Buying a franchise: how to check contractual penalties

Contractual penalties can significantly change the actual risk of buying a franchise, even though they often appear towards the end of the agreement. Before joining a franchise network, it is not enough to check the initial fee and ongoing charges: you also need to understand how much a failure to meet a particular obligation could cost you. The aim is not to avoid responsibility, but to establish clearly what attracts a penalty, under what conditions and up to what amount.

What Croatian law allows

Croatia has no dedicated law comprehensively regulating franchise agreements, nor a specific mandatory pre-contractual disclosure regime for franchises. Agreements are governed by the Croatian Civil Obligations Act, alongside other relevant legislation, such as the Competition Act and intellectual property rules. The European Code of Ethics for Franchising provides a framework for good practice, but it is not a substitute for legislation and does not, in itself, give every franchisee statutory rights.

Under the Civil Obligations Act, a contractual penalty may be agreed for non-performance, delay or improper performance of an obligation. It cannot be agreed for monetary obligations. A clause imposing a contractual penalty for late payment of a franchise fee therefore requires particular legal scrutiny. Statutory default interest is a separate legal mechanism.

The label used is not decisive. If an agreement refers to an ‘administration fee’ that is charged automatically following a breach, a lawyer should examine its true legal nature. Equally, not every charge for recovering costs is a contractual penalty.

Buyers should also be aware that, as a general rule, a penalty can be claimed without proof of loss. A penalty clause is therefore more than a warning: it represents a potential financial liability.

List every breach that could trigger a penalty

Do not review only the section headed ‘Contractual penalties’. Search the entire agreement, its schedules and any documents it refers to. Pay particular attention to terms such as ‘penalty’, ‘fixed charge’, ‘each individual instance’ and ‘for each day the breach continues’.

For each such provision, draw up a simple table covering five points:

• the obligation whose breach triggers the penalty;
• the event that establishes a breach;
• how the penalty is calculated;
• the period over which the penalty accrues;
• any other consequences of the same breach.

Obligations must be sufficiently specific. ‘Failure to follow the franchisor’s instructions’ is much broader than a precisely defined obligation to remove unauthorised promotional material. Broad wording makes it difficult to assess your exposure in advance.

Also check who establishes the facts. Ask for written notice describing the breach, identifying the relevant contractual provision and setting out the calculation. The franchisee should have an opportunity to challenge an inaccurate finding and provide supporting documents. This procedure should be clearly agreed, rather than assumed to exist simply because the relationship starts on good terms.

Calculate the cumulative cost, not just the individual penalty

An apparently reasonable amount can become substantial if it is charged daily, per outlet or for each individual incident. For example, the same unauthorised promotional material might be displayed in several places and remain there for several days. The agreement should clarify whether this constitutes one breach or a series of separate breaches.

Ask the franchisor for written examples showing how penalties would be calculated in several realistic situations. In your own assessment, use the amounts in the proposed agreement, rather than general estimates discussed in conversation. Consider an isolated failure, repeated failures and a breach that continues over an extended period.

Pay particular attention to the relationship between penalties and damages. Under the Civil Obligations Act, where the loss exceeds the penalty, the creditor may claim the difference to obtain full compensation. This means that a cap on contractual penalties is not necessarily a cap on total liability.

A lawyer should also check whether a claim for performance of the obligation can lawfully be combined with a penalty, depending on the type of breach covered by the penalty clause. Do not accept a blanket assertion that all the listed consequences can always be applied cumulatively and automatically.

What to negotiate before signing

Focus negotiations on predictability and proportionality. Propose a clear definition of an individual breach, an overall cap on penalties for related events and a precise point at which daily penalties stop accruing. Distinguish between a one-off administrative oversight and a serious breach that threatens the brand or other members of the franchise network.

Check how circumstances for which you are not responsible are treated. The Civil Obligations Act provides that a contractual penalty ceases to have effect if non-performance, delay or improper performance results from a cause for which the debtor is not responsible. However, responsibility in a particular case may be disputed, so retain notices, records and evidence of the steps you have taken.

At the debtor’s request, a court may reduce a disproportionately high contractual penalty, taking into account the value and significance of the obligation. This reduction is not automatic, nor is it a good substitute for negotiating before signing.

Practical takeaway: do not sign until you can explain what triggers each penalty, how it is calculated and which other claims it may be combined with. Take your list of penalties and several written calculation examples to a lawyer, together with the agreement.