Moderace smluvní pokuty

What is the moderation of a contractual penalty and why does it concern you?

The essence of moderation is that the court assesses whether the amount of the claimed contractual penalty corresponds to the value and importance of the secured obligation. If it concludes that the penalty is unreasonably high, it can reduce it to the amount of the damage actually incurred by the creditor due to the breach of the secured obligation.

For business owners, this represents a significant risk: the carefully negotiated protection of your business interests can be significantly weakened by a court decision. The creditor then receives only a fraction of the originally agreed amount, which may not even cover their actual damages. Therefore, it is crucial to understand how to set up contractual penalties correctly to minimize the risk of their subsequent reduction.

The lawyers at the ARROWS law firm specialize in preparing contractual documentation that can withstand moderation. We design sanction mechanisms that protect your business interests while respecting current case law. Contact us at consultation@arws.cz. 

A revolutionary change from 2023: The three-phase test that changed the rules of the game

In January 2023, the Grand Chamber of the Supreme Court adopted a landmark judgment, file no. 31 Cdo 2273/2022, which fundamentally changed the way courts approach the moderation of contractual penalties. This change has major implications for all business owners who use contractual penalties in their contracts.

Previous approach: Courts assessed the reasonableness of the contractual penalty clause itself at the time it was agreed. The circumstances at the time of the contract's conclusion were decisive – especially the amount of the agreed penalty in relation to the amount owed or the value of the performance.

New approach: Courts no longer assess the reasonableness of the contractual penalty clause as such, but the reasonableness of the specific claim for its payment. They consider the circumstances not only at the time the penalty was agreed upon, but also at the time of the breach of obligation and subsequently when the claim is made.

The three-phase test of moderation

The Supreme Court has introduced a systematic three-phase procedure that courts must follow when deciding on moderation:

Phase 1: Determining the function of the contractual penalty

The court must first use interpretation rules (Section 555 et seq. of the Civil Code) to determine what function the contractual penalty was intended to serve. Three basic functions are distinguished:

• Lump-sum (compensatory) function – the contractual penalty primarily replaces hard-to-prove damages that the creditor would suffer from the breach of obligation

• Sanctioning (punitive) function – the penalty is primarily intended to punish the breach of obligation, regardless of whether the creditor incurred any damage

• Mixed function – a combination of the two previous functions, where the penalty is intended to both compensate for damages and sanction the debtor

Determining the function is key, as it dictates which circumstances will be decisive when assessing reasonableness.

Phase 2: Assessing the reasonableness of the specific claim

In this phase, the court examines whether the amount of the contractual penalty is reasonable in relation to the creditor's interests that were harmed by the breach of the contractual obligation. It assesses:

• Circumstances at the time the contractual penalty was agreed (value and importance of the secured obligation)

• The manner and circumstances of the breach of obligation (severity, fault, length of delay)

• The extent of the consequences for the creditor (actual damage incurred, disruption of business relationships)

For a lump-sum contractual penalty, the amount of damage actually incurred plays a crucial role. If the damage is significantly lower than the agreed penalty, this may be a reason for moderation. The burden of proof regarding the circumstances of the amount of damage lies with the debtor.

For a sanctioning contractual penalty, the amount of damage is not decisive. The court primarily considers the severity of the breach, the debtor's fault, and the preventive function of the penalty.

Phase 3: The moderation itself

If the court concludes that the contractual penalty is unreasonable, in the third phase it reduces it to a reasonable amount. In doing so, it takes into account all the functions the penalty is intended to serve, and the value and importance of the secured obligation.

If the court finds that the contractual penalty is not unreasonable, or if it fails to sufficiently clarify the extent of the consequences of the breach, it must not reduce the creditor's claim for the contractual penalty.

The ARROWS law firm helps clients in this area on several levels. We prepare contracts with a precisely defined function for the contractual penalty, represent clients in court disputes over the enforcement of penalties, and provide expert opinions on the reasonableness of agreed sanctions. Do not hesitate to contact our firm at consultation@arws.cz. 

It depends on how it is formulated in the contract and the ratio between the agreed penalty amount and the expected damage. If the penalty amount roughly corresponds to the damage the breach could cause, it is a lump-sum penalty. If the penalty significantly exceeds the possible damage, it has more of a sanctioning character. The ARROWS law firm can help you analyze your contracts – consultation@arws.cz. 

