Arrangement of reverse breakup fee in acquisition agreement in a form of contractual penalty

Arrangement of contractual penalty. It is a traditional security institute, which is quite common in practice, the scale of possibilities in practice is varied. It is used in acquisition agreements, not only to secure fulfilment of important duties but also for realisation of demands due to violation of representations and warranties, but also as i.e. a reverse breakup fee which is described in detail in this article. Reverse breakup fee is used as generalized compensatory damages in the case of the premature termination of transaction. The reverse breakup fee is usually paid by buyer who caused that the transaction wasn't concluded in conformity with acquisition agreement, so the transaction was terminated due to trigger event or buyer' s backing out. [1] Is the reverse breakup fee according to Czech law a contractual penalty or it is a different legal institute? And what can be the impact for contractual parties?

Reverse breakup as contractual penalty

According to law, contractual parties can arrange a contractual penalty in case of violation of an obligation. The agreement imposing an obligation to pay in case of an event, which is not a violation of a contractual duty, so is not a contractual penalty under Section 2048 et seq. of Law No. 89/2012 Coll. Civil Code (hereinafter “Civil Code”).

In accordance with judicial practice according to old Civil Code was problematic to agree on a duty to pay the other party a sum of money just in case of backing out of contract, for example – reverse breakup fee.

The Supreme court in his judicial practice has an opinion that a contractual penalty can be arranged just in case of a violence of duty, but for example backing out of the contract based on law or on arrangement of parties is an, exercise of the right of party so it can't be violence of duty.[2]

The Supreme Court in his decisions also said that it is impossible to connect a duty to pay a contractual payment with two conditions (in case of paying the reverse breakup fee by debtor who violent of duty or backing out by creditor).[3] The contractual penalty is possible to arrange just without any condition. [4]

Reverse breakup fee as an innominate term

Despite the practice of court, the reverse breakup fee is used in transactions on regular basis. Although, we come to a conclusion, that the breakup fee is not a contractual penalty, in view of the fact that in the explanatory memorandum of the Civil Code and the principle of freedom of choice, this arrangement can't be a priori excluded. If parties arrange that the debtor pay some money to creditor in case that it will happened a situation different from breaching of some contractual duty, it won't be a contractual penalty but it will be valid provision which could be examined as compensation or innominate term, it depends on situation.[5]

In view of the fact that the party which has a duty to pay a reverse breakup fee is not the party who back out of the deal, it can't be a breakup fee. Because of this, it is necessary to think about reverse breakup fee as innominate term. In this case, there is a question – Does arrangement of reverse breakup fee as an innominate term exclude an option of moderation of an excessive penalty? Or more precisely, the height of reverse breakup fee is not limited? We think that, in this case the possibility of moderation of the excessive reverse breakup fee by court would be excluded, because the law deals just with moderation of excessive contractual penalty, but it doesn't mean that the height is actually not limited. In each case, it is necessary to examinate conformity with principles of morality.

Admission of the conditioned contractual penalty by the Supreme Court

In the decision of the Supreme court from the 30th of October 2019, file No. 23 Cdo 1192/2019, The Supreme Court concludes inapplicability of conclusions of the judication about inadmissibility of conditioned contractual penalty in interpretation of provision about contractual penalty according to Civil Code. An appellant in her appeal argued that the origin of the right to contractual penalty which was linked to violation of the contractual duty is also conditioned by backing out of contract by party who didn't violate the contract, it is not forbidden.

The Supreme Court agreed with this argumentation and said that this agreement of contractual parties can't be considered as extensive and out of limit definition in the Civil Code.

The decision of Supreme Court from the 30th of October 2019, file No. 23 Cdo 1192/2019, has an impact on the interpretation of the reverse breakup fee as generalized transaction compensatory damages. In view of the fact that cumulation of violation of duty of the debtor and simultaneously the creditor's backing out of the deal, the reverse breakup fee can be regarded as contractual penalty. In view of this fact that can be concluded that the reverse breakup fee is common institute in transactions in the Czech law system and also we can conclude that arrangement of reverse breakup fee could be moderated by court as expropriate contractual penalty.