, positive damages can have no legal basis, as there can be no indemnification resulting from a breach of an obligation that no longer exists.(6) Positive damages include damages and loss of profit resulting from non-performance. In this context, the extra price paid when the contracting party has the performance fulfilled by a third party and the contracting party’s loss of profit are positive damages. Conversely, negative damages include expenses incurred while concluding the contract and liability to compensate the other party after retrospective invalidation of the contract. Negative damages mostly consist of expenses for:
- concluding the contract;
- finalising the work to be carried out;
- fulfilling the contracted obligations; and
- taking the necessary steps to put the contractor in default.
Under procurement legislation, the content of negative damages mostly consists of loss of opportunity. According to an Appellate Court decision,(7) in terms of negative damage, the loss of opportunity should be determined by considering the difference between the second-best proposal made in the first tender (if any) and the contract price agreed in the second tender, provided that it has been conducted within a reasonable amount of time following the termination of the contract. Further, some scholars argue that when the contractor defaults the tendering entity may invoke the rights set out in Article 112 and following articles of the Code of Obligations. However, the 15th Civil Division of the Appellate Court has ruled otherwise, stating that when the contractor defaults, the tendering entity may only terminate the contract under the Procurement Contracts Code, but cannot invoke the other rights in Article 112 and following articles of the Code of Obligations.(8) Thus, when the tendering entity terminates the contract, it can claim only negative damages.(9) However, if termination by the tendering entity has a retrospective effect under the principles explained above, then the tendering entity may claim positive damages. In such a case, the contract would not be invalidated as of its entry into force and the legal implications that came into existence out of that contract would remain until the effective date of the notice of termination.
Another issue is whether the tendering entity may claim indemnification regarding the penalty contained in the contract when it terminates the contract. Under the Law on Obligations, a penalty cannot be claimed when the contract is retrospectively terminated. There are two kinds of penalties under the Code of Obligations. The first is intended for the indemnification of non-performance or defective performance. If this type of penalty is contained in the contract and a breach occurs that falls within its scope, the tendering entity may claim a penalty or specific performance. If a penalty is imposed for late performance or performance which does not conform to the place of performance clause contained in the contract, the tendering entity may claim the penalty accrued and specific performance. In that context, the penalty clause, which may be claimed in addition to the payment, may also be claimed along with positive damages. Article 20(a) of the Procurement Contracts Code includes the exception that termination will not prejudice the penalty clause. Thus, even if the contract has been retrospectively terminated by the tendering entity, the penalty will continue to accrue until the date designated by the tendering entity in the notice given as per Article 20(a). The 13th Division of the Appellate Court also adopted this interpretation, stating that the penalty imposed in the contract is consistent with the Procurement Contracts Code and the general principles on penalty will be disregarded.(10) The Appellate Court based this interpretation on the fact that delays in public procurement contracts cause the public to suffer. For this reason, penalties contained in such contracts shall be qualified accordingly. This is an issue for which the public character of public procurement contracts comes into play via the interpretation of the Appellate Court and the wording of Article 20(a) of the Procurement Contracts Code.
Commercial contracts entered into with public authorities are categorised as private contracts, but the liquidation of such contracts is treated and applied differently, due to the existence of clauses of a public nature and the Appellate Court’s interpretation. Contractors entering into such tenders must be aware of these differences, the possible legal implications that may arise from them and their impact on contracts.
First published at: www.internationallawoffice.com
(2) “Authorities acting under Code numbered 4735 provide public service. Procurement transactions are also a part of that service. Delay in procurement and delivery of products will be detrimental to the services and will cause public to suffer”, Appellate Court, 13th Civil Division, E2006/8713 K 2006/13605.
(3) The Procurement Contracts Code sets out general principles regarding termination but no specific regulation exists in that regard. Further, Articles 19, 20, 21 and 22 state that termination of contract will take effect prior to the tendering entity’s decision. Thus, it seems that a decision or declaration made after the date of termination is to inform the other party that the contract has been terminated. Therefore, the tendering entity does not need to issue a decision to have the contract terminated. This decision is only relevant to the internal operation of the tendering entity and has the purpose of certifying the event. E 2004/6043, K 2005/3488.
(4) Appellate Court, 15th Civil Division, E 1996/6770, K 1997/1356, T March 13 1997; Appellate Court, 15th Civil Division, E 1997/3723, K 1997/5352, December 12 1997; Appellate Court, 15th Civil Division, E 1998/2147, K 1998/2779, T June 24 1998; Appellate Court, 15th Civil Division, E 1999/2473, K 1999/3735, T October 21 1999; Appellate Court, 15th Civil Division, E 2000/5230, K 2001/1311, T March 15 2001; Appellate Court, 15th Civil Division, E 2001/4235, K 2002/409, T January 30 2002; Appellate Court, 15th Civil Division, 2003/1903, K 2003/5288, T November 6 2003; Appellate Court, 15th Civil Division, E 2003/4328, K 2004/1320, T March 10 2004; Appellate Court, 15th Civil Division, E 2003/4987, K 2004/1909, T April 5 2004; Appellate Court, 15th Civil Division, E 2004/7507, K 2005/505, T February 4 2005.
(5) “Positive damages are those arising out of non-performance or improper performance. Negative damages are those deriving from invalidity of a contract which is believed to be performed or to be complied with.” Appellate Court Assembly of Civil Chambers, 2006 E 13/499, K 2006/507.
(6) “The type of damages which may be claimed in case of retrospective termination are negative damages. In this context, loss of opportunity to make another contract by relying on the existing one is an item of damage which can be claimed under the notion of negative damages.” Appellate Court, 13th Civil Division, 1994/7280, E 1994/9464, K November 1 1994.