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The Italian Supreme Court intervened with an order to clarify that the penalty amount of the liquidated damages / penalty clause can be determined even after the breach.
In Order No. 11548 of May 3, 2023, the first civil section of the Italian Supreme Court clarified that the general discipline of the subject of the agreement, the nature of which can be as much determined as determinable, should be applied to the liquidated damages clause (known as penalty clause in civil law countries), so that the determination of the penalty can take place ex-post, based on a predetermined criterion considered by the parties in its objectivity, applied at a time after the breach.
The Italian Supreme Court thus overturned a ruling by the Bologna Court of Appeal that declared a penalty clause void whose amount should have been determined at the time of default.
The case concerned the construction of a building deemed to be in violation of contractual obligations regarding minimum distance and lights, in relation to which the plaintiff had sued the party deemed to be in default as part of an arbitration proceeding for the payment of the stipulated liquidated damages. The arbitrator had granted the request and, after technical expertise to determine the breach’s value, ordered the respondent to pay EUR 98,046.00, plus accessories and costs.
The defendant had then challenged the award for nullity before the Bologna Court of Appeals, which had found the clause in question to be null and void for lack of cause, as it was deemed to lack the delimiting aptitude that would be required by Article 1382 of the Italian Civil Code, where it provides that the penalty entails that the defaulter is “obliged to a certain performance.”
In particular, the Bologna Court of Appeals had ruled that since the penalty is parameterized to non-performance, it “does not constitute a precise criterion that can be objectively and pre-emptively quantified, since it can only be determined ex post according to the scheme set forth in Art. 1223 ff. c.c.,” especially since “this criterion of non-performance has not even turned out to be unambiguously quantifiable,” so that “the penalty clause de qua does not at all fulfill … the predeterminative function of the performance due for the case of non-performance,” thus failing “the core characterizing function of the penalty clause, namely the prior quantification of the indemnifiable damage,” in the absence of “determinability … since the generic criterion of non-performance … does not offer any kind of parameter to which to anchor the predetermination of the damage, limiting itself to referring to the assessment of non-performance and the ‘value’ of the same, a concept in itself indeterminate and difficult to understand.”
The losing party then appealed to the Italian Supreme Court, according to which nothing precludes that the “determined performance” referred to in Article 1382 of the Civil Code can be related to the extent of the breach, to be verified in its consistency downstream of the breach itself, thus in a predetermined measure.
Moreover, for the Supreme Court, liquidated damages that are only determinable are no less deterrent than a predetermined penalty since it still exempts the creditor from proving the damage’s existence and amount. On the contrary, the intimidating nature of the stipulation related to the “value of the breach” is even more pronounced since it is intended to warn the contractor that the greater the breach, the more he will be forced to pay.
On a similar topic, you can find the following article interesting “3 top mistakes in negotiating SLA & penalties of an outsourcing agreement“.