Contractual penalties in franchising: how to set reasonable rules

When turning an established business into a franchise network, you need to set not only the standards for working together but also the consequences of breaching them. A contractual penalty can protect important obligations, but it is no substitute for a clear procedure or properly preparing your franchisee. Before signing the first agreement, draw up a short, well-justified list of penalties rather than copying an extensive list of sanctions from someone else’s document.

1. Distinguish contractual penalties from interest and damages

Poland has no separate statute comprehensively regulating franchising. A franchise agreement is an ‘unnamed contract’, meaning it is not a specifically defined statutory contract type. It is entered into under the principle of freedom of contract set out in Article 353¹ of the Polish Civil Code. That freedom has limits: the terms and purpose of the agreement must not conflict with the law, the nature of the legal relationship or the principles of social coexistence. Depending on its provisions, other rules also apply, including those governing competition and intellectual property.

The key provisions for contractual penalties are Articles 483 and 484 of the Polish Civil Code. A contractual penalty covers failure to perform, or improper performance of, a non-monetary obligation. It may therefore apply, for example, to failure to submit an agreed operational report or a breach of confidentiality, provided the obligation and the conditions giving rise to liability are properly defined.

A contractual penalty should not, however, be stipulated for late payment of a franchise fee. For monetary obligations, interest is the principal remedy; where applicable, the rules on combating excessive delays in commercial transactions also apply.

Nor is a penalty automatically payable alongside additional damages. Claiming damages above the amount of the penalty requires an appropriate provision in the agreement. Make that decision consciously, assessing the actual risk, rather than mechanically adding such a provision to every obligation.

2. First define the obligation and how a breach will be established

Review the processes in your existing business and identify obligations whose breach could genuinely harm the franchise relationship. Not every departure from an instruction should lead to a financial sanction. A new employee’s mistake, a system failure and the deliberate disclosure of confidential information call for different responses.

For each proposed penalty, prepare a record setting out:

• the specific obligation and the party responsible for fulfilling it;
• the deadline for performance and how it is determined;
• the event that constitutes a breach;
• the documents or other evidence that can substantiate it;
• the rules for giving notice to remedy the breach, where it can be put right;
• the penalty amount or an unambiguous method for calculating it.

Instead of a clause imposing a ‘penalty for failure to cooperate’, define a measurable obligation, such as submitting a specified report by a stated deadline. Also establish what happens if the form or system provided by head office is not working. A franchisee should not face a penalty simply because the franchisor failed to provide the tools needed to fulfil the obligation.

Do not assume that every breach automatically gives rise to liability. As a general rule, what matters is whether the circumstances fall within the responsibility of the party owing the obligation. Any extension of that liability requires deliberate, precise drafting and legal review.

3. Match the amount to the importance of the obligation

There is no universal statutory cap on franchise penalties expressed as a percentage of a franchisee’s annual turnover. Nor is there a single amount suitable for every franchise network. Your starting points should be the importance of the obligation being protected, the likely consequences of a breach and the scale of the outlet’s operations.

In a working document, explain why the proposed penalty is justified. Consider the cost of intervention, potential disruption to other outlets and how difficult it would be to reverse the consequences. This is not a calculation of damages that must be paid, but a way to avoid arbitrary amounts.

If a penalty accrues daily, specify when it starts and stops accruing, and consider an overall cap. Also check whether a single event could trigger several overlapping penalties. Unclear rules on cumulative penalties increase the risk of disputes and make it harder for franchisees to assess their obligations.

Under Article 484 § 2 of the Polish Civil Code, the party owing the obligation may seek a reduction in the penalty if the obligation has been substantially performed or the penalty is grossly excessive. At the same time, a failure to prove loss does not in itself mean that the penalty is no longer payable. Do not, therefore, treat a high amount as a guarantee of effective protection.

4. Put a procedure in place before imposing the first penalty

A franchise network needs predictable rules, not discretionary sanctions. Designate someone to gather information about an incident and someone to approve the imposition of a penalty. Before making a decision, give the franchisee an opportunity to explain. Where a breach can be remedied, consider first issuing a notice requiring it to be put right within a reasonable period.

The penalty notice should identify the obligation breached, the contractual basis, what happened, how the amount was calculated and the payment deadline. Retain proof of delivery and records of any explanations provided. Also establish a process for reviewing objections amicably before a dispute reaches court.

Before signing the first agreement, work through several realistic scenarios from your own business with a lawyer. Check whether the clauses distinguish between a franchisee’s failure and a problem caused by head office. Consider using contractual penalties to protect selected non-monetary obligations of the franchisor too — liability need not operate in only one direction.

Practical takeaway: every penalty should have a clearly defined underlying obligation, a justified amount and a predictable procedure. If you cannot explain these three elements to a franchisee, revise the clause before launching the franchise.