What not to forget when negotiating a contractual penalty?

In cotractual obligations, the contractual penalty is a widely used institute. However, the fact that it is essentially a flat rate damages is often overlooked when it is negotiated. In other words, if I negotiate only a contractional penalty, I, as a creditor for a breach of a contractual obligation, cannot also claim damages resulting from a breach of that obligation. This rule is set directly by the Czech Civil Code in the provision of § 2050.

Taking this fact into account is important for both parties to the contractual obligation. For example, if a contractual penalty for a breach of a certain obligation in the amount of CZK 50,000 has been agreed, the creditor is in principle entitled to reimbursement of only CZK 50,000, even if he has suffered much higher damage as a result of the breach of the contractual obligation. The contractual penalty should therefore be agreed in an amount that truly reflects the possible risks. On the other hand, the contractual penalty should not be excessively high. When negotiating a contractual penalty, it should be borne in mind that the function of the contractual penalty is corroborating, securing, sanctioning and preventive. If the contractual penalty is agreed in an excessive amount, it may be an invalid juridical act. At the same time, an excessively high contractual penalty may also be moderated by a court.

The best solution for creditors is an arrangement according to which the contractual penalty does not exclude a right to damages. Such an exclusion of the compensatory function of the contractual penalty is in accordance with the law, as the provisions of Section 2050 of the Czech Civil Code are optional, and therefore the parties may deviate from the legal regulation.

Furthermore, when negotiating a contractual penalty, it is important to bear in mind that the contractual obligation that is to be corroborated by the contractual penalty should be as specific as possible, as the case law of the Supreme Court of the Czech Republic is not uniform in this respect. The amount of the contractual penalty should also be determined with sufficient specificity.

Increased attention must also be paid to the agreement on the due date of the contractual penalty. Often, the due date of a contractual penalty is determined at the moment of the actual breach of contractual obligation. In such a case, a problem may arise in a situation where the creditor does not become aware of the breach of a contractual obligation within the limitation period, which is generally 3 years.