Contractual Penalty

Contractual Penalty

September 01, 2023

A contractual penalty is a widespread contractual provision according to which the debtor is obliged to make a payment of money (in rare cases also another service) to the creditor if he does not fulfil certain of his contractual obligations or does not fulfil them in accordance with the contract. The obligation to pay the penalty is thus dependent on the condition of improper performance - the occurrence of this condition is also referred to as forfeiture of the contractual penalty.

In addition to contractual penalties, there is also the possibility of agreeing on a lump sum for damages, which is linked to a claim for damages existing on the merits and is intended to serve the purpose of simplified enforcement of the existing claim (whereas contractual penalties ostensibly serve to prevent breaches of duty by exerting pressure).

Contractual penalties for a breach of the main contractual obligation are regulated by law in §§ 339 ff. BGB, according to which the debtor has to pay or perform the penalty if he defaults on his main performance obligation. In addition, contractual penalty clauses have significance e.g. in employment, service and company contracts in which the promise of a penalty is intended to ensure compliance with ancillary obligations such as the duty of confidentiality or the non-competition clause.

The validity of such a clause is initially determined by general principles, i.e. it is void under section 134 BGB if it violates a statutory prohibition and under section 138 BGB if it is immoral. Promises of contractual penalties are prohibited, for example, under section 555 of the BGB in the case of residential leases.

If the contractual penalty is used as a clause in general terms and conditions pursuant to section 305 BGB by an entrepreneur vis-à-vis a consumer, its effectiveness is governed by section 309 no. 6 BGB, according to which a clause is invalid which provides for a contractual penalty in the event of non-acceptance or delayed acceptance of the performance, default of payment or dissolution of the contract.

However, also in contracts between entrepreneurs (and in consumer transactions beyond the scope of application of section 309 no. 6) the penalty clause as part of general terms and conditions must comply with the requirements of section 307 BGB, i.e. it must not unreasonably disadvantage the partner of the user of the GTC. The clause does not unreasonably disadvantage the contractual partner insofar as the user of the GTC has a legitimate interest in the contractual penalty as a means of exerting pressure to fulfil the obligation, e.g. because the claim for damages is not sufficient to secure it.

An unreasonable disadvantage may result from the indeterminacy, the unreasonable amount or the lack of differentiation according to the severity of the breach of duty.

The penalty clause is indeterminate if it does not specifically state the triggering breach of duty (such as only generally "non-compliance with contractual obligations") and the amount of the payment. These principles also apply to individually negotiated clauses outside of general terms and conditions.

The amount of the promised penalty is unreasonable if it is disproportionate to the seriousness of the breach of contract and its consequences, e.g. a considerable amount is provided for in relation to slight fault, a subordinate secondary obligation or only minor possible damages. Therefore, a maximum limit must be provided for, which must be proportionate to the seriousness of the breach of duty and the expected damages. If individually negotiated penalty clauses (§§ 339 et seq. BGB) are unreasonable in terms of their amount, a reduction to a reasonable level pursuant to § 343 BGB may be considered; in the case of clauses in GTCs that are ineffective pursuant to § 307 BGB, they are ineffective as a whole.

Especially in the case of promises of punishment in the event of a breach of confidentiality obligations or non-competition clauses, case law also regularly focuses on the fact that the clause must differentiate according to the severity of the breach of duty in the individual case. Since it is difficult to make this differentiation in advance due to a multitude of possible forms of breach, there is the possibility of the so-called "new Hamburg custom", according to which the determination of the amount of the penalty is left to the creditor in the individual case and the debtor can then have it reviewed by the courts (Sections 315 et seq. BGB).

The contractual partner is unreasonably disadvantaged if the provision in favour of the user deviates from the essential contents of the statutory provisions. For example, if the clause provides without an objective reason that the debtor owes the penalty also irrespective of whether he is responsible for the breach of duty (deviation from section 339 sentence 1 BGB). An objective reason is not given in any case if the user could also include a lump-sum claim for damages in the GTC. A substantial deviation is also given if the GTC provide for additional claims for damages (including lump sums) in addition to the penalty clause (deviation from section 340(2) BGB).

