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31 August 2010
The creditor's interest is that the debtor performs its contractual obligations as required. As a common legal remedy for the protection of the creditor's interests, the parties may agree on a contractual penalty that is triggered in case the debtor is in breach of its contractual obligations. The rationale behind penalty clauses is to encourage performance of contractual obligations. A contract clause penalising one party for non-performance or breach of contract is enforceable under Swiss law. According to Article 161(1) of the Code of Obligations, the enforcement of a penalty clause requires no proof of any real damage. Article 161(2) establishes that where the creditor has incurred damage and that damage amounts to more than the amount of the penalty, the excess amount can be claimed in addition to the penalty, provided that the damage is due to a fault of the debtor. Article 163(3) stipulates that penalty clauses can be mitigated by the court if they are excessive.
Most penalty clauses provide that the debtor must pay a fixed sum in case of non-performance or breach of contract. The payment of a fixed sum can either be construed by the parties as liquidated damages or as a penalty. Both are admissible under Swiss law. Liquidated damages are used to estimate damages in case of non-performance or breach of contract and are due only if the creditor can demonstrate the existence of damage. As the damages are liquidated, the exact amount of the damage need not be shown. On the other hand, the triggering of a penalty clause does not require proof of any real damage. The code does not define the scope of contractual penalties. In 1954 the Federal Supreme Court held that the statutory forfeiture of pension claims against a pension fund in case of breach of membership duties cannot be construed as a penalty.(1) It ruled that a contractual penalty can only arise from a conditional promise to deliver a performance, not in a forfeiture of a right. This narrow penalty scope has been widely criticised in Swiss legal doctrine.
In a decision published on April 23 2009 the Federal Supreme Court had the opportunity to review its position.(2)
The Federal Supreme Court had to decide a case in which dentist B had undertaken to sell his dental practice and to hand over the patient files to dentist A. The contract provided that payment of the second instalment of Sfr340,000 was subject to the condition that both parties perform faithfully and according to contract. Having paid the first instalment, dentist A refused payment of the second instalment on the grounds that dentist B had not properly handed over all the patient files and as such had performed neither faithfully nor according to contract. Dentist B filed action against dentist A for payment of Sfr340,000. The district court dismissed the case, but the appellate court overturned the decision. Dentist A then appealed to the Federal Supreme Court.
Federal Supreme Court decision
The court held that Articles 151 and following of the code pertaining to contractual conditions were not applicable to the case at hand. Dentist A's promise to pay the second instalment was subject to the condition that dentist B perform according to contract. According to the court, in cases in which an agreement on a conditional payment obligation serves the purpose to encourage contractual performance, the articles regarding contractual penalties rather than those on contractual conditions are applicable.
In a second step the court reviewed its 1954 precedent regarding the scope of contractual penalties. Swiss legal doctrine argued that, from an economic point of view, it is irrelevant whether a penalty clause consists in an obligation to pay money or in a forfeiture of a right. Furthermore, Swiss legal doctrine argued that it is illogical for the debtor to be protected from excessive penalties only when the penalty is construed as an obligation to perform. The purpose of Article 163(3) of the code, pursuant to which excessive penalties can be mitigated by the court at its discretion, should also be applicable to contractual clauses which provide for the loss of a right in case a contract is breached. Lastly, Swiss doctrine emphasised that penalty clauses which provide for the loss of a right are enforceable under German and Italian law and thus should also be enforceable under Swiss law.
The Federal Supreme Court held that the arguments brought forward by the Swiss legal doctrine against the case law of the Federal Supreme Court case law on contractual penalties were persuasive. The court left the position it had taken in its 1954 precedent and confirmed that the forfeiture of a right could also be construed by the parties as a penalty. The court held that dentist B had breached the contract by withholding patient files and database software. The penalty clause has been triggered with the result that dentist B had forfeited the right to receive the last instalment. The court further stated that the basic principle of nulla poena sine lege (ie, the rule of legal certainty of criminal law) does not apply to contracts. Thus, parties to a contract can agree under a blanket clause that each and any violation of the contract shall result in a penalty. In the case at hand, the Supreme Court stated that dentist A had breached obligations set forth in the contract.
The decision of the appellate court was annulled by the Federal Supreme Court. The case was remanded to the appellate court to determine whether the contractual penalty was excessively high and was thus to be reduced by the court pursuant to Article 163(3).
This revision of the Supreme Court's position on contractual penalties was long overdue. It is now possible to provide in purchase agreements, for example, that the seller will forfeit the right to claim part of the purchase price if it breaches contractually stipulated obligations. However, penalty clauses which provide for the loss of the right to claim part of the purchase price in case of breach of the seller's contractual obligations may be mitigated by the court at its own discretion if they reach a certain level of excessiveness.
For further information on this topic please contact Markus Dörig or Olivier Bauer at BADERTSCHER Rechtsanwälte AG by telephone (+41 44 266 20 66), fax (+41 1 266 20 70) or email (email@example.com and firstname.lastname@example.org).
(1) Decision BGE 80 II 123.
(2) Decision BGE 135 III 433.
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