It is common in contracts to fix exorbitant amounts if obligations are breached. It is what is known as “Penalty Clauses”. Both parties know that they are dissuasive clauses. They are only intended to dissuade the contracting party from non-compliance. But it is not always known that the Judge can moderate these amounts if he considers them excessive.
As we well know, the will of the parties prevails in contracts, but what happens when the parties fix an excessive indemnity?
Can the judge really moderate an indemnity that has been agreed by the parties in a contract? International investors find this hard to believe.
We will now resolve this question with the Law, Doctrine and Jurisprudence.Contacto No te quedes con la duda, contacta con nosotros. Estaremos encantados de atenderte y ofrecerte soluciones.
What does the Jurisprudence say about the power to moderate an indemnity by a Judge?
The Supreme Court Judgment 441/2018 gathers the most important Jurisprudence on the moderating power of penalty clauses. This Supreme Court Judgment is dated July 12, 2018.
And therefore it begins with a reference to STS (Supreme Court Judgment) 126/2017, of 24 February, which in turn cites others with identical criteria on the analyzed issue. (STS 25 January 2017, or STS 366/2015, or STS 8 /2014). In these decisions it is agreed that the mandate of article 1154 C.C. is conditioned to the concurrence of the case provided therein, i.e., that the principal obligation had been partially or irregularly fulfilled by the debtor.
In other cases, the case law – STS 585/2006, STS 470/2010, among others – rejects the moderation when the penalty had been provided, precisely, to punish the non-performance – total or even partial or deficient performance – that had occurred.
In fact, the STS 585/2006, with a very definite criterion: If the penalty clause is established for a certain breach, even if it was partial or irregular, the moderating power of Article 1154 of the Civil Code cannot be applied if exactly the intended breach occurs; Or to put it in other words, that moderation proceeds when the obligation has been partially or irregularly fulfilled and the penalty was established for its complete breach, so that, as the doctrine states, the purpose of the repeated article does not lie in resolving the question of whether the penalty should be equitably reduced for being excessively high, but in interpreting that the parties, when agreeing the penalty, thought of a breach other than the one that occurred (SSTS 962/2008 , 211/2009, 384/2009 and 170/2010.
This same criterion has been taken up in the Plenary SSTS of 15 April 2014, rec. no. 2274/2012 , and 21 April 2014, rec. no. 1228/2012 .
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What is a penalty clause?
The STS, 1st, 11.3.1957 (RJ 751), clearly defined penalty clauses.
“Stipulation of accessory character, established in a contract, with the purpose of assuring the fulfillment of the main obligation, by virtue of which the debtor of the performance to be guaranteed is obliged to pay, in general, a certain amount of money”.
In addition, it should be noted that the debtor’s liability is civil. That is to say, he has a duty to repair or indemnify with money. Article 1154 of the Civil Code, includes the moderating power of the Judge: “The Judge will equitably modify the penalty when the principal obligation has been partially or irregularly (including defective and delayed cases) fulfilled by the debtor”. The article establishes that the Judge has the duty (imperative) to review the penalty clause in case it is partial or irregular and if appropriate, to modify it.
In this way, this power attributed to the Judge, serves to reduce the (pecuniary) penalty if it is excessive. Or, on the contrary, to increase it, in the event that the amount of the penalty is minuscule in comparison with the breach of the obligation.
Therefore, this power is at the discretion of the judge who must apply it based on the principle of equity. The moderating function will not be subject to cassation. That is, it is not subject to revision or modification in cassation. In order to modify it, the qualification of the debtor’s conduct would have to be changed beforehand. That is to say, if it was partial, change it to total.
What does the Law say about the power to moderate an indemnity by a Judge?
In addition, the moderating power is given only in cases of partial or irregular non-performance. Article 1103 also allows moderation in cases of negligent performance. Moderation will be improper in the following cases:
- total non-performance,
- fraudulent non-performance
- or when only the partial or irregular non-performance that has been foreseen. This is the key. And this is the ability that the lawyer must put on record in the contracts.
Therefore, this possibility is in force today in most of the codes belonging to the Civil Law. In the German Civil Code is admitted that the excessively high penalty can be reduced (art. 343 B.G.B.). The same possibility is granted in the Swiss and Austrian codes (arts. 163 and 1.336, respectively).
Likewise, Art. 1.384 Italian Civil Code states that: “the penalty may be equitably reduced by the judge, if the principal obligation has been partially performed or the amount of the penalty is manifestly excessive, always taking into account the interest that the obligee has in the performance”. In Common Law systems, on the other hand, pacta Sunt Servanda (agreements are there to be performed) prevails.
As a result, the doctrine discusses whether Spanish law admits equity as a reason for moderation or not. Navarre Civil Law establishes that “the agreed penalty cannot be reduced by judicial arbitration”.
Currently, our civil code does not allow moderation on the grounds of equity. And, the jurisprudence of the SC considers disproportionate or abusive penalties irrelevant for moderation. But in the future this position could change. This is due to the proposed modernization of the civil code on obligations and contracts. This reform includes grounds such as equity and also disproportionate and abusive penalties.
If this article has been of interest, we also suggest you to read the following article published on our website: Judicial Compensation