Contractual penalties and strategies to mitigate them. How to effectively mitigate contractual penalties with legal support? | JDP Newsletter

Contractual penalty mitigation stipulated in Art. 484 § 2 of the Civil Code is a manifestation of the so-called judicial law, which gives courts wide discretion as to whether, and to what extent, a request for a mitigation of a contractual penalty should be granted [1].

A contractual penalty is mitigated at the request of the debtor who should indicate the grounds for such a request[2] (fulfilment of the obligation to a great extent, gross excessiveness of the penalty) and demonstrate that these grounds occurred[3]. The party that requests mitigation often proposes a method of penalty reduction based on more or less objective criteria.

Judicial practice shows that courts, when granting the debtor’s request and taking into account the grounds described above, reduce the penalty in percentage terms (e.g. by 50%, 25%), not always justifying the reduction rate in more detail.

Unconventional ways of mitigating contractual penalties

However, it happens that courts, most often relying on the method proposed by the debtor, mitigate a contractual penalty in a more unconventional manner involving calculations based on more detailed criteria.

Below we present some interesting decisions showing various approaches to determining the extent of the contractual penalty mitigation. These are just some examples from an extensive range of such decisions.

1 In a judgment[4], regarding a claim of payment of a contractual penalty for claimant’s (contractor) withdrawal from a construction contract for reasons solely attributable to the defendant (employer), initially charged in the amount of 20% of the contract value, the Court of Appeal in Lublin found it justified to mitigate the contractual penalty based on the value of the works performed by the contractor. The penalty was reduced by 85%:

Comparing the contractually agreed deadline for the claimant to perform the works (…) with the actual completion dates (…), it should be noted that the contract was performed over a period accounting for 63% of the scheduled completion time. In turn, a comparison of the value of the works performed by the claimant in this period (PLN 36,227.25, sheet 62) with the value of the works agreed in the contract (PLN 1,185,000, sheet 29) leads to the conclusion that the value of the works performed by the claimant accounted for 3%. In other words, in 63% of the time stipulated for the contract performance, the claimant had carried out works constituting 3% of the agreed value. This proves there was a disproportion between the scope of the works agreed in the contract and the scope of the works actually carried out by the claimant, taking into account the actual time of the contract performance. Although it cannot be ruled out that in the period of 40 days remaining until the end of the contract, constituting 37% of the contract term, the claimant intended to complete works accounting for 97% of their total value, the above-mentioned figures and values, and, above all, the evidence presented by the claimant do not support this conclusion. This, in turn, justifies the assessment that the contractual penalty stipulated in the amount of 20% of the total net remuneration, i.e. PLN 237,000, is grossly excessive and should be mitigated taking into account the scope of the works actually performed by the claimant. The full amount of the contractual penalty cannot be considered adequate in a situation where the claimant has carried out the works specified in the contract to a very limited extent, amounting to only 3% of their value.

Moreover, the court, when mitigating the contractual penalty, pointed out, among others, that due to the low level of progress of the works, the claimant had not purchased a large part of materials, which had a clear impact on the amount of the potential damage.

2In the case heard by the Regional Court in Warsaw , the defendant charged the claimant with contractual penalties for 11 days of delay in the construction of the water and sewage system and 6 days of delay in the construction of the retaining wall in the total amount of PLN 307,798.84 (0.5% of the total gross remuneration for each commenced day of delay, counting from the expiry of the contractual deadlines). The Regional Court found it justified to mitigate the contractual penalty in relation to not the value of the total remuneration but to the value of the delayed works alone, and consequently the Court reduced the penalty by 86%:

In addition, the contractual penalty for a total of 17 days of delay was charged in the amount of PLN 307,798.84 (over PLN 18,000 per day), which allows it to be considered grossly excessive. Although in the context of the claimant’s entire task worth over PLN 5,000,000, the amount of PLN 307,798.84 does not seem excessive, considering that it was charged for only 17 days, the penalty is clearly excessive.

Despite the penalty constituted a small percentage of the contract value, the fact that the claimant’s delay was insignificant spoke in favour of the mitigation, which the Court took into account in its decision.

