Legal securities in agreements [Securing contracts – But how?]

Contracts are keystones in effective economy. We can conclude contracts for many different reasons but sometimes we are not well aware of the fact that despite the agreement in writing, performance is not eventuate or not the way that we expected.˛

Securing contracts –and securing our aims as well- can be achieved with using proper contractual securities.

Contractual securities are leading tools in confirmation of contract. These tools are closely associated with non-performance, which are pledged voluntarily by the obligor. For the creditor it means more sanctions in case of non-performance. Parties have to stipulate these sanctions in advance, otherwise sanctions are invalid. Purposes of these sanctions are confirming performance promptitude and expanding the assets of performance.

I. Contractual penalty

Contractual penalty is one of the most commonly used contractual security. The obligor may pledge to pay a certain sum of money in case he fails to perform the contract for reasons attributable to him. In case of contractual penalty, parties have to explicitly define which the cases of non-performance are where the obligor has to pay the contractual penalty. To demand contractual penalty it is obligatory to actually have a breach of contract. It means the creditor only has to prove that there is a breach of contract and he can demand a certain sum of contractual penalty even if he does not have any damages from the actual breach.

Contractual penalty has three types:

  • One of them is where the debtor does not perform by the contractual date he has to pay. Payment of contractual penalty stipulated for late performance is not constitute an exemption from performance.
  • The second type of contractual penalty is contractual penalty for lack of conformity where the obligee is entitled to demand payment for damages not covered by the contractual penalty.
  • Last but not least if the performance is no longer demandable for reasons attributable to the debtor, the creditor is entitled to demand payment for non-performance.

II. Collateral security

Collateral security is also an effective tool in securing contracts. The Civil Code lines up wide range of collateral securities. According to the Civil Code, collateral security can be money, payment account balances and funds available through deposit account contracts or on any balance available on account maintained by an institution so authorized by law and other assets defined by law as collateral.  For example if the subject of the collateral security is money, entitle can acquire ownership of the collateral up to the secured claim.

III. Suretyship

Suretyship is given a more detailed regulation by the new Civil Code. Considering function and essence, suretyship is still an in personam security for performance but unlike the previous Civil Code the new one explicitly requires to commit suretyship contracts in writing.

Under a contract of suretyship the surety undertakes the obligation of performance to the creditor in the event of non-performance by the principal debtor.

In practice it builds up of three related legal relationship:

  • Primarily there is a legal relationship between the principal debtor and the creditor. It is the main obligation and the base of suretyship. The obligation between the parties can be about almost everything, the suretyship orientates to it.
  • There is a legal relationship between the surety and the debtor. Sometimes the parties forget to properly regulate this relationship despite the fact that the surety runs a risk on behalf of the debtor.
  • Finally, there is a relationship between the surety and the creditor which is about guaranteeing performance.

There are two types of suretyship. One of them is about fallback option and the other one is first-loss guarantee. The difference between the two types of suretyship is in order.

IV. Fallback option

The surety is entitled to refuse performance as long as the creditor is able to verify that he had attempted to recover the debt from the principle debtor but that did not lead to a result within a reasonable timeframe. This provision shall not prevent the bringing of joint action against the debtor and the sureties.

V. First-loss guarantee

The surety does not have fallback option, so the creditor can demand payment from the surety, even if the debtor is able to perform.

Apart from these contractual securities there are a wide range of other options securing contractual performance. Every legal relationship is different and can have various features. Finding the best option is not so if we can be of any further assistance, please do not hesitate to contact us.

Do you have some more questions regarding Hungarian civil law or contract law? Contact us!

Dobos István attorney at law (ügyvéd; Budapest)


T:+3630 3088151