In labour law, the agreement of contractual penalties is very common, and GTCB law is also applicable to these clauses, even if according to Section 310 (4) sentence 2 BGB the special features applicable in labour law have to be taken into account. Therefore, the prohibition in section 309 no. 6 BGB has little significance, whereas an invalidity due to unreasonable disadvantage to the employee can be considered. According to the case law of the Federal Labour Court, a strict standard must be applied in the corresponding examination of the clause in order to protect the employee. Clauses were classified as unreasonably disadvantageous if they stipulate a penalty that is too high, if their purpose is not only to secure the obligation but also to create money for the employer, or if they violate the requirement of transparency, for example because the basis of calculation is too complex, the amount of the penalty is not clearly recognisable or the breach of duty to which the penalty is linked is indeterminate.

The amount of a contractual penalty in labour law is to be determined according to the remuneration that the employee would receive during the notice period. Accordingly, a contractual penalty in the amount of one to three times the monthly salary for each individual case of a breach of a non-competition clause or, for example, in the amount of one month's salary for a notice period of 2 weeks (during the probationary period) is unreasonable. A contractual penalty clause is too vague if the user is given scope for assessment with regard to the prerequisites and legal consequences of the breach of duty, in particular in the case of "global" penalties which are only linked in an unspecific manner to "conduct in breach of contract" or "serious breaches of contract".

Interesting case law - individual decisions on various areas

General

Disproportionate amount

"The contractual penalty was created by the legislator with a double objective. On the one hand, it is intended as a means of exerting pressure on the debtor to duly perform the promised service (BGHZ [...]). On the other hand, it is intended to give the creditor the possibility of easier indemnification without individual proof in the event of a breach (BGHZ [...]). b) Taking into account these legal purposes, the Senate has not objected to contractual penalties contained in general terms and conditions which are calculated on the basis of a partial amount of the contract sum and which, at 0.2% per working day (BGHZ 72, 222 (223, 224) = NJW 1979, 212) or 0.3% per working day (BauR 1976, 279 = NJW 1976, 2259), remain within an acceptable range. On the other hand, it refused to recognise a contractual penalty of 1.5% of the contract sum per working day (NJW 1981, 1509). A generally valid determination of the permissible penalty amount is not possible. Rather, the decisive factor must be the circumstances covered by the respective penalty clause. c) Accordingly, no. 7.3. of the Special Conditions of Contract on which the building contract was based in this case constitutes a provision which unreasonably favours the principal. It does not contain any time limit, so that the contractor can lose his entire claim to payment for work even if the duration of the delay is by no means exceptional. This ignores, to the contractor's disadvantage, the fact that larger objects are often difficult to schedule precisely and that long-term delays can occur even in the case of minor negligence. Furthermore, there is no reasonable relationship to the possible damage to the building owner's community. Experience has shown that a contractual penalty calculated as a percentage of the contract sum and unlimited in time is much more likely to reach or exceed the consequences of delay in the case of large contract sums than is the case with smaller contracts. Even taking into account its "pressure function", the contractual penalty is in no way intended to serve the mere creation of new pecuniary claims detached from the principal's material interest [...]. It is therefore inadmissible to provide construction contracts with a penalty clause in the form of a form - as is the case here - which lacks any differentiation according to the consequences of the delay in question and has no upper limit. The client's interests worthy of protection are not unreasonably impaired by this, since any claims for damages arising from delayed completion remain with him even if he cannot demand a contractual penalty" BGH, judgement of 18.11.1982, NJW 1983, 385, 387.

"The amount of a contractually stipulated contractual penalty is unreasonable in particular if the sanction is out of proportion to the weight of the breach of contract and its consequences for the contracting party [...]. According to the case law of the VII Civil Senate of the Federal Court of Justice (BGH), which is particularly responsible for construction contracts, this is the case if the amount of the contractual penalty is not linked to the weight of the breach of contract, increases continuously with the progressing duration of the breach of contract and neither a limitation in time nor a limitation in amount is provided for. Then the unreasonable disadvantage of the contractual penalty debtor lies above all in the danger that the constantly increasing contractual penalty may consume his own contractual claims, become disproportionate to the possible damage of the contractual penalty creditor and even open up a source of money for the latter which is no longer covered by his material interest" BGH, judgement of 07.05.1997, NJW 1997, 3233, 3234 (on commercial agent/authorised dealer law).