For a lump-sum contractual penalty, yes – although the burden of proof primarily lies with the debtor proposing moderation, the creditor should be able to at least roughly prove what damage was incurred. For a sanctioning penalty, the amount of damage is not decisive. Are you dealing with the enforcement of a contractual penalty? Contact us at consultation@arws.cz. 

The myth of the 0.5% per day limit: Why it no longer works and what to use instead

For many years, there was a widespread belief among business owners and lawyers that a contractual penalty of 0.5% per day of the amount owed was a safe limit that courts considered reasonable. This idea had some support in case law – several decisions by the Supreme Court from the first decade of the 21st century did indeed label penalties exceeding this limit as unreasonable.

The reality, however, is far more complex, and this simplified limit cannot be taken as an absolute rule today. The Supreme Court has repeatedly emphasized that it is not possible to set a fixed daily rate for a contractual penalty above which the amount would automatically be considered unreasonable. Reasonableness is always assessed with regard to the overall circumstances of the specific case.

So what instead of a fixed limit?

When determining the amount of a contractual penalty, the following must be considered:

The value and importance of the secured obligation – the more important the breached obligation is to the creditor, the higher the penalty can be. For example, if it concerns the delivery of a key component for a production process where every day of delay causes a production shutdown, a higher penalty may be justified than for a routine delivery of goods.

The mutual ratio of the original and the sanctioning obligation – if a contractual penalty secures an obligation of relatively small value, but the penalty is set at a very high amount, this is a strong indicator of unreasonableness.

The amount of potential damage – for a lump-sum penalty, its amount should roughly correspond to the damage that the breach could cause. A significant difference suggests that the penalty has more of a sanctioning character.

The nature of the contractual relationship – in business relationships between professionals, courts tend to be more lenient when assessing reasonableness than in relationships with consumers.

Determining the correct amount for a contractual penalty requires detailed knowledge of case law and an understanding of the specifics of your business case. The ARROWS law firm has extensive experience in preparing contractual penalties for various types of business relationships – from IT contracts and supplier agreements to lease relationships. Connect with us at consultation@arws.cz. 

Maturity of the contractual penalty – a critical detail

The Civil Code does not generally stipulate when a contractual penalty is due. Therefore, it is very important to explicitly agree on the due date in the contract.

Two basic variants for the emergence of the claim:

Automatic emergence: “If the debtor fails to fulfill the obligation specified in Art. 4.2 by June 30, 2025, at the latest, they undertake to pay the creditor a contractual penalty of CZK 50,000.” The claim for the contractual penalty thus arises automatically upon breach of the contractual obligation.

Emergence upon demand: “If the debtor fails to fulfill the obligation specified in Art. 4.2 by June 30, 2025, at the latest, the creditor is entitled to demand payment of a contractual penalty of CZK 50,000.” The claim for the contractual penalty arises upon failure to fulfill the obligation only if the creditor actually claims the penalty by issuing a demand.

The ARROWS law firm regularly prepares contractual documentation for business owners of all sizes. Our contracts contain precisely formulated contractual penalties that minimize the risk of them being challenged. Need help with preparing or reviewing contracts? Write to consultation@arws.cz. 

A critical mistake: The relationship between a contractual penalty and damages

One of the most serious mistakes business owners make when agreeing on contractual penalties is not realizing the basic rule of the Civil Code: a contractual penalty excludes the right to compensation for damages.

According to Section 2050 of the Civil Code, if a contractual penalty is agreed upon, the creditor is not entitled to compensation for damages arising from the breach of the obligation, to which the contractual penalty relates. The contractual penalty thus serves the function of so-called lump-sum damages.

However, the aforementioned provision is dispositive, i.e., the parties can deviate from it and agree otherwise. It is therefore possible to include a clause in the contract that allows you to claim both the contractual penalty and full compensation for damages. 

This area is full of pitfalls and details that can have significant financial consequences for your business. The ARROWS law firm will help you set up contractual penalties in a way that provides you with maximum protection. Do not hesitate to contact consultation@arws.cz. 

It depends on the nature of the obligation. For monetary debts, a percentage is suitable (e.g., 0.3% per day), while for specific obligations (handover of documentation, compliance with confidentiality), a fixed amount is better. The ARROWS law firm will advise you on the optimal option for your case – consultation@arws.cz.

