Contractual Penalty

What is a contractual penalty?

• A contractual penalty is a provision (clause) of
the main contract with which the lender and
the borrower agreed that the borrower will pay
a certain sum of money or give him some other
material benefit if he:
• (a) fails to fulfill his obligation;
• (b) is late with fulfilling his obligations;
• (c) fullfiles his obligation with defects.
 Characteristics of contractual penalty are:

1. the parties can not agree a contractual penalty if in

the main contract the debtor's obligation is of
monetary nature (penalty interest applies to that)
2. stipulation of contractual penalty is connected and
dependent on the main contract - accessory nature
3. clause must be agreed upon in the same form
which is prescribed also for validity of conclusion of
the main contract
 Characteristics of contractual penalty:

4. contractual penalty exists only if the parties

explicitly agreed on it
5. penalty may consist either in cash or in any other
material benefit
6. the amount of penalty depends on the
agreement of the parties of the main contract
7. if parties agree a disproportionately high penalty,
the debtor may ask the court to reduce its
amount
 Characteristics of contractual penalty are:

• In our law parties may agree a penalty only for

three cases:
1. in case the borrower fails to meet the contract
2. in case the borrower is late with the fulfillment
of the contract
3. in case the borrower defectively fullfills the
contract
 Characteristics of contractual penalty are:

• If parties of the main contract do not indicate

clearly which of these three cases will their
contractual penalty apply to, then our ORA
assumes that such incompletely agreed
contractual penalty will relate only to the case
of debtor's delay in fulfillment of the contract
if something else does not result from other
provisions of the contract
 APPLICATION OF CONTRACTUAL PENALTY
• in case of debtor’s delay in fulfilling the obligation, and
• in case of deficient fulfillment of debtor's obligations lender has
the right to require cumulatively:
1. fulfillment of debtor’s obligation from the main contract, and
2. contractual penalty

• If the debtor fails to fulfill the obligation creditor is not entitled

to cumulation but must opt for one of the two solutions:
1. seek fulfillment of debtor’s obligation from the main contract,
or
2. demand payment of the contractual penalty
Indemnification by contractual penalty
• A creditor is entitled to payment of contractual penalty
even if no damage occured in case of delay, deficient
fulfillment or non-fullfillment.
• If however some damage is caused to him, (its existence,
causal connection, altitude etc.) he does not have to prove
(according to our law he may charge a contractual penalty
even when its amount is much higher than damage he
suffered).
• If the damage is greater than the contractual penalty, the
creditor will have to prove in court the difference to full
indemnity
 Preventive character of the contractual
penalty
• contractual penalty serves to protect the rights of
creditors
• the debtor can not decide for himself that, instead of
fulfilling an obligation under the main contract, he will
pay a contractual penalty and thus cancel the
fulfillment of his obligation
• The debtor could only do this if the parties of the
contract at the time of conclusion of the contractual
penalty allowed such an option that a contractual
penalty is also a withdrawal fee.
 NOTIFICATION
• In order to achieve legal certainty and business
promptness our law requires that lender - when
receiving belated or incorrectly fulfilled
obligation of the debtor - simultaneously
notifies the debtor that he retains the right to
charge a contractual penalty
 The relationship between contractual
penalties and penalty interest
Contractual penalty Penalty interest
• can be agreed only with • can be agreed only for
non-monetary obligations, monetary obligations,
• it can be collected either • it can be collected only
due to a delay in fulfillment, because of a delayed
defective fulfillment, or fulfillment or defective
because of non-fulfillment fulfillment of debtor’s
of debtor’s obligation obligations
• It may consist of the
amount of money or some
other material benefit for • may be exclusively in cash!
the creditor.
 SOURCES OF LAW
In our law a contractual penalty is stipulated in provisions:
1. Obligatory Relations Act (ORA, Art. 350-356)
2. General and custom practice
3. Other regulations
Parties often agree on contractual penalty in service
and construction contracts. Therefore, individual issues
of penalties are regulated by business customs, both
General pratice for transport of goods as well as Special
practices in the construction industry.
 SOURCES OF LAW
• according to ORA relationships among
retailers are regulated by:
1. mandatory rules of our law,
2. trade customs (usages) which the dealers
have agreed, as well as
3. business practice that they mutually
developed, and only secondarily
4. dispositive provisions of our law
Thank you for your attention!

mvehovec@zsem.hr