Contractual penalties in franchising: how can you limit the risk?

A penalty for breaching standards may seem like a minor detail until a single incident triggers several claims at once. Before buying a franchise, it is therefore worth checking not just the size of each penalty, but also how it is calculated and how you can challenge it. Within a franchise network, transparent liability rules protect the shared brand, but they should also allow franchisees to assess the risks of running an outlet.

1. Understand the legal limits of contractual penalties

In Poland, a franchise agreement remains an ‘unnamed contract’: there is no separate statute comprehensively governing franchising, nor a specific statutory disclosure regime for prospective franchisees. The 14-day period mentioned in descriptions of proposed legislation should not be treated as a generally applicable legal requirement. The main rules are the general provisions of the Polish Civil Code, alongside competition law, intellectual property law and other legislation where relevant.

For contractual penalties, the key provisions are Articles 483 and 484 of the Polish Civil Code. A contractual penalty may secure performance of a non-monetary obligation, such as the requirement to use agreed signage at an outlet, and apply if that obligation is not performed or is performed improperly. It cannot, however, secure payment of the franchise fee itself. For late payment, interest is the primary remedy.

Simply reading the heading of a clause is not enough. A charge described as an ‘administrative’ or ‘disciplinary’ fee may in fact function as a contractual penalty. Its legal classification depends on the substance and purpose of the provision, not just its name.

Importantly, a penalty may be payable even if the franchisor does not establish the amount of loss suffered. This does not mean that every demand for payment is automatically justified: the breach, the terms of the agreement and the grounds for holding the franchisee liable all need to be examined.

2. Map out the penalties rather than just reading the fee schedule

Gather the penalty provisions from the entire contractual package. They may appear in the main agreement, appendices, rules and documents setting out operating standards. Also check whether these documents have been validly incorporated into the agreement and whether the franchisor reserves the right to amend them.

For each penalty, note:

• Obligation: what exactly must you do, or refrain from doing?
• Trigger: does the penalty apply to a single breach, each day it continues or each identified instance?
• Calculation: is it a fixed amount, a daily rate or a specified formula?
• Evidence: how are the breach and its duration established?
• Cumulative penalties: can the same set of circumstances trigger other penalties?
• Cap: is there a maximum liability per incident and an aggregate limit for an agreed period?

Phrases such as ‘any breach of standards’ or ‘conduct damaging to the brand’s image’ warrant particular caution if they are not accompanied by clear criteria. Ask for examples of conduct covered by the clause and for its scope to be clarified.

Run a simple test: an outlet uses the wrong advertising material for several days. Does this result in one penalty, a penalty for each day, a separate penalty for each item of material, and an additional penalty for failing to follow an instruction to put things right? This kind of scenario reveals the risk more clearly than the amount shown in a fee schedule alone.

3. Negotiate a remedy procedure and limits on liability

The most useful safeguard may not be a lower penalty rate, but the right to remedy a breach before a penalty is imposed. Propose a written notice describing the breach, identifying the evidence and setting a reasonable deadline for putting it right. Not every breach can be remedied, so exceptions to this procedure should be clearly defined.

Also agree when a daily penalty stops accruing. Is it enough to remedy the breach and provide evidence, or is another inspection required? A franchisee should not incur additional costs simply because they are waiting for someone to become available to approve the corrective action.

In your negotiations, address:

• a prohibition on multiple penalties for the same breach of an obligation;
• a cap on penalties per incident and an aggregate cap;
• exclusions for circumstances attributable to the franchisor;
• rules for raising objections and a deadline for responding;
• the relationship between a penalty and damages exceeding its amount.

The final point is particularly important. Under the Polish Civil Code, damages exceeding the agreed penalty cannot be claimed unless the parties agree otherwise. A cap on penalties does not necessarily cap all claims. Check the two mechanisms separately.

4. Establish how to challenge a penalty before a payment demand arrives

Ask whether, after you raise an objection, the franchisor can still draw on security you have provided or set the amount off against sums due to you. Challenging a penalty does not necessarily stop these actions. It is worth negotiating a procedure for handling disputed amounts and a requirement to explain why the penalty has been imposed.

The Polish Civil Code allows you to seek a reduction of a penalty if the obligation has been substantially performed or the penalty is grossly excessive. This is known as judicial reduction of a contractual penalty. It does not happen automatically and is no substitute for a well-negotiated agreement; in a dispute, it requires an appropriate request supported by arguments and evidence.

Keep notices, inspection reports, photographs, correspondence and evidence of corrective action. Before signing, ask a lawyer to assess not only the size of the penalties, but also the potential for them to accumulate and for liability to extend beyond them.

Practical takeaway: do not sign the agreement until, for every typical breach, you can establish how the penalty would be calculated, whether you would have an opportunity to put things right and whether you could face additional claims beyond the penalty.