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Can the Conduct After the Conclusion of the Contract be Considered When Assessing Sham Contracting?

Can the Conduct After the Conclusion of the Contract be Considered When Assessing Sham Contracting?

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When we consider the validity of a contract on the basis of the parties' will, it is usually the will at the time of the conclusion of the contract that is relevant. In a recent decision, however, the Supreme Court of Hungary has pointed out that in the case of a long-lasting legal relationship, such as an employment relationship, the parties' actions after the conclusion of the contract in order to perform it must also be taken into account when determining the contractual intention.

Facts of the case

The plaintiff was a company that employed the defendant as an employee. The main task of the employee was to do market research in connection with car diagnostics. The two managing directors of the company were the defendant's husband and his business partner. The defendant was employed 40 hours per week, her workplace was the plaintiff's premises, and the person exercising employer’s rights was her husband. A few days later, the parties changed the employment contract to remote working. After 3 months, the parties terminated the employment relationship by mutual agreement.

Following a breakdown in relations between the defendant's husband and the other manager, the company started lawsuit against the ex-employee and claimed compensation for the wages paid to the her. In its action, the plaintiff claimed that the employment contract was a sham because the defendant had no intention of working at the time the contract was concluded and did not actually work after the conclusion of the employment contract.

First instance decision

The first instance court upheld the action. It found that the defendant had not undergone an occupational health examination and did not have the necessary competence, knowledge and experience for the job. It concluded that the parties could not realistically have intended to create an employment relationship in accordance with the terms of the employment contract and that the employment contract was therefore null and void.

Second instance decision

The second instance court altered the judgment of the first instance court and dismissed the plaintiff's action.

It held that the first instance court had based the nullity of the employment contract solely on the defendant's failure to perform her work, however this circumstance did not correspond to the parties' intention at the time of the conclusion of the contract. All of the circumstances listed by the first instance court examined the work itself, its content and quality, which is irrelevant for the purposes of assessing the intention to conclude the contract.

In its judgment, it referred to previous case-law according to which invalidity is a defect which arose at the time of the conclusion of the contract, and therefore the invalidity of the contract can only be examined and interpreted at the time when the employment relationship was created.

The decision of the Supreme Court

Although the Supreme Court did not find that damages could be awarded since the damage was not caused by the defendant's wrongful conduct, the Court disagreed with the reasoning of the second instance court.

The Supreme Court stated that intention expressed in an employment contract must be to establish an employment relationship, and there was no such serious intention between the parties according to all the circumstances of the case. This is demonstrated, inter alia, by the fact that there was no examination as to fitness for work, no substantive work and no educational qualifications to prove the defendant's technical knowledge, and that the employment contract was amended three days after its conclusion to allow for remote working.

In its judgment the second instance court wrongly held that the conduct of the parties after the conclusion of the contract has no relevance with regard to the parties' intention at the time of conclusion of the contract.

In the case of long-term legal relationships such as agency contract or employment, that is to say, contracts which are not intended to provide a one-off service and consideration, the conduct of the parties after the conclusion of the contract cannot be disregarded. In the case of a continuing legal relationship, the parties' post-contractual conduct in order to perform the contract must be expressly taken into account when determining the contractual intention.

Comment

With the above decision, the Supreme Court supplemented its previous practice by stating that although the validity of a contract must be examined primarily at the time when the employment relationship is established, in the case of long-term legal relationships the conduct of the parties after the conclusion of the contract cannot be disregarded.

By Agnes Bartus, Junior Associate, SmartLegal Schmidt & Partners

Hungary Knowledge Partner

Nagy és Trócsányi was founded in 1991, turned into limited professional partnership (in Hungarian: ügyvédi iroda) in 1992, with the aim of offering sophisticated legal services. The firm continues to seek excellence in a comprehensive and modern practice, which spans international commercial and business law. 

The firm’s lawyers provide clients with advice and representation in an active, thoughtful and ethical manner, with a real understanding of clients‘ business needs and the markets in which they operate.

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Nagy és Trócsányi is a legal entity and registered with the Budapest Bar Association. All lawyers of the Budapest office are either members of, or registered as clerks with, the Budapest Bar Association. Several of the firm’s lawyers are admitted attorneys or registered as legal consultants in New York.

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