Yes, the total amount of contractual penalties is not limited by law, as long as they concern different breaches of different obligations. However, be aware that very high cumulative penalties can be moderated by a court. Are you dealing with recurring problems with a business partner? Write to consultation@arws.cz.

Specifics of contractual penalties in different types of contracts

The setup of a contractual penalty varies depending on the type of contractual relationship. What works for a supplier agreement may not be suitable for a software license agreement or a lease relationship.

IT contracts and software licenses

In the field of IT contracts, contractual penalties are often linked to delays in software delivery, typically 0.05% of the purchase price for each day of delay, or to delays in rectifying defects, where a higher rate is commonly used, e.g., 0.2% of the purchase price per day. A fixed amount for each breach of confidentiality or use of illegal software is also standard.

For IT contracts, it is also advisable to explicitly state that the payment of a contractual penalty does not affect the right to compensation for damages incurred by the party claiming the contractual penalty in connection with the breach of contract. This is because in IT projects, it is often difficult to estimate at the time of contract conclusion how high the damage could be in the event of their failure.

Lease agreements

In the case of a residential apartment or house lease, the agreement of contractual penalties is subject to strict legal limits under Czech legislation. According to Section 2254 of the Civil Code, the sum of the contractual penalty and the security deposit (kauce) may not exceed three times the monthly rent. This regulation has been effective since July 2020; until then, this type of sanction was completely prohibited in residential lease agreements. Now, they can be agreed upon, but only within the specified limits.

In practice, contractual penalties are most often used to secure specific obligations of the tenant. They are typically agreed for cases of late handover of the apartment after the lease ends, if the tenant does not repaint the apartment before returning it, or in a situation where the apartment is damaged beyond normal wear and tear.

Different rules apply to lease agreements for business purposes, i.e., for non-residential premises. These relationships are not bound by the aforementioned limits set for housing. In commercial leases, general rules apply, with the decisive factor for the penalty amount remaining its reasonableness.

Supplier and purchase agreements

In the area of goods or services supply, contractual penalties are most often used as a sanction for the breach of key obligations. This typically involves delays in delivery, where the sanction is often determined by a percentage rate, or delays in rectifying claimed defects. Contractual penalties also effectively secure compliance with non-compete clauses and protect the customer in case of incomplete or faulty documentation.

When agreeing on these sanctions, it is necessary to be aware of one specific risk. If the creditor sets the contractual penalty too low and at the same time does not explicitly reserve the right to compensation for damages beyond this penalty in the contract, they may lose a substantial part of their claim. In such a case, the obligation to compensate for damages is extinguished by the payment of the lump-sum penalty, which does not cover the actual loss.

The ARROWS law firm has experience with preparing contractual documentation for all types of business relationships. Whether you are dealing with IT projects, lease agreements, goods deliveries, or complex construction contracts, our Prague-based firm will help you tailor contractual penalties specifically to your business. You can connect with them via email at consultation@arws.cz. 

A contractual penalty is not a universal solution: When to choose other security?

Although a contractual penalty is a universal tool for securing a debt, it has its limits. In some situations, other security or sanctioning instruments are more appropriate.

What to do when you already have a problematic contract?

Many business owners find out only in retrospect that their contracts contain contractual penalties that are poorly set up and can be easily moderated or challenged. What to do in such a situation?

For obligations in the tens of millions, setting a reasonable penalty is difficult. An extremely high sanction could be moderated by a court, while a low one would have no motivational effect. Here, a bank guarantee or a security transfer of right is a better choice.

If your business partner has questionable creditworthiness, the penalty alone will not protect you, as it may not be realistically enforceable. In such a case, it is necessary to combine the sanction with a security deposit (kauce), a bank guarantee, or a third-party guarantee. For delays in monetary payments, interest on late payment is more effective. It arises automatically by law, the creditor does not have to prove anything, and unlike a one-off penalty, the interest accrues continuously without an upper limit.

A specific case is the breach of a non-compete clause or trade secret, where damages are difficult to quantify. The solution is a high fixed penalty for each breach, ideally in combination with the right to compensation for actual damages.

