The principle of free will is a fundamental principle of civil and contract law. This basic principle provides and allows the parties to regulate and build legal and juridical relationships in the way that suits them best. In essence, they may freely establish the conditions of these legal relationships.
This principle is commonly expressed as pacta sunt servanda, that is to say, agreements must be kept. This is provided for in article 1,255 of the Spanish Civil Code, which establishes that “the contracting parties may establish the pacts, clauses and conditions which they deem convenient, as long as they are not contrary to the law, moral or public order”.
These limitations, however, are vague, and leave room for different interpretations, which allows the intrusion of third parties in contracts made between individuals.
Said interpretation, and the possibility that the courts may intervene in these private contracts is clearly an interference with the principle of freedom of the parties, and is especially important with reference to penalty clauses in contracts.
Penalty clauses are provisions in contracts that guarantee the performance of the main obligation by imposing a financial penalty in case of failure to comply. Thus, these clauses allow the parties to agree on a penalty in the event of non-fulfilment.
However, notwithstanding what has been agreed, judges may modulate this penalty on the basis of the principle of equity of Article 1,154 of the Civil Code, which provides that “the Judge shall equitably modify the penalty when the principal obligation has been partially or irregularly fulfilled by the debtor”.
Thus, this faculty is only applicable when, faced with penalty clauses for non-fulfilment of the obligation, the compliance is partial or irregular. This means that the Judge may not moderate the penalty clause when the obligation has been totally breached. Furthermore, in the past the Supreme Court, has already restricted this faculty to moderate the sanction under two other premises:
- when the non-compliance for which the penalty was provided is that for which the penalty has been incurred; and
- in the case of delay in the event of a late payment penalty clause.
These limitations are crystallised and consolidated pursuant to the recent judgment of the Supreme Court of 10th December 2021. In said judgment, the High Court pronounces regarding the modulation of a penalty clause carried out by the Court of First Instance with subsequent ratification by the Provincial Court.
The case revolves around the lease of business premises operating as a nightclub. The lessor and lessee did not reach an agreement for the renewal of the lease, whereupon the owner of the premises claimed the return of the possession thereof, a claim which was rejected by the usufructuary lessee company.
Thus, the owner filed a claim for eviction by oral hearing, furthermore claiming a daily penalty of Euro 500 as compensation, from the finalisation of the contract up until the effective handing over of the keys, as set forth in the penalty clause of the contract:
“The lessor has the right as recognised by the lessee, to recover the leased premises within the contractually agreed term, […] should the lessee not comply with the obligation to hand over the leased premises on the due date, they will be obliged to compensate the Lessor with the daily amount of five hundred Euros, as from the date of breach until the effective handing over of the premises, ….”.
The Court of First Instance partially upheld the claim of the plaintiff, but it reduced the compensation claim to 150€, upon the understanding that the penalty clause «is completely disproportionate, and therefore moderation is required», as provided for in article 1,154 of the Spanish Civil Code”.
The Provincial Court also ruled in the same vein, and understood that in the event of an excess in the agreed amount of the penalty on the foreseeable damage, the lower court could apply a modulating criterion.
However, the Supreme Court opposes this interpretation, deeming that the appealed judgments were not in line with the established case law on the matter. The High Court recalls that in order to moderate penalty clauses in accordance with article 1,154 the requirements of said article must be met, namely, that the principal obligation has been satisfied in part or irregularly. In the case at hand, the non-fulfilment of the contract has been complete, so it does not give rise to any modulation.
The Supreme Court clarifies that the analogous application of article 1,154 of the Spanish Civil Code would be possible in cases wherein the amount of the penalty to be paid and the amount of the damages caused for non-fulfilment is so disparate and extraordinarily elevated that it must be attributed to an unforeseeable circumstance that has altered the damaging result from what was reasonably foreseeable at the time of contracting.
This, without doubt, does not apply to the case at hand, so the High Court upheld the appeal accepting the plaintiff’s argument in its entirety.
Aleix Cuadrado
Vilá Abogados
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21st January 2022
