The aim of this paper is to show in detail the application of the institution of contractual penalty in the construction contract. After a section that thoroughly analyses the institution of contractual penalty and construction contracts, the paper focuses on the regulation of contractual penalties in construction contracts as viewed by the Civil Obligations Act and the Special Usages in Construction and gives the interpretation of contractual penalties using a concrete example of a construction contract. The well-known principle of freedom in regulating contractual relationships, which proclaims the freely expressed will of the participants in regulating contractual relationships, complying with the Constitution of the Republic of Croatia, mandatory regulations, and the morals of society, is one of the most important principles of civil obligations. Although the parties are free in regulating contractual relationships, they often do not respect the equally important principle of contract law, which is the principle pacta sunt servanda. For this reason, parties often include various protective clauses in contracts to ensure contractual discipline. It is the institution of contractual penalty as a means of personal reinforcement of contractual relationship that is one of the most commonly agreed upon clauses. It is particularly common in construction contracts, where a penalty clause is considered an indispensable addition to almost every construction contract. This is not surprising given the fact that the construction sector is characterized by instability, deadlines, sudden and frequent changes in material prices, and other risk factors that, among other things, affect the price as an essential element, which then greatly influences the ability to fulfil contractual obligations properly. When interpreting contractual penalties in construction contracts, it is not enough to only consider the provisions of the Civil Obligations Act, but also the provisions of the Special Usages in Construction, codified commercial customs, whose regulation of this institution is not identical to that in the Civil Obligations Act.