Buying a franchise: how to assess contractual penalties

Contractual penalties help protect the shared rules of a franchise network. For a buyer, however, they also represent a financial liability that may not be included in the budget for opening an outlet. Simply reading the amount stated in the agreement is not enough. Before signing, you need to understand what conduct triggers a penalty, whether it can keep accumulating and what other claims the franchisor can make at the same time.

1. Distinguish penalties from damages and other charges

The Czech Republic has no specific franchise legislation. Franchise agreements are usually entered into as contracts not specifically defined by statute under Section 1746(2) of Act No. 89/2012 Coll., the Civil Code. Sections 2048–2052 of that Act are central to contractual penalties. There is no statutory tariff or maximum penalty specifically for franchises.

A contractual penalty can be claimed regardless of whether the breach of an obligation actually caused any loss. The amount, or the method for calculating it, must be agreed, and the contractual obligation it secures must be clear. Paying the penalty does not, in itself, release the franchisee from the original obligation.

Damages are a separate claim. Under the default rule in Section 2050, the creditor is not entitled to damages for loss caused by a breach of the obligation covered by the contractual penalty. However, the agreement can depart from this rule. Look particularly closely for wording that preserves the right to claim damages in full alongside the penalty.

Assess late-payment interest, inspection costs and repeat training fees separately. The label alone is not decisive: a solicitor should check the substance of each charge and how it relates to other claims.

2. Compile a list of all obligations carrying penalties

Penalty clauses may be scattered across the main agreement, schedules and operating documents. For your review, bring them together in a single table. Each row should set out the obligation, the trigger for the penalty, the calculation method, the payment deadline and any opportunity to remedy the breach.

For each item, ask:

• Is the breach described precisely, or does the clause use a vague term such as “damage to reputation”?
• Is the penalty charged once, for each occurrence, for each outlet or for each day?
• When does any accumulation start and stop?
• Can a single act trigger several penalties under different clauses?
• Is there a cap per incident or an overall limit?

The difference between a one-off and a daily penalty can have a major impact on your budget. For repeated breaches, it must be clear what counts as a new occurrence. Otherwise, a single incorrect figure in a repeatedly submitted report, for example, could lead to a dispute over several separate penalties.

Pay particular attention to obligations that depend on co-operation from head office. If the franchisor supplies information needed for timely reporting, negotiate how any delay on its part will affect your deadline. Do not rely solely on informal assurances that it will not impose penalties in such circumstances.

3. Negotiate an opportunity to remedy breaches and a documented inspection process

A sensible arrangement distinguishes serious breaches from operational errors that can be corrected. For remediable shortcomings, propose a written warning, a specific description of the problem and a reasonable period to put it right before a penalty becomes payable. A franchisee has no automatic right to such a remedy period; it must be provided for in the agreed terms.

Where confidential information has been leaked, later remedial action may not undo the consequences. By contrast, a missing operational document may be supplied quickly. Applying the same penalty to both situations therefore warrants a detailed explanation and, potentially, an amendment.

Also agree on how breaches will be recorded. An inspection report should state the date, specific findings, the obligation concerned and the available supporting evidence. Negotiate the right to add your own comments and provide evidence that the issue has been resolved. Signing to acknowledge receipt of the report should not, in itself, amount to an acknowledgement of debt.

Find out whether head office can unilaterally deduct a penalty from money it owes you. Such a clause affects cash flow before any objections have been resolved. Propose a notification procedure and rules for disputed amounts: raising an objection alone may not automatically suspend the payment deadline or prevent set-off.

4. Test the combined claims, not just a single amount

Before signing, work through a hypothetical scenario: an outlet fails to submit a mandatory report, receives a notice and only remedies the error later. Using the draft agreement, calculate the one-off penalty, any daily penalties and other charges. Also check whether the same conduct allows the franchisor to terminate the agreement or claim damages.

Show this test to both your solicitor and the person preparing your financial plan. The aim is not to estimate how often you will break the rules, but to identify a liability whose extent you cannot predict or control.

Under Section 2051 of the Civil Code, a court may reduce an excessively high contractual penalty at the debtor’s request. This does not mean the clause is automatically invalid, nor does it guarantee a particular outcome. Do not rely on future court intervention as a substitute for negotiation.

Practical takeaway: Before signing, ask for a complete list of penalties, a clear calculation method and an agreed opportunity to remedy errors that can be corrected. Assess the risk by looking at the combined potential consequences, not the lowest amount stated in the agreement.