Independence from fault

"It is correct that § 339 BGB links the forfeiture of a contractual penalty to fault on the part of the obligor (cf. BGH, NJW 1972, 1893 = LM § 339 BGB No. 16). However, the contracting parties may agree on a deviating provision (BGH, NJW 1972, 1893 = LM § 339 HGB no. 16). However, the opinion is expressed in the literature that the fault requirement cannot be waived in general terms and conditions or in a form contract; this "would abolish one of the cornerstones of the legal regulation and establish liability regardless of fault" (Schmidt=Salzer, AGB, 2nd ed., marginal no. F. 220). However, the invalidity of a no-fault contractual penalty promise in general terms and conditions or in a form contract depends on whether such a clause unreasonably disadvantages the contractual partner of the user contrary to the principles of good faith (cf. § 9 I of the General Terms and Conditions Act). In this respect, the deviation from the fault requirement of § 339 BGB is relevant (cf. § 9 II AGB Act). However, this does not preclude the clause from being considered valid due to other weighty aspects. This is the case here" BGH, Judgment of 28.09.1978, NJW 1979, 105 (on sea freight contract).

"According to the provision of § 12 of the contracts, the defendant must pay a contractual penalty of 20000 DM plus VAT in the event that he breaches essential contractual obligations. The court found this to be a violation of § 9 II AGBG (now: § 307 II BGB). In its reasoning, it stated that the provision was unreasonable because it was based solely on the existence of a breach of duty and not additionally on the defendant's having to be responsible for it and also because no weighty interests of the plaintiff justified the agreement of a claim for contractual penalty in general terms and conditions without fault as an exception. This assessment does not reveal an error of law" BGH, Judgment of 20.03.2003, NJW-RR 2003, 1056

Cumulation of contractual penalty and damages

"The court of appeal rightly considered the right of the plaintiff provided for in § 12 of the representative agreement to claim damages from the defendant in the event of a breach of the non-competition clause and, in addition, to claim all cancellation reserves accumulated on the cancellation account as a contractual penalty as invalid due to the violation of § 9 of the German General Terms and Conditions Act. The provision made by the plaintiff on the basis of a form is also not valid in dealings between merchants - as is the case here. It deviates from the basic legal idea contained in §§ 340 II, 341 II BGB that damages for non-fulfilment and contractual penalty cannot be claimed side by side and thus represents an unreasonable disadvantage to the contractual partner of the plaintiff[...] The entrepreneur can also only assert the claim for payment of a contractual penalty when he becomes aware of a breach of contract by the commercial agent. In this respect, his situation is no different than when asserting a claim for damages for non-performance. The accumulation of both claims does not improve his situation in this respect. The difficulties cited by the revision in calculating a claim for damages also do not justify considering the contractual provision at issue in § 12 as appropriate. According to § 340 II 1 BGB, the creditor who is entitled to damages for non-performance may demand the forfeited penalty as the minimum amount of damages. He only has to prove the further damage" BGH, judgement of 21.11.1991, NJW 1992, 1096 (commercial agency contract)

No differentiation according to the severity of the breach in different individual cases

"The permissible form of a contractual penalty agreed in general terms and conditions cannot, however, be determined in a generally valid manner. Rather, it must be based on the dual purpose of the contractual penalty. On the one hand, as a means of pressure, it is intended to urge the debtor to duly fulfil his contractual obligation, on the other hand, it is intended to enable the creditor to hold himself harmless in the event of a breach of the sanctioned contractual obligations up to the amount of the contractual penalty without individual proof (BGH NJW 2000, 2106, 2107). The pressure function does allow for a noticeable contractual penalty; however, it must be oriented towards the effects to be considered. Furthermore, it must be within the range of probable damage amounts, whereby a supra-individual-generalising approach, disregarding the concrete circumstances of the individual case, must take place (BGH loc. cit.). The contractual penalty provided for here in the amount of € 25,000.00 for each form of commission and each conceivable type of breach of competition does not meet these criteria and therefore constitutes an unreasonable disadvantage. Contrary to the plaintiff's view, at least according to the wording of the clause in clause V of the financial advisor contract, the stated contractual penalty also applies if the commercial agent has merely negligently breached a non-competition clause.[...] The clause lacks any differentiation with regard to the severity of the breach and basically provides for a contractual penalty of € 25,000.00 for the lightest breaches. The contractual penalty also bears no relation to the damages to be expected. If - as is the case here - a customer is merely misled into changing his motor insurance policy, the loss incurred by the plaintiff due to the loss of the premiums is rather small." OLG Munich, Judgment of 29.07.2010, BeckRS 2010, 20437.

