Construction Arbitration in Turkey

Introduction

Turkish construction companies have a key role in the construction industry worldwide. They have long been included on Engineering News Record’s Top International Contractors list. More than 40 companies are on the 2022 list, of which eight are in the top 100; based on these entries, Turkey is the second-largest country in terms of construction.^[2] Construction is at the heart of the economy too: according to a 2021 report by the Turkish Contractor’s Association, the leading non-governmental organisation representing construction companies in the country, the construction industry affected 30 per cent of the Turkish economy.^[3]

Between 1972 and 2022, Turkish contractors had undertaken more than 11,000 projects in as many as 133 countries, with a total business volume of US$472 billion.^[4] Although Russia ranked first in the 2021 and 2022 lists of countries in which Turkish contractors carried out the most work, the data for January to June 2023 shows that Turkish contractors now carry out most of their work in Spain, Libya and Turkmenistan.^[5]

Recent major construction projects in Turkey itself include the New Istanbul Airport, Istanbul Finance Centre, Canakkale 1915 Bridge, Canal Istanbul and the remaining City Hospitals, 13 of which have been operational as of 2020.^[6]

Overarching principles applicable to construction contracts

Regardless of the type of construction contract parties enter into, any construction contract subject to Turkish law would call for the application of the overarching principles of Turkish contracts law, the first of which is the principle of good faith – or, more precisely, the principle of honesty:^[7] a party must act with honesty in exercising its rights and performing its obligations, and the law shall not protect a manifest abuse of a right.^[8] Importantly, contrary to the popular belief in non-civil law jurisdictions, the principle of honesty itself is not a master key that can be used to pick any lock and it is rarely the primary argument in a dispute. In fact, using it to try to resolve all disputes would only sweep away the credibility of the legal system.^[9]

That being said, the principle of honesty does form the basis of other principles that are applicable to construction contracts, one of which is the duty to mitigate damage. This includes the prohibition to take advantage of one’s own fault,^[10] and it mainly imposes an obligation on parties to help mitigate (including preventing the increase of) damage by way of, for example, taking necessary precautions to prevent or limit damage.^[11]

Two critical principles that arise out of the principle of honesty are the duty of care and the duty of loyalty, both of which are applicable in construction contracts.^[12] According to the Turkish Code of Obligations (TCO),^[13] a contractor is under the obligation to perform its work diligently, which mainly means that the contractor is under the duty of care at every stage of the contract and in any type of obligation it has undertaken. This duty applies to selecting material, performing the work itself or work carried out under its supervision, and notifying the employer of any defects or delays or any event that the contractor should notify the employer of immediately.^[14] This does not mean that it is exclusively the contractor who must comply with the principle of honesty – the employer, too, must act in accordance with the objective good faith principle.^[15]

Clauses in construction contracts: common practice

In this section, we take a look at some of the typical clauses in construction contracts that are subject to Turkish law or that involve a Turkish party, with a view to identifying Turkish parties’ tendencies and common practice.

Bonds and securities

Construction contracts almost always provide for a security mechanism whereby the contractor is required to provide to the employer at least one letter of guarantee from a bank. Letters of guarantee are not specifically governed by Turkish law,^[16] which has led to lengthy debates with respect to the legal nature of these types of securities to determine whether they are akin to surety contracts or guarantee contracts, or are sui generis contracts.^[17] Whatever legal theory is attached to the nature of letters of guarantee from a bank, the main mechanism as regards construction contracts is the same: a bank undertakes to pay the employer if the employer notifies the bank that the contractor has breached its obligations.

