Richard Schmidt November 24 2020 Can judges control excessive terms in lease agreements? SMARTLEGAL Schmidt & Partners | Litigation - Hungary Richard Schmidt Litigation FactsFirst-instance decisionSecond-instance decisionSupreme Court decisionCommentCan parties stipulate in a commercial lease that a user charge amounting to three times the monthly rent will apply if the lessee fails to vacate the leased premises? Further, can a judge qualify such an excessive fee as a penalty which the court can reduce? This article analyses a recent Supreme Court decision in order to address these questions.FactsIn 2012 the lessor and lessee entered into a commercial lease for an indefinite period in respect of part of a commercial property where the lessee operated business units.The parties stipulated that if the lessee failed to vacate the leased premises and return them to the lessor's possession on termination of the lease, the lessee would pay a monthly user charge amounting to three times the monthly rent of the leased premises.The parties modified the lease to provide for a definite period, and the lessor indicated several times that he was unwilling to lengthen the lease period. The parties could not agree on lengthening the lease and it terminated on 31 July 2016 on the expiry of the definite period.However, the lessee failed to vacate the leased premises and return them to the lessor's possession. The lessor switched off the electricity and started to invoice the lessee for the user charge (calculated at three times the monthly rent) based on the lease.First-instance decisionThe lessee sued the lessor and asked the court to modify the lease to provide for an indefinite period. The lessee contended that the lessor had previously promised to modify the lease to provide for an indefinite period if he executed certain development works in respect of the leased premises, which he was willing to do.The lessor denied that the lessee had any right to ask for the lease to be modified since no extraordinary circumstances had occurred after the conclusion of the lease that would justify the court modifying the contract based on the Civil Code.(1)In addition, the lessor filed a counterclaim, demanding the vacation of the leased premises and payment of the user charge at three times the monthly rent.The first-instance court decided in favour of the lessee and modified the lease to provide for an indefinite period. The court also dismissed the lessor's counterclaim because the contract still existed; therefore, the lessee did not have to pay any increased rent because of its failure to leave the leased premises.Second-instance decisionBased on the appeal lodged by the lessor, the second-instance court quashed the first-instance decision and ordered the lessee to hand over the leased premises to the lessor and pay double the monthly rent as a user charge.The second-instance court emphasised that the courts can modify a contract only when:a long-term legal relationship exists between the parties;a circumstance arises after the conclusion of the contract; andan essential rightful interest of one of the parties has been breached.According to the second-instance court, these conditions were not met in the given case.However, when analysing the user charge stipulated for a delay in vacating and handing over the leased premises (equal to three times the monthly rent), the court concluded that this amount could be characterised as a penalty, which is subject to court review according to the Civil Code.(2)When deliberating to what degree it should reduce the penalty, the second-instance court considered the fact that the lessee had been unable to use the leased premises for their original purpose as the electricity had been switched off. On the other hand, the lessor had been unable to use the leased premises because of the breach of contract by the lessee.Deliberating on the above circumstances, the second-instance court fixed the user charge at two times the monthly rent and dismissed the lessor's counterclaim.Supreme Court decisionThe parties submitted a request for review of the second-instance decision to the Supreme Court.As to the issue of contract modification by the court, the Supreme Court agreed with the second-instance court, emphasising that this constitutes interference in party autonomy and is limited to exceptional circumstances, which did not apply in this case.However, the Supreme Court ruled that the second-instance court had erred in its qualification of the user charge as a penalty under the Civil Code because this was governed by the provisions of the Housing Act as lex specialis.(3)In the Supreme Court's view, the user charge was not a consideration for use of the premises, but amounted to a sanction for the failure to vacate the leased premises because the lessor could not fully enjoy its right of disposal over the leased premises – namely, he could not take possession of or use the leased premises at will.The court remarked that, similar to a penalty, the user charge served as an incentive for the lessee to vacate the leased premises. However, the court highlighted that unlike a penalty, the user charge could not be qualified as lump-sum damages. In addition, a user charge is objective, to be paid irrespectively of culpability, while a penalty is payable in accordance with a culpable contractual breach.Based on the above, the Supreme Court established that the tripled rent stipulated in the lease was a user charge and did not qualify as a penalty; therefore, it could not be reduced by the court. Consequently, the lessee had to pay the tripled amount, as invoiced by the lessor.CommentIn most civil law countries, the courts have final control over contractual terms. Parties can not only challenge unfair contractual terms, they can also ask the courts to modify the contract. The court's right to reduce excessive penalties is an example of the latter power.The question of whether the amount undertaken to be paid by one contracting party in case of a contractual breach qualifies as a penalty is a matter of construction.It is a general principle of contract interpretation that contract terms are not qualified based on their names, but rather on their content.However, in the present case, the Supreme Court applied another method of construction, the lex specialis derogate legi generali principle, according to which, in cases where a general legal provision and a specific legal provision contradict each other, the latter will prevail.At the same time, it was clear in this case that there was no real contradiction between the specific rule (the obligation for the person using the property without title to pay the user charge) and the general rule (the court's power to reduce the excessive penalty), since these rules governed different factual situations.The real issue was whether the user charge amounting to three times the monthly rent could be characterised as contract security, which, under Hungarian law, is subject to judicial control and can be reduced by a judge if they consider it to be too excessive.The Supreme Court brought two arguments to differentiate the user charge from a penalty or contract security – namely:the fact that it was not, by its nature, a lump-sum damages payment; andthe absence of a subjective element (ie, culpability).These arguments are unconvincing for the following reasons.First, there is no unified standpoint in Hungarian legal literature that a penalty must, by its nature, be a lump-sum damages payment, since some commentators emphasise the private fine element of this form of contract security, which is payable irrespective of whether actual damage has occurred. In addition, damages not covered by the penalty can be still claimed.(4)Second, in the absence of culpability, the Supreme Court failed to consider that in cases where a behaviour amounts to a contractual breach, it is necessarily culpable. In other words, culpability was the central element of the user charge because it was to be paid in case of a contractual breach.By stipulating a user charge fixed at a price which was substantially above the rent's market price, the parties wanted to penalise the lessee for failing to vacate the leased premises. This meant that the user charge functioned as a form of contract security, which the Supreme Court admitted when it alluded to the fact that the user charge worked as an incentive for the lessee to leave the premises.Based on the above, a better approach would have been for the Supreme Court to uphold the second-instance judgment which characterised the user charge in light of its function as a penalty and reduced it for being excessive.By not taking this approach, the Supreme Court has left the excessive contractual stipulation without final judicial control, a function that the courts should employ to achieve their key objective: achieving justice for parties.For further information on this topic please contact Richard Schmidt at SMARTLEGAL Schmidt & Partners by telephone (+36 1 490 09 49) or email ([email protected]). The SMARTLEGAL Schmidt & Partners website can be accessed at smartlegal.hu.Endnotes(1) Section 241 of Act IV of 1959 on the Civil Code provides as follows:(Amendment of Contracts by Court) The court may amend a contract if the contract breaches any essential rightful interest of one of the parties in consequence of a circumstance arising in the long-term legal relationship of the parties following the conclusion of the contract.(2) Section 247 (1) of the former Civil Code provides that the "excessive penalty can be reduced by the court".(3) Section 20 (1)-(2) of Act LXXVIII of 1993 on the lease of flats and premises provides that:[T]he person using the real estate without legal title shall pay user charge to the owner. The user charge shall be equal to the monthly rent. After 2 months, the user charge can be raised.(4) Commentary to the New Civil Code -HVG-ORAC Jogkódex Database, Article 6:186 and commentary to the former Civil Code HVG-ORAC Jogkódex Database, Article 246.