Labour law

Culpable inducement to extraordinary termination (inconsistent BAG case law).

"An unreasonable disadvantage can also result from the fact that the provision is not clear and understandable (§ 307 I 2 BGB). A provision according to which a contractual penalty is forfeited by "culpable conduct of the employee in breach of the contract which causes the employer to terminate the employment relationship without notice" is unreasonable because it does not indicate by which specific breach of duty the contractual penalty is forfeited. The triggering breach of duty must be designated so clearly that the promisor can anticipate it. Global promises of penalties which aim at securing all contractual obligations are invalid." BAG, Judgement of 21.04.2005 - 8 AZR 425/04, NZA 2005, 1053

"§ 11 Contractual penalty. ... If the employee does not take up work or takes up work late, if he temporarily refuses to work without justification, if he terminates the employment relationship without justification without observing the relevant notice period or if the employer is induced to terminate the employment relationship extraordinarily as a result of the employee's conduct in breach of the contract, the employee shall pay a contractual penalty to the employer. [...] Furthermore, the contractual penalty clause does not violate the rule of ambiguity of § 305c II BGB.[...] The defendant did not stipulate a staggered contractual penalty ("for each day of the infringement") for all cases of a breach of contract, but only for certain cases, including the case of non-compliance with the notice period, and in principle to be assessed on a daily basis. [...]Contractual penalties as a sanction in the event of premature actual termination of the employment relationship by the employee because he does not comply with the relevant notice period or the termination date and accordingly no longer performs his work until the legal end of the contract are a common case of application of contractual penalties. The employee must expect such a provision" BAG, Judgement of 28.05.2009 - 8 AZR 896/07, NZA 2009, 1337

Principle of certainty

See also BAG, Judgement of 21 April 2005 - 8 AZR 425/04, NZA 2005, 1053 (see above).

"The revocable benefit must be unambiguous in terms of its nature and amount so that the employee can recognise what, if any, is "in store for him". This requirement can usually be fulfilled even in view of the special features of labour law (§ 310 IV 2 BGB). With regard to the preconditions for the amendment, i.e. the grounds for revocation, it is at least possible to indicate the direction for which the revocation should be possible (economic reasons, performance or conduct of the employee). What the reasons are is by no means self-evident and is certainly important for the employee. The degree of disruption (economic distress of the enterprise, negative economic result of the operating department, insufficient profit, decline in or failure to achieve the expected economic development, below-average performance of the employee, serious breach of duty) must be specified in concrete terms if the contracting party intends to base its decision on this and if reasons generally based on the economic development, the performance or the conduct of the employee are not already sufficient according to the scope of the reservation of the right of amendment and are also to be sufficient according to the contractual provision" BAG, Urteil vom 12. 01.2005 - 5 AZR 364/04, NZA 2005, 465 - on a reservation of revocation with regard to an above-tariff bonus + reimbursement of travel expenses (cited in the literature on contractual penalties)

"Global penalty clauses which aim at securing all contractual obligations are invalid. Thus, a clause has been rejected as too vague and thus unreasonable for the employee, according to which the contractual penalty should be forfeited by 'culpable conduct of the employee in breach of the contract which causes the employer to terminate the employment relationship without notice'. The clause did not indicate which specific breach of duty triggered the contractual penalty. The employee could not see "what might be in store for him". "Conduct culpably in breach of contract" without further specification could not develop the necessary warning function and, due to the punitive nature of the promise of a contractual penalty, did not comply with the principles of the rule of law either." Eisenbeis, in Münchener Anwaltshandbuch Arbeitsrecht, § 17 Non-performance and poor performance, marginal note 60.