A construction contract will typically provide for one or all of the following securities guarantee:

• Bid bond: This is simply a security given by the contractor to the employer as an assurance that the contractor will fulfil its obligations in relation to the tender (i.e., the bid). These bonds are temporary in nature and are typically replaced with a performance security if and when the contractor is awarded the tender and signs the contract. It is generally accepted under Turkish law that these types of bonds cannot be called in for breach of contract but only if the contractor breaches whatever tender-related obligations it had.^[18]
• Advance payment bond: If a construction contract provides for an advance payment to be made to the contractor, then it is usually in the form of an interest-free loan paid to the contractor before the work commences. Where there is an advance payment, there is a guarantee. An advance payment will almost always warrant an advance payment bond, so that the employer is assured that the contractor will repay the advance payment. Frequently, an advance payment bond will remain valid until the entire advance payment is repaid to the employer. Importantly, under Turkish law, it is generally accepted that an advance payment bond can only be called in when the contractor has breached its obligation to repay the advance payment bond,^[19] so it is not an umbrella guarantee that can be called in for any breach of contract.
• Performance bond or security: A performance bond (or a performance security, as they are referred to on International Federation of Consulting Engineers (FIDIC) forms), is a guarantee provided by the contractor to ensure the performance of its obligations. It is common practice that a contractor provides an unconditional, on-demand letter of guarantee form a bank, enabling the employer to call in the guarantee without any conditions or explanations as to how the contractor breached its obligations. It is also common practice for the contractor’s submission of a performance bond (as described under the contract) to be a pre-condition of any notices to proceed and (or) any payments to be made to the contractor. Typically, a performance bond will be valid until the end of the warranty period (or defects notification or liability period), although the amount of the bond will be halved following the issuance of a ‘taking over’ certificate (i.e., temporary acceptance).
• Warranty period bond (also called a defects notification period bond or defects liability period bond, or warranty bond, colloquially): This is a type of letter of guarantee from a bank by which the contractor guarantees to the employer that it will comply with its obligations during the period between the issuance of the taking over certificate and the performance certificate. A contractor would be expected either to maintain the performance bond over a reduced amount until the issuance of the performance certificate, or to swap the performance bond with a separate warranty period bond as of the issuance of the taking over certificate.
• Retention money or retention bond: Regardless of any other bonds provided by the contractor, it is common for employers in Turkey to include a retention mechanism in contracts. ‘Retention money’ means the employer would withhold a certain rate (usually between 5 per cent and 10 per cent) from progress payments or milestone payments, with a view to hold additional cash security. It is common practice to seek release of 50 per cent of the retention money after the issuance of the taking over certificate, with the remaining amount being released after the issuance of the performance security. The parties are free, however, to agree as part of their contract, or at a later stage, that the contractor provides the employer with a retention bond instead. Although it appears counterintuitive to provide a letter of security from a bank in lieu of what is originally a cash security, it may work best for the contractor’s cash flow. As with the other securities, it is important under Turkish law to define the purpose and scope of the retention money.

More often than not, alleged breach of obligations by the contractor or a termination of the construction contract will lead to the forfeiture of whatever securities the employer might have available at the time, which, in turn, leads to disputes between parties. It is accepted under Turkish law that if a security is called in by the employer without any reason – or for a reason that later turns out to be unjust in a dispute – will lead to a damages claim by the contractor. This is similar to the FIDIC 1999 Sub-Clause 4.2, which obliges the employer to indemnify the contractor for all damage, loss and expenses resulting from a claim under the performance security, to the extent to which the employer was not entitled to make the claim.^[20]

To prevent the employer from making any claims under a performance bond, the contractor must obtain an interim injunction, in which case the bank will be barred from honouring the employer’s demand to be paid. Turkish law allows parties to seek interim injunctions despite an arbitration agreement,^[21] and obtaining an interim injunction does not have any effect on the validity of the arbitration agreement.^[22] That being said, Turkish law also adopts a ‘pay first, sue later’ approach for on-demand bonds (the most common types of bonds in the construction industry),^[23] which makes it challenging to obtain an interim injunction.

Acceptance of work

As a rule, the TCO does not govern the specifics of the conditions or requirements surrounding acceptance of work in construction contracts; instead, it merely sets forth that the contractor will be released from liability once the work is accepted expressly or impliedly (save for any defect that could not have been discovered during inspection or was deliberately concealed by the contractor).^[24] The TCO is silent as to what constitutes express acceptance or implied acceptance.

