The nature of penalty clauses in contracts

Penalty clauses are a common element in contracts made between professionals, as well as between professionals and consumers. The presence of these clauses, as well as the potential sanctions they impose in established circumstances and conditions, are usually not conflicting. However, the application of these clauses is more complex, especially when the conflict between the parties needs to be settled before jurisdictional bodies.

This article aims to offer the reader a basic and general idea of the nature of these penalty clauses, without delving into other relevant aspects such as: the differences and features of these clauses in the finalization of contracts between professionals and consumers or users, the moderation criteria for the penalty imposed by these clauses, or the assumptions which consider the clauses as replacing indemnity for damages suffered.

It is worth beginning this brief explanation of the nature of penalty clauses by highlighting that it involves an extra obligation to a main obligation, usually of a pecuniary character (although it can be any type of accepted service as subject to an obligation), that imposes sanctions on the parties for irregular compliance or incompliance with the primary obligation. Additionally, it is worth mentioning that penalty clauses can carry out an anticipated value of the existence, range and extent of the damages resulting from irregular compliance or incompliance with the primary obligation. Accordingly, we should note the consistent criteria of the Supreme Court, STS 230/1992, of 7 March which clearly states the following:

“… a coercive or guaranteed purpose, encourages the debtor to comply with the primary obligation by the threat of having to pay a penalty, a liquidating damages purpose that anticipates an evaluation of the damages that the incompliance or inappropriate compliance with the obligation would have caused the creditor, or a strictly penal purpose which consists in sanctioning or punishing the said incompliance by attributing more onerous consequences to the debtor than those which are normally related to contractual infractions…” (in the same effect STS of 20 June 2000).

Thus, the sentence above indicates a three-fold purpose of the penalty clauses, which could be included in the primary objective to be exercised:

  • Legitimate coercion over potential offenders and therefore creates incentive for the parties to duly comply with the assumed obligations
  • Liquidating purpose for damages arising from irregular compliance and/or incompliance with the primary obligation
  • Penalty purpose intended to punish irregular compliance or incompliance, allowing the sanctions applied to the incompliant party to lead to more serious consequences than those resulting from regular compliance to the primary obligation.

It must be underlined that the three previously described purposes (legitimate coercion, liquidation and penalty) are not incompatible with each other. Consequently, a penalty clause can have two or three purposes simultaneously.

This article is not considered as legal advice

Nicolás Melchior

A Law graduate from the Universidad Carlo III de Madrid, Nicolás Melchior specialises in corporate Law, commercial contracts and electronic commerce. Working languages: Spanish, German, English and French. For any further enquiries please Contact us