Mitigation of contractual penalties

The amount of the contractual penalty and damages

Article 484(1) of the Civil Code provides that a contractual penalty is payable to the creditor for non-performance or improper performance of an obligation in the amount stipulated for such an event, irrespective of the amount of damage suffered. The above provision expressly states that the condition which must be met for the creditor to be entitled to claim payment of the relevant sum of money is the non-performance or improper performance of the obligation and the reservation of a contractual penalty. These conditions must be demonstrated by the creditor when pursuing the claim.

However, the legislator has limited the creditor’s scope for pursuing a claim for a contractual penalty by identifying two situations in which the debtor may demand a corresponding reduction, which in practice is referred to as the mitigation of the contractual penalty. The specific grounds entitling the debtor to request a reduction in the amount of the contractual penalty are described below. It should be emphasised that Article 484(2) of the Civil Code is a right which must be exercised by the debtor. Even where the statutory grounds exist, the court cannot reduce the contractual penalty of its own motion, but only at the debtor’s request (judgment of the Supreme Court of 16 November 2022, ref. no. II CSKP 578/22, Lex no. 3521679).

Another important issue regarding the mitigation of a contractual penalty is whether it can be reduced to zero. In this regard, it is worth noting one of the Supreme Court’s rulings, according to which:

One must agree with the view that excludes the possibility of completely waiving the obligation to pay the penalty where the grounds for its imposition have arisen. This conclusion follows from the fact that Article 484 § 2 of the Civil Code grants the debtor only the right to request a reduction of the penalty, and not complete exemption from its payment.

(Judgment of the Supreme Court of 18 December 2018, ref. no. IV CSK 491/17, Lex no. 2618489)

As the Supreme Court indicates in the above judgment, the purpose of moderating a contractual penalty is to prevent a situation arising in which the debtor would have to pay a grossly excessive contractual penalty in view of the adverse consequences for which the creditor is demanding payment. Consequently, reducing the amount of the contractual penalty to zero would, in a sense, completely disregard the creditor’s interests and the consequences of non-performance or improper performance of the contractual penalty, and would thus be contrary to the very purpose of the contractual penalty. However, it should be emphasised that this applies to situations where the condition entitling the creditor to claim the contractual penalty has been met, and the contractual penalty itself has been correctly agreed between the Parties.

It is worth noting the existence of a less common, opposing view, according to which there are situations justifying the reduction of the contractual penalty to zero. In particular, this applies where special circumstances warrant it, e.g. where the court finds that the contractual penalty, even if reduced to the lowest possible amount, would still be grossly excessive. This can be justified on the grounds that the creditor should not be allowed to benefit without justification.

Reduction of the penalty on the grounds that the debtor has performed a significant part of the obligation

One of the grounds on which a debtor may request the court to reduce the amount of the contractual penalty is where the obligation has been performed by the debtor to a significant extent. The legislator has set out the rather vague criterion of a ‘significant’ part, which should be assessed on a case-by-case basis in the light of the specific factual circumstances. However, it is possible to indicate how the courts most frequently interpret the condition of ‘a significant’ part of the obligation having been performed.

In one of its judgments, the Supreme Court stated that determining whether a significant part of the obligation has been performed cannot be understood as the debtor’s actual partial performance of the obligation, e.g. by indicating that more than half of the obligation has been fulfilled. According to this position, the issue is to determine whether the debtor’s performance of a significant part of the obligation satisfies, and if so to what extent, the creditor’s legitimate interests. Hence, one of the criteria which the court should take into account when determining the significance of the performance of the obligation is the extent to which the creditor has been satisfied as a result of the debtor’s performance of a substantial part of the obligation. If it is determined that the performance of a significant part of the obligation is of no significance to the creditor, a reduction of the contractual penalty would be unjustified (see the judgment of the Supreme Court of 25 March 2011, ref. no.: IV CSK 401/10).

Moderation of the penalty on the grounds of grossly excessive contractual penalty

As in the case of the debtor having performed a significant part of the obligation, the grossly excessive nature of the contractual penalty constitutes a non-rigid criterion which is analysed on a case-by-case basis in the light of the specific factual circumstances. However, both legal doctrine and case law point to certain factors which the court takes into account when assessing whether the contractual penalty is grossly excessive. It is most commonly pointed out that a contractual penalty is grossly excessive when its amount is clearly too high in relation to what it ought to be, for example, compared to the amount the creditor would claim under general principles (i.e. in the case of damages). When assessing the amount, the functions of the contractual penalty—namely, its compensatory, restitutory and preventive functions—should also serve as a point of reference.

One may also note a situation where, following the taking of evidence, there are still doubts as to whether the contractual penalty is too high. This usually indicates that, in such a case, the penalty is most likely not too high, since it is a matter of doubt, whereas the provision requires it to be manifestly excessive.

Summary

In summary, the reduction of a contractual penalty is carried out exclusively at the debtor’s request and is subject to the Court’s assessment as to whether one of the conditions set out in Article 484 § 2 of the Civil Code has been met. These conditions may be met simultaneously. When analysing whether at least one of the conditions has been met, the factual circumstances of the case are of primary importance. However, it should be noted that when determining whether the conditions for moderating the penalty have been met, the court takes into account the extent to which the creditor’s interest has been satisfied, notes whether a significant overestimation of the contractual penalty is evident, takes into account the functions of the contractual penalty and may, where appropriate, refer to the amount of compensation the creditor would have received under general principles.

Author

Adrianna Bracichowicz

Associate

Adrianna Bracichowicz is a dedicated lawyer at our firm, specializing in business law and also in litigation law. She graduated with a master's degree from the University of Wroclaw, and also developed her skills while studying at the University of Bergen in Norway under the Erasmus+ program. She is currently continuing her legal education by completing the first year of her lawyer's apprenticeship.

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