In practice, construction contracts involving Turkish parties or Turkish law would typically involve a two-stage acceptance procedure: taking over (acceptance of work, provisional acceptance or temporary acceptance) and final acceptance (i.e., the performance certificate under the FIDIC forms). The two-stage approach is in fact a requirement under construction contracts that are subject to public procurement legislation under Turkish law,^[25] which governs when the work would be accepted: the work would be accepted only with final acceptance, not with taking over of the work, and there would be no ‘implied acceptance’, contrary to the generic principle under the TCO.^[26]

It is good practice to set out the terms and conditions surrounding acceptance procedures under a construction contract. As with any construction contract, what the acceptance procedure entails will substantially depend on the nature and scope of the work, and this is especially so in specific projects. One example of such projects is electricity generation or storage, for which acceptance of work is governed by specific legislation, requiring acceptance by Turkish authorities.^[27]

Contractor’s liability for breach and limitations to liability

The rule for a contractor’s liability under Turkish law is simple: a contractor is liable for any breach of contract, including delays, unless it proves it could not have been at fault (where ‘fault’ extends to any type or degree of fault).^[28] This is the main principle under Turkish private law as far as breach of contract is concerned.

Turkish law does allow parties to be excluded from liability or to limit their liability, with a few caveats. First, a party is barred from limiting its liability for gross fault (the term ‘gross fault’ encompasses intention and gross negligence).^[29] Second, a party is prohibited from limiting its liability for ‘slight fault’ if the party’s line of work requires expertise and if it can only be performed based on a permission or licence to be granted by authorities.^[30] In short, Turkish law does not allow an absolute limitation of liability.

Delays, damages and penalties

If a contractor falls into delay, Turkish law assumes that the contractor is at fault in causing the delay^[31] and the burden of proof to prove otherwise (unless otherwise agreed) is on the contractor. Examples of cases where the contractor would not be responsible for delay are when the delay was caused by the employer or by force majeure.^[32] As such, the reason for the delay and whether the contractor was at fault are key to contractors’ liability.

The consequences of contractor delay are naturally manifold, but the basic principle is that if the contractor falls into delay, a number of options are available to the employer. The first is to demand that the contractor perform the same obligations and that the contractor pay damages for the delay. Alternatively, the employer may forego its demands for the obligations be performed and for damages for delay and, instead, either seek damages for breach of contract or rescind the contract.^[33]

For these options to be available, the contractor must be in delay; however, Turkish law allows the employer to rescind the contract even if the contractor has not yet fallen into delay. If a contractor fails to commence work on time or delays the work in breach of contract and if, by all estimations, it is clear that the contractor will fail to complete the work on time, then the employer may rescind the contract without having to wait until the time for completion.^[34]

Often, the parties will not leave the consequences of delay to general provisions provided under the TCO but will set out the consequences of delay in the contract, which will include delay penalties. Unlike in common law jurisdictions, Turkish law does allow delay penalties and penalties to be imposed regardless of whether the employer has suffered damage or not – so the main rationale is to exert pressure on the contractor to force timely performance.^[35] In line with the presumption of fault against the contractor, the employer does not have to prove the contractor’s fault. On the contrary, it is the contractor who must prove to the employer that it was not at fault in delaying the work, in line with the general principles governing default.^[36] The employer is allowed not only to impose penalties but also to seek damages in excess of penalties – but there is a twist: if the employer is seeking damages in excess of the penalty amount, then the burden of proof shifts to the employer, who will need to prove the contractor’s fault.^[37]

Unlike delay penalties, liquidated damages are not provided for under the TCO. Nevertheless, the Supreme Court of Appeals does acknowledge the concept.^[38] Liquidated damages are less common than penalties under Turkish law, probably because penalties are permitted.

Another concept not specifically governed by the TCO is concurrent delay, which is simply when two events delay the work at the same time. As contractor’s default is closely associated with ‘fault’ (owing to the presumption of fault on the part of contractor), it is generally accepted that the contributory fault provisions would be applicable in cases of concurrent delay: if the party who suffered damage contributed to the damage or otherwise exacerbated the suffering party’s position, then the court may decrease the amount of damages or may dismiss the claim altogether.^[39] The Supreme Court of Appeals, however, does accept that instead of delving into the concept of what was at fault in the event that caused the delay, the court should focus on which reason caused the delay in completion, and to what extent.^[40]

