Can a contractual penalty be stipulated in the employment agreement?

In 2020, Serbian Supreme Court of Cassation reversed the decisions of the lower courts which had found that an employee who had refused to enter into an annex to employment agreement was lawfully terminated.

Under Serbian law, the terms of employment agreement can be amended through a special procedure which involves the employer’s offer to the employee for the change of specific terms, accompanied with an instruction as to the legal consequences of refusal by the employee, specifically whether the employee can be terminated if s/he refuses the offer. Termination is possible only if the employee refuses transfer to another job, transfer to another place of work, temporary transfer to another employer, redeployment measure in case of redundancy and change of constitutive elements of salary. In other cases, the employee cannot suffer adverse consequences if s/he refuses offer for the change of job terms.

The offer for the annex in the case at hand proposed changes of several employment terms, specifically transfer to another job, 30-day notice in case of unilateral termination by the employee and contractual penalty in case of non-compliance with the said notice period, as well as contractual penalties in case of breach by the employee of confidentiality and non-compete undertakings. The employee refused to enter into the offered annex, and was terminated by the employer in accordance with the warning in the offer. The reviewed decision of the Supreme Court of Cassation does not reveal whether the employer’s warning of termination of employment was restricted to the refusal of transfer to another job, or was given without any specification.

The court acting in the first instance held that termination was lawful since the employer complied with the procedure for the annex to the employment agreement. The appellate court confirmed. The Supreme Court of Cassation, however, reversed both decisions stating, amongst other things, that contractual penalty is a matter of general contract law and cannot be a part of an employment agreement. Because the offer for the annex to the employment contained what was in the view of the Supreme Court of Cassation an unlawful provision, the employee was entitled to refuse the offer and could not have been lawfully dismissed for doing so.

Instead of analysing whether the employer was entitled to terminate the employment agreement for the employee’s refusal to accept the offer for the annex, given that the offer was not restricted to the terms the refusal of which warrants termination, the Supreme Court maintained that an employer and an employee cannot validly agree on a contractual penalty. We think this is incorrect on law. An employment contract is a contract, although it also confers a status upon the employee.  According to the Obligations Act, which regulates contracts, a creditor and a debtor of a non-monetary obligation can agree that the debtor shall pay a contractual penalty in case it fails to fulfil the obligation. A breach of an undertaking not to compete with the company or a breach of an undertaking to keep information confidential or to comply with a notice period is a breach able to activate the obligation to pay a contractual penalty if one is agreed upon. Although the Labour Act does not explicitly foresee a contractual penalty as an element of employment contract, it does not prohibit it either. That legislation does not regulate the contents of an employment agreement exhaustively but merely prescribes its mandatory content. The decision of the Supreme Court of Cassation does not explain why an obligation to pay contractual penalty offends the Labour Act.

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