Penalty amount

"6 The employer usually has a legitimate interest in compliance with the main obligation under the employment contract, whereas the employee usually has neither a right nor an interest worth protecting in breaching the employment contract. The employer's interest can be secured by a contractual penalty. 7 One month's salary is generally suitable as a benchmark for the assessment of an appropriate contractual penalty. However, if the notice period during the probationary period is only two weeks, a contractual penalty of one month's salary is generally unreasonably high. 8. If a contractual penalty in a form employment contract is too high, a reduction in accordance with the law is generally not possible. The legal concept of § 343 BGB also does not lead to a reduction of the contractual penalty to the appropriate level.[...] For the question of the appropriate level of the contractual penalty it is - in contrast to the reduction of an already forfeited contractual penalty pursuant to § 343 BGB - again only a matter of a typifying approach related to the time of the conclusion of the contract. The focus is on any employee or, if applicable, a group of employees who could be the addressee of the respective contractual penalty (Thüsing, BB 2004, 42 [45]). The absence of damage does not yet lead to invalidity, because the primary purpose of the contractual penalty is to exert effective pressure on the debtor to comply with his obligation (BAG, judgement of 25 October 1994 - 9 AZR 265/93). When assessing an appropriate amount, however, it must be taken into account whether typically only minor damage is to be expected. Moreover, when reviewing the content of a form agreement pursuant to § 307 BGB, as a rule only standards accessible to a generalised approach can be used, such as, for example, the gross monthly remuneration [...] " BAG, Judgement of 04.03.2004 - 8 AZR 196/03, NZA 2004, 727

"Pursuant to § 307 I 1 BGB, provisions in general terms and conditions are invalid if they unreasonably disadvantage the contractual partner contrary to good faith. Unreasonable is any impairment of a legally recognised interest of the employee which is not justified by justified and equitable interests of the employer or is not compensated by equivalent advantages. 3. (3) A provision according to which a contractual penalty is forfeited in the case of a serious breach of contract (for example, against the non-competition clause ...) in the amount of one to three times the monthly salary in each individual case is unreasonable. [...] However, the fact that § 8 of the employment contract provides for a contractual penalty in the amount of one to three times the monthly salary for each individual case of a breach of competition, with the exact amount being determined by the employer according to the severity of the breach, constitutes an unreasonable disadvantage for the defendant. [...] The Federal Court of Justice (BGH) has approved a contractual penalty agreement in principle, according to which it is incumbent on the creditor to determine the amount of the contractual penalty for the case of infringement up to a fixed maximum amount pursuant to §§ 315, 317 BGB (BGH [12 July 1984], NJW 1985, 191). As far as the specifically determined contractual penalty is within a reasonable range, this does not put the debtor in a worse position than a contractual penalty determined from the outset [...] In the case in dispute, however, the right of the plaintiff to determine performance within the set framework is inequitable and thus not justified. There is already a lack of a reasonable framework because a contractual penalty for each individual case of a breach of competition amounting to one to three months' salary can no longer be regarded as reasonable but contains an unreasonable "over-securing" (see ErfK/Müller-Glöge, 5th ed., §§ 339 - 345 BGB, paragraphs 15 et seq.) However, if the contractual penalty primarily serves the mere creation of new monetary claims detached from the material interest of the user, the employer's legitimate interest is lacking [...]". BAG, Judgement of 18 August 2005 - 8 AZR 65/05, NZA 2006, 34

"A contractual penalty agreement contained in general terms and conditions does not, in principle, unreasonably disadvantage the employee within the meaning of § 307 I BGB if it provides for the agreement of a contractual penalty in the amount of one month's gross salary in the event that the employee does not commence his fixed-term trial employment and the notice period during the trial period is one month. [...] According to the case law of the Senate, in order to determine the appropriateness of a contractual penalty in connection with the employee's failure to perform work, the relevant notice period is of considerable importance. The length of the notice period expresses the extent to which the employer can demand work performance from the employee and what interest he has in the work performance. Since the agreement of a contractual penalty is in any case also about a pecuniary compensation for contractual services not rendered, the notice periods not observed by the employee due to the breach of contract are a relevant consideration in determining the appropriateness of the amount of the contractual penalty (18 December 2008 - 8 AZR 81/08 - mwN, ). The amount of the remuneration is in principle a suitable yardstick to determine the value of the work performance. It expresses the means the employer must use, taking into account market conditions, to obtain the equivalent value of the work performance with the help of which it pursues its economic goals. The length of the respective notice period and the remuneration to be paid for this period thus regularly reflect the employer's economic interest in the employee's labour. Accordingly, these circumstances are also relevant for the scope of possible damages in the event of a termination of the employment relationship in breach of the contract. Accordingly, a contractual penalty in the amount of the employee's remuneration up to the expiry of the ordinary notice period for not starting work is in principle appropriate." BAG, Judgement of 19.08.2010 - 8 AZR 645/09, BeckRS 2011, 65096

