Liquidated damages represent one of the classical institutes of the law of obligations as a security in contractual discipline and aim to provide protection and safety for the creditor, in the sense of securing that the debtor fulfils their contractual obligation. The liquidated damages force the debtor to adhere to that which was agreed, since the purpose of a contract is precisely the fulfilment of contractual obligations.
Liquidated damages are regulated by Articles 270-279 of the Law of Contracts and Tors (“Official Gazette of FNRY”, no. 29/78, 39/85, 45/89 – decision of the Constitutional Court of Yugoslavia and 57/89, “Official Gazette of FRY”, no. 31/93, “Official Gazette of SM”, no. c1/2003 – Constitutional Charter and “Official Gazette of RS”, no. 18/2020). The creditor and the debtor may agree that the debtor will pay to the creditor a specific monetary amount or procure another material benefit should they fail to fulfil their obligations or be in default. Unless otherwise implied by the contract, it is understood that the damages agreed will also apply if the debtor is in default concerning the fulfilment of obligation. The contracting parties at their own discretion agree on the level of liquidated damages in a single total amount, in percentages, or for each day in default, or otherwise. This has to be agreed in a form prescribed for the contract serving as the origin of the obligation whose fulfilment it concerns. The agreement on liquidated damages shares its legal fate with the obligation whose security it concerns. What’s interesting about liquidated damages is that they cannot be agreed for monetary obligations, in which case the debtor will owe interest along with the principal debt.
Types of liquidated damages and creditors’ rights
Based on the legal definition one can conclude that there are two types of liquidated damages in our law. Namely, liquidated damages can be agreed to secure the performance of obligation within a set timeframe, in which case the creditor secures the rights to collect the liquidated damages should the contractual obligation be performed with default. When damages are agreed in the event of the debtor’s default in fulfilment, the creditor is entitled to seek both the fulfilment of obligation and the liquidated damages, but the creditor cannot seek liquidated damages once they have accepted the fulfilment of obligation, without notifying the debtor without delay that he or she is retaining their right to liquidated damages. The method of notification for retaining the right to liquidated damages stems from the contract itself, but it can be communicated verbally unless the contract clearly stipulates that such notification must be given in writing. The creditor is not entitled to the collection of liquidated damages in case of default after the contract has been terminated.
The second type of liquidated damages are in the event of nonfulfillment of contractual obligation where the presumption for the collection of liquidated damages is that the debtor has failed to fulfil their contractual obligation. Where the damages for nonfulfillment of contractual obligations have been agreed, the creditor can request from the debtor the realization of liquidated damages in the amount which has been prescribed by the contract, with the creditor losing his or her right to demand the fulfilment of obligation if he or she has previously requested the payment of the liquidated damages. When the damages have been agreed for nonfulfillment, the debtor is not entitled to pay the liquidated damages and terminate the contract, unless that had been the contracting parties’ intent when agreeing on the damages.
The liquidated damages for nonfulfillment of contractual obligation, pretty clear in their own right, are still the reason for uneven judicial practices as the answer to the question of whether the creditor is entitled to terminate the contract according to the provisions of the Law of Contracts and Torts which prescribe the right to terminate the contract for unfulfillment and seeking liquidated damages in the event of unfulfillment at the same time, or is the creditor able to collect the liquidated damages only if he or she has not terminated the contract?
This question on the one hand mostly concerns the accessory nature of liquidated damages in the context of the consequences of contract termination due to nonfulfillment and the premise that all obligations of the contracting parties cease to exist with termination. According to one legal standpoint, due to contract termination for nonfulfillment the contract on liquidated damages shall also cease to exist, i.e., the obligation from the accessory contract shares the fate with that of the main contract, and if there has been a contract termination the creditor has no right to seek liquidated damages. This type of legal standpoint is provided by the judgements of the High Court, as well as the Commercial Appellate Court which is particularly significant to highlight since this institute has immense presence in economic contracts. One example from the case law states: “Lower courts have established that the Agreement on the purchase of socially owned capital of social enterprise for agricultural production and processing „Porečje“ sa p.o. Vučje from Leskovac in restructuring as of 20.04.2011 was terminated due to nonfulfillment of contractual obligations by the purchaser now the defendant in the dispute. Considering the provision of Article 272 paragraph 1 of the Law of Contracts and Torts, which prescribes that the agreement on liquidated damages shares the legal fate of the obligation whose security it concerns, the lower courts have concluded that the plaintiff’s request seeking the establishment of the merit of claims in the name of liquidated damages is groundless, since the plaintiff may not seek the payment of liquidated damages after contract termination, having in mind that Article 41a of the Law on Privatization fails to provide for liquidated damages as a consequence of termination, therefore the decision is made in application of provisions of Articles 270, 271, 272 and 273 of the Law of Contracts and Torts.”