Force majeure, impossibility and hardship

Contrary to popular belief, force majeure is not codified in all civil law countries. As far as Turkish law is concerned, although the Supreme Court of Appeals and legal doctrine have long endorsed the concept, the TCO has historically remained silent on what constitutes force majeure and its consequences. It is generally accepted under Turkish law that an event must meet the following conditions to qualify as a force majeure event: (1) it must be a compelling event that is natural, social or legal; (2) it must be external (i.e., it cannot be associated with or attributable to the obligor); (3) the obligor’s breach of its obligation was inevitable (i.e., an unavoidable event that could not have been provided against); and (4) it must be unforeseeable, and the event must cause a breach of an obligation, preventing the performance of the obligation.^[41]

Importantly, the prevailing concept of Turkish law that is triggered by failure to be able to perform duties because of an external, uncontrollable event is ‘impossibility’ not force majeure. Mainly, the principle provided under the TCO is that if performance of an obligation is rendered impossible for reasons not attributable to the obligor, then the obligations will be terminated,^[42] and force majeure is an event that may render performance impossible. Notably, however, the TCO governs impossibility in whole or in part, but it does not govern ‘temporary impossibility’. The Supreme Court of Appeals, however, acknowledges temporary impossibility to perform obligations, and on a case-by-case basis, it determines the amount of time that the parties are expected to ‘endure’ the continuance of the contract.^[43]

Turkish law also specifically governs cases where performance becomes impossible for reasons in relation to the employer. This is a concept that is exclusively applicable in contracts for work, which include construction contracts, and it mainly sets forth that if performance is rendered impossible for a reason that is in relation to the employer, then the contractor would be entitled to the value of the work and its costs. If the employer is further at fault in the impossibility, then the contractor may seek damages as well.^[44] This is a special impossibility provision and it is generally accepted that circumstances such as expropriation of the site, or a cancellation of the zoning plans for reasons that arise after the entry into force of the agreement between parties, would fall within the scope of this provision.^[45]

An external, unexpected event that does not render performance impossible but renders it extremely difficult may qualify for hardship under Turkish law. ‘Hardship’ mainly means that an obligation could still be performed but it has become so difficult that the party cannot in good faith be expected to perform the same obligation under the same terms and conditions as were agreed initially.^[46]

Arbitration regime

Turkey has been a contracting state to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards^[47] (the New York Convention) since the early 1990s, when arbitration had already become quite popular worldwide, particularly in pro-arbitration jurisdictions. At the time, this was not the case in Turkey because although the Convention had become part of domestic law according to the Turkish Constitution (ratified in 1982),^[48] Turkish law was not adequately equipped with mechanisms to put Turkey on the same level as other jurisdictions as far as arbitration was concerned.

The change in the Constitution in 1999 was a major step in support of arbitration, as ‘domestic or international arbitration’ was officially accepted as a dispute resolution mechanism for contracts providing for public work and concession contracts.^[49] This was followed by the adoption of the Turkish International Arbitration Act of 2001 (IAL),^[50] the first piece of legislation governing the main principles of international arbitration. By that time, domestic arbitration was governed under the Civil Procedure Law and recognition and enforcement of international arbitration awards were governed under the International Private Law (which was in force at that time), but Turkish law lacked legislation governing the main principles or procedure of arbitration.^[51]

The IAL, which is still in force, was modelled on the Model Law on International Commercial Arbitration (adopted by the United Nations Commission on International Trade Law in 1985) and it is the main piece of legislation governing foreign arbitral proceedings, as are the domestic arbitration provisions of the Civil Procedural Law (CPL).^[52] As a rule, proceedings will be ‘domestic’ and will be subject to the CPL if the place of arbitration is Turkey but the dispute does not include a foreign element. If, however, the place of arbitration is Turkey but the dispute carries foreign elements, then the dispute will fall within the scope of the IAL. Importantly, the definition of what constitutes a ‘foreign element’ is considerably broad in the IAL, which considers a wider range of factors to determine whether a foreign element exists. These factors include, apart from those based on where the parties are located, whether the shareholders of a party to the agreement have brought in foreign capital, or if the main contract allows for the movement of capital or goods from one country to another.^[53]

