In a decision on June 7, 2017 (file no. 23 Cdo 3894/2015), the Czech Supreme Court addressed an important question: Can the duty to pay a contractual penalty be contingent on a breach resulting in rescission of the contract?
In the case in question, the parties had concluded a cooperation agreement that stated that if a breach by one party led the other party to terminate the contract, the party in breach would pay a contractual penalty to the other party. That penalty would be equal to the product of CZK 50,000 and the number of calendar days by which the agreed contractual term was shortened because of the termination.
The Supreme Court found that if a duty to pay a contractual penalty is contingent on a breach of duty and resulting rescission of the contract (i.e. the exercise of a contractual right), then this penalty may not qualify as a sanction for breach of duty under section 554 of Act no. 40/1964 Coll., the Civil Code, in effect until December 31, 2013 (or section 2048 of Act no. 89/2012 Coll., the Civil Code, as amended). In the case at hand, the agreement was not valid because the entitlement to the contractual penalty arose not at the time of the breach but at the moment of termination.