Contractual penalties appear often in construction works contracts - for delay, for culpable delay, for withdrawal from the contract, for failing to remove defects on time, or for breaching obligations towards subcontractors.
The mere presence of a penalty in the contract does not, however, mean that it must be paid in the amount demanded and in every situation. Before you accept a penalty or set it off against the contractor’s remuneration, three things are worth checking: whether the clause is valid, whether the penalty was calculated correctly, and whether there are grounds to have it reduced.
Step 1. Check what the penalty was charged for
A contractual penalty may be stipulated only for the non-performance or improper performance of a non-monetary obligation. That follows from Article 483 § 1 of the Civil Code.
In practice this means the penalty may relate to, for example, delay in carrying out the works, failure to remove defects on time, breach of a ban on subcontracting without the investor’s consent, or withdrawal from the contract for reasons attributable to one of the parties.
It is different with a penalty for failure to pay remuneration. Payment is a monetary obligation, so as a rule it is not secured by a contractual penalty but by interest. The Supreme Court has confirmed that it is not permissible to stipulate a contractual penalty for withdrawal from a contract on account of non-performance of a monetary obligation.
Particular situations do call for care, though. In construction matters there may be obligations concerning payment to subcontractors. Case law has accepted that a penalty for failure to pay, or late payment of, remuneration due to subcontractors may be permissible, because what is at stake is then the contractor’s obligation towards the investor, not an ordinary penalty for failing to pay one’s own invoice.
So the label “penalty for delay in payment” is not enough on its own. You have to check precisely which obligation the clause secures.
Step 2. Check whether the penalty was calculated correctly
In construction disputes the problem is often not the penalty itself but the way it was worked out.
First establish whether the contract speaks of delay or of culpable delay. Delay means simply that the deadline was exceeded. Culpable delay is delay for which the party is at fault. So if the contract provides for a penalty for culpable delay, showing that the deadline passed is not enough. It still has to be assessed whether the delay is genuinely attributable to the contractor.
The site documents also matter: the schedule, the annexes, the correspondence, the handover protocols, the entries in the construction log, the notifications of readiness for handover and the investor’s objections. It is these that show whether the deadline was exceeded, for what reason, and for how many days the penalty could be charged.
It is also worth checking what amount the penalty is calculated from. A penalty calculated on the whole remuneration produces a very different result from one calculated on the value of the unperformed part of the works. If most of the works have been carried out and the penalty is still being calculated on the full contract value, that may matter when applying to have it reduced.
Step 3. Assess whether there are grounds to reduce the penalty
Reduction means the court lowering the contractual penalty. The basis is Article 484 § 2 of the Civil Code. The provision identifies two situations: where the obligation has been performed in substantial part, or where the penalty is grossly excessive.
In construction matters the first ground arises often. The contractor has handed over most of the works, the investor is using the structure, and the dispute concerns part of the work, a delay or defects. In such a situation it is worth checking whether demanding the full penalty is proportionate to the actual breach of contract.
The second ground concerns the size of the penalty. It may be grossly excessive if it stands in obvious disproportion to the contract value, the extent of the breach, the length of the delay, the consequences for the investor or the size of the loss. A creditor pursuing a contractual penalty does not, as a rule, have to prove the size of the loss, because the penalty is due in the amount stipulated regardless of that size. That does not mean, however, that the absence of loss, or a small loss, is irrelevant when it comes to reduction.
An application to reduce the penalty has to be made and justified. The court does not lower a penalty of its own motion merely because it looks high. You have to show why, in the specific case, the penalty is disproportionate.
What is worth preparing
Before assessing a contractual penalty, gather the contract, the annexes, the schedule, the handover protocols, the correspondence with the investor or contractor, the debit notes and the documents showing what caused the delay. In construction matters the details count: who was to perform a given obligation, when the delay arose, whether the other party cooperated, and whether the works were in fact accepted.
If the penalty has already been set off against the remuneration, you additionally have to check whether the set-off was effective, whether the penalty claim was due and payable, whether it was properly specified, and whether the declaration of set-off was correctly made.
In short
A contractual penalty should be neither paid automatically nor charged automatically. First check whether the clause concerns a non-monetary obligation. Then whether the penalty was properly calculated. Only at the end do you assess whether there are grounds to reduce it.
In construction works contracts the difference between a well-charged and a badly-charged penalty can be very large. Sometimes it is decided by a single sentence in the contract, an annex or a handover protocol.
This article is for information only and does not constitute legal advice. Assessing a specific case requires reviewing the documents.