The IAL and the CPL are similar, including in the constitution of arbitral tribunals, challenging arbitrators, the place of arbitration and the substantive law to apply (absent any party agreement, the tribunal will decide), requirements with respect to the form of the award, and the like. In line with international practices, both laws clearly acknowledge the principles of ‘separability’ and Kompetenz-Kompetenz.^[54]

Ad hoc and institutional arbitration

Parties are free to choose ad hoc arbitration or institutional arbitration, but the latter is more common in contracts that include international elements. Turkish parties have long preferred well-established arbitration institutions, such as the International Chamber of Commerce (ICC), the London Court of International Arbitration, the Stockholm Chamber of Commerce and the Vienna International Arbitral Centre, with the ICC being particularly popular in construction matters. This arguably stems from the fact that Turkish parties to construction contracts are quite familiar with the FIDIC forms of contract, which support ICC arbitration following the dispute adjudication board (DAB) process.^[55]

As for Turkish arbitration institutions, the Istanbul Arbitration Centre (ISTAC) appears to lead the race, with the Istanbul Chamber of Commerce Arbitration and Mediation Centre (ITOTAM) as the likely second contender. The ISTAC Rules, which substantially channelled the ICC Rules of Arbitration, entered into force in October 2015, following the publication of the Istanbul Arbitration Centre Law in 2014^[56] and it currently offers fast-track arbitration^[57] and emergency arbitration services as well as arbitrator-appointment services in ad hoc proceedings.^[58] ISTAC’s construction disputes caseload is on the rise, and the ISTAC arbitration route has also been adopted in public procurement contracts. Prior to 2017, litigation was the only dispute resolution mechanism available in construction projects falling within the scope of the Turkish Public Procurement Authority, but with the 2017 changes, ISTAC arbitration has officially been adopted as an alternative to litigation.^[59] Time will tell whether this will help increase ISTAC’s caseload and whether ISTAC will be able to succeed in establishing itself as a contender in the global arbitration institutions race.

Arbitration agreements

Turkish law requires arbitration agreements to be in writing, and the agreement will be deemed to be writing if it is contained in a document signed by the parties or in an exchange of letters, telegrams, telex, facsimiles or other means of telecommunication or in electronic form. Further, an arbitration agreement will be deemed to be in writing if it is contained in an exchange of statements of claim and defence in which the existence of an agreement is alleged by one party and not denied by the other.^[60]

If there is a reference in a contract to a document containing an arbitration clause, so as to make that clause part of the contract, then this would constitute an arbitration agreement as well,^[61] but it is absolutely crucial for the arbitration agreement to record the parties’ intention to arbitrate in an unambiguous and certain manner. The Supreme Court of Appeals is strict in interpreting what constitutes ‘ambiguity’ and it almost always highlights the requirement that the arbitration agreement must be clear, precise and unambiguous – by way of example, the Supreme Court of Appeals rejects validity of arbitration agreements if one party can choose between arbitration and litigation whereas the other can only initiate arbitration proceedings.^[62]

Two important requirements of arbitration agreements under Turkish law are that if a person is entering into an arbitration agreement in his or her capacity as an attorney (including proxy or agent) then a special authority is required. Second, although highly debated and although there are decisions not adopting this approach, it is generally accepted by the Supreme Court of Appeals that if parties to the arbitration agreement are business entities and are all Turkish, then the arbitration agreement must be in Turkish for it to be enforceable or valid. The basis of this is an outdated law (Law No. 805) on the mandatory use of Turkish by economic enterprises.

It is common for construction contracts to provide for multi-tiered dispute resolution mechanisms that include arbitration. In a decision dated 1995, the Supreme Court of Appeals decided that referring the dispute to the ‘engineer’ would not render the arbitration agreement invalid.^[63] However, owing to the strict approach of the Supreme Court of Appeals on clarity of arbitration agreements, parties would be encouraged to define in precise terms what the multi-stage steps entail and clearly stating the intention to arbitrate in no uncertain terms.