The choice of the right tool always depends on the specific circumstances of the transaction. The ARROWS law firm will help you design an optimal mix of security to ensure you are maximally protected. Are you looking for specialists who will set up contracts just for you? Write to us at consultation@arws.cz

Audit of existing contracts

The first step to remedy is a comprehensive review of your contractual relationships. They often lack an explicit exclusion of Section 2050 of the Civil Code, which in practice means that the claim for damages is extinguished upon payment of the penalty.

Vague formulations such as 'a reasonable penalty' or the absence of an agreement on its maturity also pose a risk. Problems also arise from sanctions agreed for the exercise of a right instead of a breach of an obligation, or the accumulation of sanctions without a clear structure.

The ARROWS law firm will conduct a detailed audit of your documentation, identify weak points, and propose concrete steps for correction. Need to have your contracts reviewed? Contact us at consultation@arws.cz. 

Amendments to existing contracts

If you discover problematic provisions in active contracts, they can be corrected with a written amendment. This allows you to add missing rules for damages, clarify vague formulations, or adjust the penalty amount.

Remember, however, that concluding an amendment requires the consent of the other party. If the partner is in the position of a debtor, they may not have the motivation to change. An effective strategy is therefore to offer a mutually beneficial adjustment in their favor as well.

Preventive measures for future contracts

For future business, create a set of standardized templates with legally robust penalties. It is also important to train the sales team to understand the principles of sanctions and to know when consultation with lawyers is necessary.

Do not underestimate the development of legislation and judicial practice either. What worked five years ago may not hold up in court today. The ARROWS law firm offers long-term support, training, and documentation optimization. Write to us at consultation@arws.cz.

Why it's better to leave it to the professionals

Setting up contractual penalties may seem simple at first glance, often just a matter of adding a number and a rate. However, the reality is much more complex, as confirmed by current case law, which is constantly evolving.

Each type of relationship has its specifics. What works for supply agreements may be a problem for software licenses. Moreover, the law changes, and ignorance of new Supreme Court decisions exposes you to unnecessary risks. A contractual penalty is not isolated but is closely related to damages or withdrawal from the contract. A change in one article can thus have unexpected and significant impacts on the entire contractual documentation.

Furthermore, handling legal issues on your own is inefficient. As company management, you should be running the business, not studying case law. Our Czech legal team deals with this agenda daily and will provide you with legal protection much faster.

The ARROWS law firm is insured for up to CZK 500 million. If our advice were to cause damage, you have a guarantee of compensation. Unprofessional solutions or a standard consultation cannot provide this. Even if you have your own lawyers, we can act as specialized partners. We will effectively use our deep expertise in Czech contract law to strengthen your internal team in specific cases.

For international business, the situation is even more complex. Thanks to the ARROWS International network, we handle cases with an international element daily and will provide you with support in cross-border transactions as well. We will help you with document preparation, contract review, and representation in disputes. Do not hesitate to contact us. Contact us at consultation@arws.cz. 

Conclusion: Why a correctly set contractual penalty protects your business

A contractual penalty is one of the most effective tools for protecting business interests and motivating partners. However, its incorrect setup can mean an unnecessary risk associated with financial loss and damage to reputation.

The transformation of judicial practice plays a significant role, as since 2023, courts no longer evaluate only the amount of the penalty at the time it was agreed upon, but also consider circumstances that arose after the breach of obligation. This increases the demands on the precision of contracts.

Determining the function of the sanction itself is also crucial. It is necessary to define whether it is primarily intended to compensate for damages or to serve a punitive role. The legal argumentation in a potential dispute then depends on this purpose.

In practice, the previously widespread myth of a safe limit of 0.5% per day no longer applies. A universal rate does not exist, and reasonableness is always assessed completely individually with regard to the specifics of the particular case. A common mistake is the loss of the right to compensation for actual damages. If this right is not explicitly agreed upon in the contract alongside the penalty itself, the creditor may lose a substantial part of their financial compensation.

The ARROWS law firm deals with this issue daily for clients from the IT, manufacturing, and development sectors, among others. Our Prague-based firm provides tailor-made contract preparation, representation in disputes, and the drafting of expert opinions. Services also include comprehensive debt recovery and the preventive setup of company processes.

Don't risk unnecessary sanctions or reputational damage. Contact the ARROWS law firm at the email address consultation@arws.cz, and together we will find a solution that protects your business.

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