Turkey: Termination Of Defense Industry Contracts And Related Consequences

Turkish defense industry, which is equipped with high technology systems and becoming more powerful due to its technological attempts and improved projects, recently has become a significant market for entrepreneurs and investors who are active in this field. Today, many investors get involved in defense industry projects or they provide materials and services as subcontractor or supplier of such projects.

The defense industry projects and the related purchases are realized by Undersecretariat for Defense Industries (SSM) by using standard forms of contracts which are specifically drafted by SSM for such purpose. Due to the reason that the related subcontracts are also drafted in a manner as to include same provisions of such standard SSM contracts ("Flow Down" contracts), the subcontractors may be subject to serious sanctions as a result of the severe provisions which are regulated in favor of the owner.

Especially, termination of defense industry contracts by the owner causes severe costs and damages for the contractors and many contracts, which are signed with the aim of having profit, dramatically convert into loss items for companies. In that respect, analysis of the liabilities of contractors within the scope of defense industry projects and the possible sanctions that may be imposed on the same is of the essence.

Below stated sections of this article cover the analysis of the termination of defense industry contracts and related consequences.

1. MAIN CONTRACTUAL OBLIGATIONS OF THE CONTRACTOR

Contracts executed with SSM are generally related to manufacturing and delivery of a product by the contractor in accordance with the technical specifications included under such contract. In other words, the subject of the project contracts signed with SSM would be the manufacturing of a product in accordance with technical specifications to be provided by SSM, instead of sale of a ready to use product. Therefore, these contracts have different characteristics than sale contracts.

Such contracts, which impose obligations on both parties, are considered as "Construction Contracts" within the scope of Turkish Code of Obligations. Under a construction contract, the contractor is responsible for the completion and delivery of the work undertaken by the same in compliance with the contract and the owner is responsible for making the payments to the contractor as specified in the contract. Accordingly, each party has a debt, as well as a receivable within the scope of the contract.

In consideration of construction contracts and accordingly, standard contracts of SSM, the primary obligation of the contractor under the contract is to complete the work within due time and in conformity with technical specifications and provisions of the contract. In case of breach of these obligations, the contractor may be subject to different types of contractual and legal sanctions.

2. SANCTIONS TO BE IMPOSED ON THE CONTRACTOR

The sanctions that can be imposed on the contractors in case of failure of the same to perform their obligations under the contract are regulated under the related contracts, as well as the Turkish Code of Obligations.

2.1. Contractual Sanctions

The standard SSM contracts generally include two types of termination. First one of these termination types enables SSM to rightfully terminate the contract if there is a default of the contractor (which is called "termination for default"), where the other one enables SSM to terminate the contract at any time during the term of the contract without providing any justified reason (which is called "termination for convenience"). Consequences of each type of termination differ within the context of rights and obligations of the contractor.

2.1.1. Termination for Default

The owner has right to terminate the construction contract with immediate effect or through a prior notification, in case of the occurrence of some specific conditions. Following the occurrence of the mentioned conditions, the owner generally gives a grace period to the contractor in order for the same to remedy the current defaults/breaches and if contractor fails to remedy such defaults/breaches within the indicated period, the owner terminates the contract by default. Although the circumstances which entail "termination for default" differ in each contract, such conditions are generally as follows:

  • Breach of any contractual obligation by the contractor or
  • Bankruptcy, insolvency or liquidation of the contractor, appointment of a trustee for control of all or a substantial part of the contractor's assets

Although main liabilities of the contractors arising from termination for default differ in each contract, such liabilities are generally as follows:

  • The contractor shall be obliged to return to SSM all the payments which are made by SSM until the date of termination together with the interest to be accrued until the time of the actual payment and
  • The contractor shall also be obliged to indemnify SSM for any additional costs and expenses to be incurred due to having third parties to supply the terminated portion of the contract.

Further, the most important sanction that can be imposed on the contractor is that SSM shall be entitled to liquidate the performance bond of the contractor.

If the contract is partially terminated by SSM, the obligations of the contractor related to the unterminated part of the contract will continue under the same conditions.

Although the termination rights of SSM are regulated under the SSM contracts in detail, the standard contracts of SSM do not provide any right to the contractor to terminate the contract. However, it is always possible for the contractors to terminate the contract under the general provisions of Turkish Code of Obligation in case of failure of SSM to comply with its obligations under the mentioned contracts.

As an example to the termination for default by the owner, pursuant to the below mentioned case which was analyzed under the decision of 15th Civil Chamber of Supreme Court numbered E. 2010/6550 K. 2011/6667 and dated 17.11.2011; a construction contract was executed between the contractor and the owner. Subsequent to execution of the contract, the owner made the agreed payments to the contractor in accordance with the provisions of the contract. However; the contractor failed to commence the works within the agreed time and the materials that were used by the contractor were not suitable for the characteristics of the work. Accordingly, the contract was terminated by the owner due to the failure of the contractor to perform its obligations under the contract and the owner requested for the repayment of all amounts which were previously paid to the contractor under the contract.

