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Dear clients and cooperation partners,
On 1 January 2014, amendments to the Latvian Civil Law will come into force significantly affecting all contracts where the parties have agreed on a contractual penalty.
For several years public discussion has focused on the need to limit excessive contractual penalties. Under the present Civil Law, the parties set the amount of contractual penalties. However, the absence of specific limitations in the Civil Law has frequently led to excessively large contractual penalties. In these circumstances, the contractual penalty has become a source of enrichment. With the amendments, the legislator has tried to specify the concept of a contractual penalty, as well as to limit its amount because case law on limiting contractual penalties has developed too slowly and has not been consistent. We draw your attention to what we see as the most significant novelties:
- In future, the Civil Law will determine contractual penalties depending on whether the penalty is imposed for absolute non-performance of obligations or undue or late performance:
- a contractual penalty imposed for absolute non-performance of obligations can be set as a sum of money or other material value that cannot be expressed as a multiple or increasing payments or contribution;
- a contractual penalty imposed for undue or late performance of obligations can be set as an increasing amount, though the total would be limited to 10% of the principal debt or the amount of the main obligation.
- Further, the Civil Law will directly state that a contractual penalty must be proportionate and comply with transaction practice.
- The Civil Law will not allow claims for late payment interest and losses plus a contractual penalty. A contractual penalty for undue or late performance can be claimed only in an amount that exceeds the accrued amount of interest claimed after occurrence of non-performance. In turn, a contractual penalty for absolute non-performance of obligations can be claimed only in an amount that exceeds the amount of losses that can be collected unless the contract directly specifies that the contractual penalty excludes this compensation.
- The Civil Law will set a procedure for allocating the amount of money paid if it covers only part of a debt (so far, contracts usually contained a provision that any amount paid is first applied to covering the contractual penalty). From now on, partial payments will first cover outstanding interest, then the principal amount and thereafter any contractual penalty. The parties will have the option to withdraw from this procedure only if the creditor agrees to accept payment towards the principal debt. Any other agreements on the procedure for settling the debt will be ineffective.
- The courts will be required to decrease an excessive contractual penalty, unlike the previous regulation that only allowed the courts the right to do so.
In practice, the fact of the amendments coming into force on 1 January 2014 can be expected to trigger disputes regarding application of both the previous regulation and the new regulation because there is no single answer to the question whether and how the new legal regulation applies to contracts concluded before 1 January 2014.
Although the new Civil Law amendments are not accepted unequivocally and have attracted criticism in the business environment, only practice will show whether the new regulation brings the hoped-for positive changes in performance of obligations in Civil Law transactions. |