Fault

"It is also harmless for the required transparency of the provision that the provision does not expressly state that the contractual penalty is only forfeited if the non-performance of the service owed is due to the fault of the employee (Senate 18 December 2008 - AZR 81/08 - ). As the Regional Labour Court rightly pointed out, this already follows from the fact that the provision is based on the legal term "contractual penalty". The requirement of transparency under § 307.1 sentence 2 BGB does not intend to force the user of a clause to provide every general business condition with a commentary, as it were. Rather, he is permitted to adopt legal terms from the statutory language (Lapp in jurisPK-BGB vol. 2 § 307 marginal no. 84; Palandt/Grüneberg § 307 marginal no. 18). If he makes use of this possibility, these legal terms are also to be understood in their actual legal meaning. With regard to the contractual penalty, this leads to the fact that it is only forfeitable under the conditions of § 339 BGB. Consequently, the forfeiture of a contractual penalty requires the debtor's default. However, according to § 286 (4) BGB, the debtor is not in default as long as the performance is omitted due to a circumstance for which he is not responsible. Thus, the contractual provision in § 1 para. 3 of the employment contract is formulated as clearly and precisely as possible; it does not contain any avoidable ambiguities or leeway. The clause can in no way be understood in the sense that the contractual penalty should also be forfeited in the event of the employee's conduct through no fault of his own. Mentioning the requirement of fault in the wording of the clause would not have made it any clearer for an attentive and careful participant in commercial transactions, especially since the concept of fault is also a legal concept which, for its part, is to be understood in the light of § 276 BGB. It is simply not possible for the user of a clause to specify in a contractual penalty provision all constellations in which fault - formulated positively - exists or - formulated negatively - does not exist. Moreover, it must not be disregarded that the requirement of fault in § 339 BGB is a circumstance favourable to the employee (Senate 18 December 2008 - 8 AZR 81/08 - loc.cit.)." BAG, Judgment of 19 August 2010 - 8 AZR 645/09, BeckRS 2011, 65096

Violation of transparency requirement

"A contractual penalty agreement used by the employer as a general business condition is invalid due to a violation of the requirement of transparency (§ 307 I 2 BGB) if it provides for a contractual penalty in the amount of two average gross monthly incomes for each case of violation of a non-competition clause by the employee and at the same time stipulates that in the case of a permanent violation of the non-competition clause each commenced month is deemed to be a new violation. [...] The precondition for a contractual penalty agreement to be sufficiently specific is not only that the breach of duty triggering it is so clearly defined that the promisor can adjust to it in his conduct, but also that the penalty to be paid is clear and specific in terms of its amount [...] Thus, in particular, it is not clear how the case is to be dealt with which is virtually typical for breaches of the agreed non-competition clause, namely that the employee works for a competitor company by performing activities for it or procuring customers for it. Whether a contractual penalty of two or more "average gross monthly incomes" should then be forfeited for each individual case of violation of the non-competition clause or whether this constitutes a "permanent violation" of the non-competition clause within the meaning of no. 11 III of the employment contract, so that for each month in which one or more violations of the contract were committed, the contractual penalty of two gross monthly incomes is due only once. The same ambiguities arise in the case of the employee's "participation" in a competing company. [...] There is also no evidence that the parties had a common understanding of the terms "permanent breach" and "each case of infringement".

[30]Contrary to the opinion of the revision, no. 11 III of the employment contract does not contain a restriction of the contractual penalty claim to the effect that the contractual penalty in the amount of two gross months' income can be forfeited at most once per month. The wording of No. 11 III of the employment contract is unambiguous. According to this, in the case of a permanent violation, each month that has elapsed even counts as a new violation. No. 11 III of the employment contract thus regulates an extension of the contractual penalty agreement pursuant to No. 11 II 4 of the employment contract for the case of a permanent violation, but not a restriction in the case of repeated individual violations." BAG, Judgement of 14.08.2007 - 8 AZR 973/06, NZA 2008, 170