Contractual Penalty, i.e., a stipulation that compensation for damage resulting from non-performance or improper performance of a non-monetary obligation will be effected through the payment of a specified sum, is one of the most commonly encountered additional contractual provisions, especially in professional transactions (construction contracts, contracts for specific work, lease agreements, or leasing agreements). The basis for demanding payment of this “contractual compensation” is a breach related to the performance of non-monetary obligations, such as delays in contract performance or quantitative or qualitative deficiencies in the subject of performance.
Stipulating a Contractual Penalty for Termination
In contractual practice, it is also common to stipulate a “contractual penalty for termination of the contract.” This shorthand concept essentially refers to situations where one party terminates the contract for reasons attributable to the other party, and the basis for this termination is the non-performance or improper performance of an obligation by the counterparty.
There is no explicit legal provision that directly allows for the stipulation of a contractual penalty in the event of contract termination. However, its basis can be found in Article 494 of the Civil Code, which states that “A party that rescinds a contract may demand not only the return of what it has provided but also compensation for the damage resulting from non-performance of the obligation under general principles.” The contractual penalty is intended to cover this damage in full. The stipulation of a contractual penalty excludes the obligation to prove the amount of damage; it is sufficient to demonstrate the validity of the declaration of contract termination.
Basis for Termination and Contractual Penalty
However, the stipulation of a contractual penalty is not always possible. The permissibility of stipulating a contractual penalty in the event of contract termination should be assessed in relation to the grounds for the termination.
Termination of a contract (or its withdrawal) may result from non-performance or improper performance of both monetary and non-monetary obligations. However, a contractual penalty can only be stipulated for the non-performance or improper performance of a non-monetary obligation (Article 483 § 1 of the Civil Code). Consequently, the stipulation of a contractual penalty for termination should be considered permissible only if it was caused by the non-performance of a non-monetary obligation by one of the parties. The stipulation of a contractual penalty for termination due to the non-performance of a monetary obligation by one party is contrary to Article 483 § 1 of the Civil Code. This position was confirmed by the Supreme Court in a Resolution of the Panel of Seven Judges – Civil Chamber, in the Judgment of November 20, 2019, III CZP 3/19.
Therefore, clauses obligating the debtor to pay a contractual penalty in the event of contract termination (withdrawal) caused by a delay or failure to fulfill a monetary obligation (e.g., lease installments, rent payments, or payments for construction works) should be deemed invalid. The competence arising from Article 494 § 1 of the Civil Code to claim “compensation for damage resulting from non-performance of the obligation under general principles” does not in any way eliminate the connection between the contractual penalty and the non-monetary obligation.
Effect of Exercising the Right of Termination on the Existence of a Claim for a Contractual Penalty
Doubts may also arise regarding the effect of exercising the right of termination on the continued existence of a claim for a contractual penalty. The effect of a party’s decision to terminate the contract is the retroactive (ex tunc) dissolution of the contract – the contract is considered null and void. This raises the question of whether the termination of the contract also extinguishes the claim for a contractual penalty arising from that contractual relationship.
Judicial rulings provide an answer, with the prevailing view being that, as a rule, the submission of a declaration of contract termination does not deprive the creditor of the right to claim a contractual penalty for improper performance of the obligation by the debtor (particularly for failure to meet the deadline for performance) that occurred before the termination (Supreme Court Judgment – Civil Chamber of December 17, 2008, I CSK 240/08, and of October 5, 2006, IV CSK 157/06). In such cases, the contractual penalty replaces the compensation owed to the creditor for improper performance of the obligation, which formed the basis for the termination.
Judicial practice widely accepts the admissibility of a contractual penalty in the event of contract termination. However, it should be remembered that it may not always be effectively stipulated. The specific circumstances of the case determine the validity, particularly the grounds that, under the contract, entitle a party to terminate the contract.
