Penalty Clause and Damages

In an agreement (contract or settlement), a penalty clause is agreed by the parties in an amount determined by them. The amount does not have to be proved; it is sufficient to establish that there has been a failure to perform — complete, defective or delayed.

Any contractual penalty may be freely determined by the parties insofar as autonomy of will and freedom of contract are fundamental constitutional freedoms, respect for which is mandatory for private-law entities and state authorities. The legislature has introduced a restriction in Article 9 of the Obligations and Contracts Act, according to which the parties may freely determine the content of their contracts only insofar as it does not contravene the law or good morals. A contradiction with the law exists where there is a conflict with a legal principle which, although not expressly formulated, is embodied in numerous individual provisions and forms part of the legal system in force. As regards good morals, Article 26 of the Obligations and Contracts Act gives them legal significance, placing a breach of good morals on an equal footing, in terms of consequences, with a violation of the law. A distinctive feature of good morals is that they are unwritten and not specifically defined, but exist as general principles or are derived from them.

An agreement providing for a contractual penalty serves not only a compensatory but also a punitive function; through their combination, due performance by the debtor is secured.

Compensation is a remedy distinct from a contractual penalty, although it performs a similar function. Where compensation is claimed, evidence is required, unlike in the case of a contractual penalty. The claimant must prove not only the failure to perform that gives rise to compensation, but also its amount.