What is a penalty clause?

Question

José Manuel Alburquerque · Accepted Answer

It is a term in a contract (the “cláusula penal”) that sets in advance what a party will have to pay if it fails to perform or performs badly, for example a sum for each day of delay in handing over building work. Unless the contract says otherwise, that sum replaces compensation for the losses, so the party that receives it does not have to prove the loss, but cannot claim more either. Paying it does not release a party from performing, unless the contract expressly allows this. The judge can reduce it if the obligation was performed in part or irregularly, but not simply because it seems high. How it works It is governed by the Spanish Civil Code (“Código civil”), which also applies in Catalonia because the “Código Civil de Cataluña”, the Catalan Civil Code, has no general rules on it. The agreed sum is called a penalty, but it normally works as compensation calculated in advance. Its rules are these: It replaces compensation for losses and interest, unless the contract says that it is added to them. If it does, the party that receives it can also claim the losses it proves. The party that has to perform cannot get out of doing so by paying the penalty, unless the contract expressly reserves that right to it. Nor can the party that receives it demand both performance of the contract and payment of the penalty, unless the contract clearly allows this. That rule does not prevent a penalty for delay from being collected, since it is designed to be paid on top of the late delivery. If the penalty clause is invalid, the rest of the contract still stands. If it is the main obligation that is invalid, the penalty falls with it. The most common are penalties for delays in building works, penalties for leaving a service before the minimum term and those that make the buyer lose what they have already paid if they do not complete the payment. When the judge can reduce it The Spanish Civil Code allows the judge to moderate the penalty, that is, to reduce it on grounds of fairness, where the obligation has been performed in part or irregularly. The courts apply this rule within limits: If the penalty was agreed precisely for the breach that has occurred, it is not reduced. For example, if the contract sets 100 euros for each day of delay and the work is handed over twenty days late, 2.000 euros are owed, even if the delay caused less harm. Nor is it reduced because it is greater than the actual loss. The “Tribunal Supremo”, Spain's Supreme Court, only allows this, exceptionally, if the difference is extraordinary and is due to a change of circumstances that could not be foreseen when the contract was signed. In consumer contracts, a clause that imposes disproportionately high compensation on a consumer who fails to perform is unfair and invalid. What to check before signing Which breach makes the penalty payable, for example delay, total failure to perform or non-payment. Whether it replaces compensation or is added to it. Whether it allows the party that receives it to demand performance of the contract as well. Whether the amount is in proportion to the harm it is meant to cover. Do not confuse it with a deposit (“arras”). A penalty deposit (“arras penales”) is a form of penalty clause, but a withdrawal deposit (“arras penitenciales”) is the agreed price for backing out. In Catalonia, unless the contract says otherwise, the money the buyer hands over to the seller on signing is a payment on account of the price. Under the Spanish Civil Code, which applies in most of the rest of Spain, the rules on penalty clauses are the same.