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Based on ruling 81087 of the Eretz Hemdah-Gazit Rabbinical Courts

Who Breached the Contract? – part IV


Beit Din Eretz Hemda - Gazit

Iyar 20 5783
Case: The plaintiff (=pl), who owns a chain of eateries, made a franchise agreement with the defendants (=def) to open a branch in a region of Israel. Def received, among other things, use of the chain’s trademarks and experience and pl’s commitment to rent a place to open the branch and receive a license. Pl and def were each to own 50% of the branch. Def were to pay 300,000 NIS under a payment plan, including 25,000 NIS to be paid directly and 100,000 NIS put into an escrow account, both soon after signing. The contract stated that either side who would breach the contract would have to pay 150,000 NIS. Def did not make the initial payments. Each side is suing based on the breach of contract clause, pl, because def did not pay, and def, because pl did not rent a place for the branch.

Ruling: [We have seen that def are to pay for breach of contract, but the question now is whether the amount written in the contract is binding.]
Pl was damaged by breach of the franchise agreement by lost opportunity and unrewarded effort, but damage was only in the tens of thousands, not 150,000 NIS. Since the obligation was in def’s ability to control and the listed payment is exaggerated compared to damages, it is considered an asmachta (an obligation one took because he did not expect to have to pay it), which is generally not binding (Shulchan Aruch, Choshen Mishpat 328:1-2). Is this case one of the exceptions to that rule?
Tosafot (Bava Metzia 66a) gives two explanations why we honor penalty agreements for a broken engagement: 1. It is an accepted societal practice (along the lines of situmta). 2. The matter embarrasses the "victim." #2 indicates that the obligation may not be exaggerated. #1 is based on the idea that whereas asmachta lacks gemirut da’at (full consideration), if something is known to be binding, one who accepts it considered it well. Whether we accept distinction #1 may depend on the machloket cited in the Pitchei Teshuva (CM 201:2) whether situmta works to transfer an object that did not exist at the time of agreement. However, that might be a technical problem, for which situmta is less helpful (see Rav Elyashiv, Piskei Din Rabbaniim V, p. 265). Not only do the Rambam/Shulchan Aruch (CM 207:16) not accept Tosafot and require a different system to overcome asmachta, but the Rama (ad loc.), who accepts Tosafot, does so only based on the second distinction, not based on it being accepted practice.
While it is not simple to ignore the law of the land and local practice regarding monetary matters, Israeli law gives the courts the prerogative to decide whether to enforce penalty clauses to the fullest degree. Often, they do not. Instead of either accepting or rejecting the clause, it is reasonable to use it as a guide to figure damage based on a high estimation of what could be the damage even if it is not proven (see Pitchei Choshen, Kinyanim 21:(25)). This is an accepted approach in our batei din. In this case, we will also factor in that pl also did not carry out all the obligations he accepted. Therefore, we will set the amount that def have to pay for breach of contract at 25,000 NIS.

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