15th Civil Chamber of Supreme Court decided that the failure of the contractor to perform its obligations under the contract was a justified reason for the owner to terminate the contract and that the contractor is under the liability to return all the payments which were previously made by the owner for the terminated part of the works under the contract together with the interests to accrued until the actual date of payment.

2.1.2. Termination for Convenience

Generally, the owner is vested with the right to unilaterally terminate the contract with a prior notification at any time during the term of the contract without providing any justified reason. This unilateral right of termination is regulated under the contracts in favor of the owners and such right of termination for convenience is generally not provided for the contractors.

In case of termination of the contract by the owner in this manner, the owner will be obliged to take over all the works and services, together with the related documents, which are wholly or partially performed / completed by the contractor until receipt of the termination notice by making the related payments to the contractor as agreed under the contract. In that case, the owner will also be obliged to return the performance bonds of the contractor which were previously submitted to the owner by the contractor under the contract.

Similar to termination for default; in case of partial termination of the contract by SSM, the obligations of the contractor related to the unterminated part of the contract will continue under the same conditions.

As an example to the termination for convenience by the owner, pursuant to the below mentioned case which was analyzed under decision of 15th Civil Chamber of Supreme Court numbered E. 2010/7098 K. 2012/350 and dated 27.01.2012, a construction contract was executed between the contractor and the owner. The contract was terminated for convenience by the owner on the date of 05.10.2006.

15th Civil Chamber of Supreme Court decided that the owner has the right to terminate the contract prior to the completion of the work without providing any reason under the condition that the agreed payments shall be made by the owner for the completed parts of the work and the losses and damages incurred by the contractor as a result of such termination shall be indemnified by the owner. It is also decided by 15th Civil Chamber of Supreme Court that the expenses of the contractor which were made until the date of termination (negative) and the net profit that would have been made if the work had been completed (positive) shall constitute the total damages of the contractor.

2.2. Legal Sanctions

First of all, in case of failure of the contractor to complete the works in accordance with the provisions of the contract and the technical specifications, the contractor shall legally be regarded as "the defaulting party". In such case, the owner is vested with three alternative rights under Article 125 of Turkish Code of Obligations.

The first right of the owner is to "request for specific performance together with the indemnification of damages arising from delay". The owner, who prefers this alternative, has right to request the contractor to perform his obligations under the contract and file a litigation for compensation regarding its losses and damages arising from delay. However, it should be noted that the owner should exercise this right within 10 years which is the lapse of time regulated under Article 146 of Turkish Code of Obligations.

Another matter which should be addressed here is the determination of the items which should fall under the term of "delay damages". Generally, the delay damages consist of the difference between the assets that would have been owned by the owner if the contractor would have performed its obligations under the contract and the assets that are owned by the owner as a result of the delayed performance of the contractor. These damages also include the actual costs and expenses incurred by the owner as a result of delay and the loss of profit due to delayed performance.

Second alternative right of the owner is to "request for the indemnification of damages arising from non-performance of obligation instead of specific performance". According to this alternative, the owner notifies the contractor that the same waives from its right to request for specific performance and indemnification of damages and loses arising from delay and request for the indemnification of its positives damages incurred as a result of the non-performance of the obligations of the contractor. In this case, positive damages of the owner shall be calculated based on the date of the waiver of owner from specific performance.

The final right of the owner is to "revoke the contract and request for indemnification of its negative damages". The owner who exercises this right can terminate the contract by notifying the contractor that the same waives from its right to request for specific performance and indemnification of damages and loses arising from delay. In such case, the termination retroactively extinguishes the debtor-creditor relationship between the parties. The owner, who terminates the contract, will be discharged from its obligations under the contract and the same shall also be entitled to request for the repayment of the amounts which were previously paid to the contractor under the contract (if any) in accordance with "unjust enrichment" regulations included under Article 77 of the Turkish Code of Obligations. Likewise, the products which were delivered by the contractor until the date of termination will also be returned to the contractor in accordance with the "unjust enrichment" regulations, unless otherwise agreed. Pursuant to Article 125 of the Turkish Code of Obligations, the owner, who terminates the contract, has the right to request for the indemnification of its damages arising from invalidity of the contract (negative damage).

3. CONCLUSION

As a conclusion, several legal and contractual sanctions may be imposed on the contractors due to the failure of the same to duly and timely perform the contracts. Therefore; the related contractual and legal risks should be analyzed through examination of standard contracts and administrative specifications provided to the contractor during the tender process, the sanctions that may be imposed should be identified and then the pricing and working schedule should be made in accordance with this analysis. In addition, the provisions of the main contracts to be signed with the owner should also be reflected in the subcontracts to be concluded with the subcontractors in order to be able to recourse the subcontractors for any damages to be incurred in case of termination of the main contract by the owner due to the defaults of the subcontractor.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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