The new Civil Code entered into force on 15 March 2014, pursuant to Act V of 2013. This has changed in many aspects the rules of the previous Civil Code (Act IV of 1959; hereinafter the “Previous Civil Code”). There have been significant changes in the rules relating to breach of contract, and of particular importance are the new legal provisions on compensation for breach of contract. As the new Civil Code will apply to every contract concluded after its entry into force, it is important for businesses to understand the regulations applicable to their contractual relationships. In this newsletter our aim is to assist our clients in becoming more familiar with the new legal rules on breach of contracts, by highlighting the most significant changes. However, it is essential that in concluding a particular contract, the parties should understand the new regulations in detail and their impact on the contract in question.
In Part I of our newsletter we will review the changes of the general rules of breach of contract and the liability for the damages caused by breaches of the obligations.
- Changes of general rules of the breach of contract
The general definition of the breach of contract
Contrary to the Previous Civil Code, the new Civil Code, gives a definition of breach of contract as an omission of performance of any contractual obligation. Moreover, it declares in general terms that in case of a breach of contract, the aggrieved party shall be entitled to claim performance of the obligation.
The general consequences of breach of contract
The Previous Civil Code only permitted the non-performance of services in cases where there was an absence of security, and under some limited specified circumstances (for example, in case of a service to be performed in stages or continuously, if the other party causes a delay, then non-performance is excused for the period of delay by the other party; if the party’s counter-obligation is jeopardized as a result of the deterioration of the other party’s financial status; or if the other party has unpaid debt towards the creditor because of insolvency). In contrast, the new Civil Code prescribes that the obligee is entitled hold back performance of its own obligations until the obligor performs his services or provides the securities due. Furthermore, the aggrieved party may rescind the contract, or may terminate it if (i) the restitution of the original status is impossible, or (ii) he set a deadline for performance, and (iii) the other party failed to remedy his non-performance within that time limit or failed to provide adequate security for the performance.
Within the general rules of breach of contract the new Civil Code contains the right of rescission or termination of the contract because of the Hungarian principle of “lapse of interest”.
The Previous Civil Code did not mention contingency contracts at all, although the judicial practice had already accepted the use of these. This gap has been filled by the new Civil Code which regulates the terms of concluding a contingency contract in the event of rescission/termination of a contract due to a breach. The obligee is entitled to conclude a contingency contract and to the reimbursement of the difference between the contract price and the price quoted in the contingency contract, as well as the costs arising from the conclusion of the contingency contract.
- Liability for damages caused by the breach of contract
The greatest change introduced by the new Civil Code is in the rules of liability for damages caused by the breach of contract. A completely new legal regulation changed the position under the Previous Civil Code on liability, which was based on an attributability/culpability principle; liability based on this principle now only remains in force within the scope of damages outside of contracts.
Liability independent from the culpability, and the conditions of exemption
According to the new Civil Code, liability for the reimbursement of the damages caused by the breach of contract does not depend on attributability/culpability. The person responsible for the damage may only be relieved from the liability, if he proves that the breach of contract,
- occurred as a result of unforeseeable circumstances which were:
- beyond his control; and
- there was no reasonable expectation to take action for preventing or mitigating the damage.
It is a very important part of this regulation that the burden of proof is on the person responsible for damage.
The new Civil Code introduces a new concept of foreseeability, which was not part of the Previous Civil Code. When considering the conditions of the exemption from liability, it is important to determine at what point the circumstances causing the damage ought to have been foreseeable by the person ultimately responsible for the damages: at the time of concluding the contract, at the time of breaching the contract or when the damage occurred? The new Civil Code declares that the person responsible for damage shall be relieved if the circumstances were unforeseeable at the conclusion of the contract.
With regard to the last condition of the exemption from liability, in relation to mitigating or preventing the damage, it is to be noted that such exception is not to be assessed from the subjective viewpoint of the person responsible for damages- Instead, the new Civil Code lays down objective criteria of the expectation which is generally required from a person being in the same situation as the person responsible for the damage.
The extent of compensation for loss
- in case of intentional breach of contract: the obligee shall be compensated for all losses and damages;
- in case of damage in the subject matter of the service: the obligee shall be compensated for all losses and damages;
- in case of damages for other asset of the obligee, including loss of income (so called consequential losses) in the amount as the obligee proves that the damage was foreseeable at the conclusion of the contract.
What should be foreseen? The damage.
The concept of foreseeability has been newly introduced by the new Civil Code, thus there is currently no any Hungarian practice for its interpretation.
According to international practice, it is not the exact size, or amount of the damage that must be foreseeable, but only the character, the type and the order of magnitude should be foreseeable. We anticipate that the Hungarian judiciary will take into account judicial practice and legal theories arising from the Vienna Convention on Contracts for the International Sale of Goods (“CISG”) when assessing the typically foreseeable damages:
- loss of profit, but limited to the not extra profit;
- the damages arising from the stoppage of production;
- the proportional and necessary costs of preventing and mitigating the damage;
- the reasonable and proportionate costs of legal and expert advice in connection with the breach;
- any regulatory penalties;
- insurance and storage costs;
- damage to business reputation is not normally recoverable, except in cases where the market particularly sensitive to reputation or has few participants.
Parallel claims for damages
If a particular act results in a number of causes of action (eg, claim for breach of contract and claim for damages outside of a contract), the damages will be assessed in accordance with the rules relating to breaches of contract.
Liability for damages caused during performance of obligations
If, in the course of performing his obligations a party causes damage to the other party, that other party may claim compensation in accordance with the rules relating to liability upon breach of contract.
Interim breach of contract
The New Civil Code has also clarified the position in respect of certain types of contract nd claims arising from delays in performance. A party commits a breach if he fails to take measures or to make statements that are necessary to enable the other party to perform his obligations under the contract. Such an omission precludes any by the other party, where his performance is prevented by the omission.
Pre-emptive breach of contract
The New Civil Code extends the provisions in the Previous Civil Code relating to breaches of business contracts, so that they now apply to contracts generally. If it becomes apparent that a party will be unable to perform his obligations by the contractual deadline, and as a result, performance of the contract is no longer in the other party’s interests, then that other party is entitled to exercise his rights arising from the consequent delay. If, before the contractual deadline, it becomes apparent that a party will perform his obligations incorrectly, the other party may set a deadline for correction of the error. If the problem is not corrected, that other party may exercise his rights arising from the incorrect performance.
The liability of the executive officers to the legal entity they represent
The rules governing the liability of executive officers in carrying out their functions have also greatly changed. The standard rules of breach of contract now apply to such liability.
IMPORTANT! We would like to draw your attention to fact that the rules of the compensation for damages can be overridden by the terms expressly agreed in the contract. As a result, it is possible to restrain or exclude the liability in the contract. However, the liability for the damages caused intentionally or for personal injury cannot be restrained or excluded.
This is a significant change from the Previous Code. Previously, the rules prohibited any restriction or exclusion of liability for intentional damage, personal injury and gross negligence. Further, any other restrictions or exclusions were subject to the payment of fair compensation for the disadvantage caused by such a term.