Penalty clause and its moderation in Courts

The penalty clause seeks to enforce the contract by punishing non-compliance with the penalty in question.

In sales of companies’ shares agreements, this clause is related to the non-competition clause. The party obliged by the non-competition clause must pay a monetary penalty if he fails to comply with such obligation.

Courts, under the basis of the principle of equity, can adjust these penalties. However, it has to be taken into account that the Supreme Court cannot review it or modify it on appeal.

Contacto No te quedes con la duda, contacta con nosotros. Estaremos encantados de atenderte y ofrecerte soluciones.

 The function of the penalty clause

The usefulness of this contractual prevision derives from the function of the penalty clause. Its main purpose is to secure strict compliance with the provisions of the agreement. But it is also used as a deterrent, and as a coercive function. Through penalty clauses is possible to quantify in advance the damages for non-performance.

If agreed, penalty clauses can also have a cumulative function. With the cumulative function, creditor may require performance of the obligation in addition to satisfaction of the agreed penalty. As it is provided in article 1153 of the Spanish Civil Code.

Si te ha interesado este artículo no dudes en leer:

The 10 Key Steps of Mergers and Acquisitions in How to Sell a Company

The process of selling a company or an acquisition involves much more than agreeing on a price. There are several hundred aspects to negotiate. And if one refuses to agree on a price or sell their company, they won’t be able to buy someone else’s company. It is not about charging fees. This is simply business. Even if one certain company does not buy the selling company, it will be bought one way or another.

Courts Moderation

 We often forget that Courts can moderate penalty clauses as it is provided in Articles 1.152 and following of the CC.

The power of the Court to moderate the penalty clause enters into action when there is a faulty, partial or late compliance. Not when there is an absolute disregard with the obligation, and the breach is whole.

The Supreme Court states that the penalty cannot be tempered if the breach pertains to the clause foreseen in the contract. (Sentence 1151/2018 of 12 July). The moderating power of the judge cannot be applied if the exactly foreseen infraction occurs. (Supreme Court Ruling 1293/2007 of 5 December). All of this because the free will of the contracting parties shall prevail in those cases.

Excessive or disproportionate penalty

There is a minor case law in favor of moderating penalty clauses that may result abusive for the debtor. I.e. those penalty clauses where there is an imbalance between the real damages and the penalty included in contract. Particularly when this imbalance is extraordinarily high. So much so, that the result of the penalty clause could not be foreseen when agreeing to the contract. And when the application of the penalty in its exact terms will cause unjustified enrichment of the creditor. (As sentenced by the Supreme Court 175/2017, 25 January).

Conclusion

A Court can hardly moderate a penalty clause if all requisites that prompt the planned compensation concur. And that can also be said in the case that it has been agreed beforehand that the penalty clause will be applied in both cases of total and partial non-compliance. This will force the debtor to comply with the agreed obligation or else to pay the consequences. Whatever the case may be, it´s useful to bear in mind what we said above about excessive or disproportionate penalties.

If this article has been of interest, we also suggest you to read the following article published on our website:

Defects of consent, brief concept and consequences