Setting aside and grounds to refuse enforcement

According to the IAL, an award will be set aside if a party proves any of the following:

• a party lacked capacity or the arbitration agreement was invalid;
• the procedure or composition of the tribunal was irregular;
• the tribunal unduly assumed jurisdiction (or failed to assume jurisdiction);
• the arbitrators have acted beyond their jurisdiction;
• the equality of parties’ principle was not observed; or
• the award was not rendered within the time limits.^[64]

Arbitrability and public policy are grounds on which a court may set aside an award ex officio.^[65]

Recognition and enforcement of arbitral awards

Recognition and enforcement of arbitral awards are governed by the Convention and the International Private and Civil Procedure Law (IPPL),^[66] the latter applying to cases falling outside the sphere of application of the Convention. Grounds to refuse enforcement under the IPPL are substantially the same as those set forth under the Convention, but a major difference is that while the Convention famously uses the permissive language ‘may’,^[67] therefore allowing the court to use discretion in enforcement, the IPPL does not allow the court to enforce an award if there are any grounds to refuse enforcement. As such, under the IPPL, enforcement of an award will be refused if a party proves that:

• there is no arbitration agreement or the arbitration agreement is invalid;
• due process is violated;
• arbitrators have acted beyond their jurisdiction;
• there is an irregularity in procedure or composition of the tribunal; or
• the award is not final, binding or enforceable or was set aside in the place of arbitration.

A Turkish court will evaluate ex officio whether an award is contrary to public morality or public policy, or is not arbitrable under Turkish law, and will refuse enforcement if so.^[68]

FIDIC influence and approach to dispute adjudication boards

For domestic construction projects such as flat for land projects,^[69] residential projects and the like, standard forms of construction contracts are rarely used, save for public procurement contracts that require by law the use of the public procurement standard construction forms. Again, in domestic construction projects, litigation is still the leading dispute resolution mechanism.

This is not the case for projects that include international elements, and arbitration is quite common in construction contracts in Turkey, especially in contracts involving international parties or other foreign elements, including financing. Turkish contractors mainly started operating in the international arena in the 1970s, and as they undertook more work abroad, they became more exposed to international contracts, most particularly the FIDIC suite of contracts. The FIDIC forms have long been the standard form of contract in international projects involving Turkish parties, especially when projects are financed by the World Bank, the United Nations or the European Bank for Reconstruction and Development. The large Turkish projects that have used FIDIC contracts include the Baku-Tbilisi-Ceyhan Pipe Line Project, the Istanbul-Ankara Motorway Project, irrigation channel construction in the cities of Sivas and Erzincan^[70] and the Marmaray Project. The FIDIC Red Book and Silver Book are the two leading forms that are used most often, with the Yellow Book third.^[71]

Interestingly, the disposition of lenders towards the use of the FIDIC suite is not the primary reason why Turkish parties choose FIDIC forms. A 2012 study showed the main reason why FIDIC forms are used is the employers’ disposition towards their use, with lenders making that decision being the second reason.^[72] Other reasons included the belief that the risk dispersion in the FIDIC forms is fair, that these standard forms of contract are suitable for different types of tenders and that they provide for an easier way to resolve disputes.

Unlike the Joint Contracts Tribunal and the New Engineering Contract – both of which are favoured in the United Kingdom – Turkish construction companies’ preferred form of construction contract is FIDIC, and unlike the United Arab Emirates, where the FIDIC 1987 forms are extremely popular, Turkish construction companies have long used the FIDIC 1999 forms.

Although Turkish companies are very familiar with FIDIC, they are not particularly familiar with DAB procedures. It is not uncommon for a Turkish party to request full deletion of the DAB (or the dispute avoidance/adjudication board) clauses. A 2017 study showed dispute boards are less common than amicable settlement and legal remedies, including arbitration, as participants cited ambiguity and obscurity surrounding the legal effect of the dispute resolution boards among disadvantages.^[73] Recently, however, the Association of Turkish Consultant Engineers and Architects (TMMMB) has introduced a new list of Turkish professionals, comprising engineers and legal professionals, who can act as DAB members if the TMMMB is an appointing authority. Time will tell whether this will increase the appetite for dispute avoidance and adjudication processes for Turkish parties.

Footnotes