Contractual Penalty

A contractual penalty is a predetermined amount the debtor will pay if it fails to perform. It relieves the creditor of proving loss and encourages performance. The parties may freely set the amount (TCO Article 182(1)).

Types (TCO Article 179)

• Alternative penalty: Agreed for non-performance or improper performance. Unless the contract indicates otherwise, the creditor may claim either performance or the penalty, not both.
• Cumulative penalty: Agreed for failure to perform at the agreed time or place (e.g. a late delivery penalty). Unless the creditor expressly waived it or accepted performance without reservation, it may claim the penalty in addition to performance.
• Withdrawal penalty: Where the debtor may rescind or terminate by paying the penalty.

With cumulative penalties, accepting performance without a reservation may forfeit the penalty claim — one of the most common mistakes in practice.

Loss and Penalty (TCO Article 180)

• The penalty is payable even if the creditor suffered no loss.
• If the loss exceeds the penalty, the creditor may claim the excess only by proving the debtor’s fault.

Invalidity and Reduction (TCO Article 182)

• No penalty can be claimed if the main obligation is invalid or has become impossible for reasons not attributable to the debtor.
• The court reduces penalties it considers excessive of its own motion.
• Merchants: A debtor who is a merchant cannot seek reduction of an allegedly excessive penalty (TCC Article 22). Penalty amounts in commercial contracts should therefore be set carefully; see Prudent Businessperson.

Special Areas

In employment contracts, penalty clauses must apply to both parties and must not be disproportionate against the employee. Penalties in consumer contracts are subject to unfair contract terms review. Penalties are a common safeguard in non-disclosure agreements and non-compete clauses.