Even though this legal standpoint is largely present in today’s case law, it still annuls the possibility of realization of liquidated damages and the implementation of its purpose in the legal system, and that is securing the creditor, since through this institute the creditor in placed by law in a significantly more favourable position in terms of recovering the damage caused by the termination of contract than the one that he or she would find themselves in had the contract not provided for liquidated damages in the event of nonfulfillment of the debtor’s obligations.
On the other hand, the courts also defend the institute of liquidated damages agreed for nonfulfillment in the event of contract termination, for precisely its compensatory purpose which is expressed as presumed liquidated damages whose existence need not be individually proven, and which the creditor can seek in the event of contract termination. This practically means that the creditor will exercise his or her right to payment of liquidated damages solely based on the fact that the legally prescribed circumstances for its realization had occurred – culpable default in nonfulfillment or culpable nonfulfillment of the debtor’s obligation established through a contract, and that the standpoint by which the right to payment of liquidated damages cannot be realized if the contract is terminated for nonfulfillment is legally unacceptable. “In interpreting the provisions of Articles 270, 273 and 275 of the Law of Contracts and Torts it is concluded that in stipulating the liquidated damages its accessory function is realized which represents a significant factor of contractual discipline of the contracting parties. The purpose and goal of the contract is the performance of contractual obligation. The right to liquidated damages for nonfulfillment cannot be excluded for the fact that the main contract for whose security they had served has been terminated. With the contractual constitution of the right to liquidated damages the creditor of the non-monetary claim is recognized the realization of rights to compensation for damages up to the level of liquidated damages which shall be realized with no further special conditions. Accordingly, with the termination of the agreement on the sale of capital as of 23.01.2009 the plaintiff has not surrendered his right to liquidated damages for unfulfillment which was provided at the expense of the defendant as the purchaser of the capital. The realization of rights to liquidated damages in this concrete case is conditioned by the nonfulfillment of one obligation of the defendant, for which the liquidated damages have been stipulated.” – from the High Court judgement number Prev 301/2020 as of 17.12.2020.
The probability of reducing liquidated damages
What’s important for the debtor in connection with this institute is that the court will at their request reduce the amount of liquidated damages if it finds that they are disproportionately high considering the value and significance of the subject of obligation. However, the Law of Contracts and Torts contains no provisions on the criteria which the court must adhere to during the reduction of liquidated damages, side from the value and significance of the obligation subject as a staring point.
The relationship between liquidated damages and compensation for damages
Liquidated damages indeed are the contract security, but on the other hand there is the presumed damage which the creditor will suffer in the event of culpable default or culpable nonfulfillment of debtor’s obligations constituted through a contract. In this way the legal nature of liquidated damages is defined as security and compensation for damages. Where there is a case with agreed liquidated damages, the creditor does not need to prove the damage suffered, or the extent of that damage. The creditor is entitled to liquidated damages even when no damage was suffered at all. However, when liquidated damages are insufficient for covering the damage suffered by the creditor, in that case he or she may also seek compensation for damages in addition to liquidated damages, in which case he or she will have to prove the existence of damage in the amount exceeding the liquidated damages, and that the damage had occurred due to nonfulfillment of contractual obligation secured through liquidated damages. These rights of the creditor are regulated by Article 275 of the Law of Contracts and Torts. If compensation under the name of penalties, liquidated damages, reimbursement or any other name, had been prescribed by the law for nonfulfillment of obligation or in the event of default in the fulfilment of obligation, and the contracting parties had in addition agreed on liquidated damages, the creditor is not entitled to demand both liquidated damages and the damages set by law, unless this is permitted by the law itself.
Conclusion
Irrespective of the uncertainty in legal transactions stemming from the differences in judicial practices, this institute still plays an important role in providing contractual discipline and indeed the contracting parties should continue to use this institute which, even though it seems beneficial for the creditor, it also is in favour of the debtor in the sense that they can know in advance what to expect in case of unfulfillment or delay on fulfilment of their obligations. In addition, even though our legal provisions do not limit the contracting parties in the sense of determining the amount of liquidated damages, they should be agreed on with presumed damage in mind to the extent in which it can be observed at the time of contract conclusion, all for the purpose of the creditor subsequently having greater success in the dispute should the debtor object to the liquidated damages being too high.