3 There are also cases in the jurisprudence, where mitigation was based on the comparison of the penalty with the remuneration that would be due for the proper performance of the contract. Such a situation occurred in a case heard by the Court of Appeal in Szczecin[6], where the Court reduced the penalty based on the ratio of the defendant’s remuneration to the value of the accepted contract amount. Ultimately, the Court mitigated the penalty by 84%:

The Court of Appeal took into account that under § 2 of amendment no. 1 to the consortium agreement (sheet 78), the defendant’s maximum remuneration under the contract concluded with the claimant was to amount to PLN 6,000,000 net. This constitutes approximately 16% of the accepted contract amount, which amounted to PLN 37,302,306.06 net (PLN 45,881,836.45 gross – PLN 8,579,530.39 VAT in accordance with amendment no. 1 to contract no. TS-I02/2011 of 5 November 2011, sheet 66). The contractual penalty (in accordance with clause 15.4.c of the particular conditions of the contract, sheet 59 and schedule no. 1 to the bid form for the contract, sheet 1469) amounted to 25% of the accepted contract amount, i.e. PLN 11,470,459.11; 16% of this amount is, when rounded, PLN 1,835,274.

It was therefore assumed that since the defendant’s remuneration was 16% in relation to the total accepted contract amount, the contractual penalty charged should also be reduced to this ratio.

4 The Regional Court in Poznań[7] ordered unusual mitigation of the contractual penalty under a supply contract, which was originally calculated in the amount of 0.5% of the value of the contractual remuneration for each day of delay in delivering the subject of the contract (specialised cars), i.e. in the total amount of PLN 485,253.45.

As the reference point in this case, the Court took the amount of the contractual penalty for contract withdrawal, which amounted to 20% of the contractual remuneration (PLN 196,062). The Court found it justified to mitigate the penalty by the amount of the difference between the contractual penalty charged, i.e. PLN 485,253.45, and the contractual penalty for contract withdrawal, i.e. PLN 196,062, justifying its decision, on the one hand, with the fact that the contractual penalty significantly exceeded the claimant’s margin for the performance of the contract (which was pointed out by the claimant itself in the request for mitigation), but on the other hand, taking into account the fact that the contract completion deadline had been significantly exceeded (99 days).

As a result, the contractual penalty was reduced from PLN 485,253.45 to PLN 289,191.45, i.e. by more than 40%.

5 In a case heard by the Court of Appeal in Lublin[8], which concerned a contract for the supply of medicinal products, the parties stipulated a contractual penalty for the event of failure to deliver in whole or in part in the amount of 10% of the total gross value of the product specified in the contract (a penalty of PLN 157,291.20 in total was charged). When mitigating the contractual penalty, the Court pointed to a number of factors, including: the ratio of the penalty amount to the value of undelivered medicines (154%) or the value of the unexecuted orders, and ultimately reduced the penalties by the amount of PLN 19,403.20 resulting from multiplying the sum of the value of the unexecuted orders x 10% (i.e. by a total of approximately 12%).

The Court agreed with the debtor’s proposed way of mitigating the penalty.

Criteria taken into account by courts

The presented examples indicate that courts, apart from mere discretion, are also keen to rely on objective criteria, e.g. the value of works performed with delay, the amount of other contractual penalties provided in the contract, the ratio of the contractual penalty to the debtor’s margin for the performance of the contract or the value of unexecuted orders, in case of e.g. supply contracts. Proposals for mitigating contractual penalties presented by debtors are also often taken into account by courts.

Conclusions

It is very important to carefully formulate the content of the request for contractual penalty mitigation, referring to precise and measurable criteria relevant to the performance of a given contract. It is therefore necessary to analyse the case in detail and rely on judicial decisions that best align with a given situation.

Experienced litigators can offer great support in this regard. As the judgments referred to above illustrate, this may result in a significant reduction of the contractual penalty charged.

If your company is defending itself against a claim for a contractual penalty or is already involved in a court dispute regarding contractual penalties, our experts will be happy to discuss possible solutions.

JDP’s Litigation and Arbitration Team has extensive experience in this type of court proceedings.

Contact:

Wojciech Bazan – Attorney-at-law | Partner in the Litigation and Arbitration Team

Justyna Solarska – Attorney-at-law | Senior Associate in the Litigation and Arbitration Team