1. Legal Grounds Governing Remedies for Breach of Commercial Contracts
Contractual penalties and compensation for damages arising from commercial activities are governed by the following legal instruments:
- The Law on Commerce 2005: The primary legislation governing commercial activities between traders, specifically Sections 2 and 3 of Chapter VII (Articles 300 to 307).
- The Civil Code 2015: The general law governing civil contractual relationships, which applies supplementarily where the Law on Commerce does not provide otherwise, particularly under Articles 360, 418, and 419.
- The Civil Procedure Code 2015: Regulates the parties’ obligations to collect evidence and prove the occurrence and extent of damages in business and commercial disputes.
2. Legal Nature and Key Rules Applicable to Each Remedy
2.1. Contractual Penalty
a. Conditions for Application
Pursuant to Article 300 of the Law on Commerce 2005, a contractual penalty is a remedy whereby the aggrieved party requests the breaching party to pay a penalty for its breach of contract.
- Key principle: The right to impose a contractual penalty must be expressly agreed upon in advance in the contract. If the contract does not contain a contractual penalty clause, the aggrieved party is not entitled to claim a penalty, even where the counterparty has committed a serious breach.
b. Statutory Cap on Contractual Penalties – 8%
Pursuant to Article 301 of the Law on Commerce 2005, the penalty for a breach of a contractual obligation, or the aggregate penalty for multiple breaches as agreed by the parties, must not exceed 8% of the value of the breached contractual obligation, except for the circumstances specified in Article 266 of the Law on Commerce concerning assessment services.
How Should “Value of the Breached Contractual Obligation” Be Understood?
The 8% cap is not calculated based on the total contract value. Instead, it is calculated based only on the value of the specific contractual obligation that has been breached.
Example:
A commercial contract for the sale of equipment is worth VND 10 billion. The seller has properly delivered the first batch valued at VND 8 billion, but delays delivery of the second batch valued at VND 2 billion.
In this case, the maximum contractual penalty should be calculated based on the VND 2 billion value of the breached obligation, rather than the total contract value of VND 10 billion.
Accordingly, the maximum penalty would be:
VND 2 billion × 8% = VND 160 million.
2.2. Compensation for Damages
a. Legal Nature and Conditions for Liability
Pursuant to Articles 302 and 303 of the Law on Commerce 2005, compensation for damages requires the breaching party to compensate the aggrieved party for losses caused by the contractual breach, with the purpose of restoring the aggrieved party’s financial position to the extent permitted by law.
The following three conditions must generally be satisfied:
- A breach of contract has occurred;
- Actual damage has occurred; and
- There is a direct causal link between the breach and the damage.
- Statutory right to claim damages: Unlike a contractual penalty, the right to claim compensation for damages arises by operation of law. The parties are therefore not necessarily required to have agreed in advance on a damages clause in the contract.
b. Scope of Compensation
Pursuant to Article 302 of the Law on Commerce 2005, compensation for damages consists of two principal components:
- Actual and direct losses suffered by the aggrieved party, such as storage costs, costs of engaging a third party to remedy defective goods, penalties imposed by other contractual counterparties, and other directly incurred losses.
- Direct profits that the aggrieved party would have earned in the absence of the breach, i.e., directly lost profits.
c. Burden of Proof and Duty to Mitigate Losses
- Burden of proof: Pursuant to Article 304 of the Law on Commerce 2005, the party claiming compensation bears the burden of proving the loss, the extent of the loss, and the direct profits that have been lost.
- Duty to mitigate losses: Pursuant to Article 305 of the Law on Commerce 2005, the aggrieved party must take reasonable measures to mitigate its losses, including losses relating to direct profits.
If the aggrieved party fails to take such reasonable measures, the breaching party may request that the amount of compensation be reduced by the portion of the loss that could reasonably have been prevented or mitigated.
3. Relationship Between Contractual Penalties and Compensation for Damages
Where one party breaches a commercial contract, can the aggrieved party apply both remedies simultaneously?
Pursuant to Article 307 of the Law on Commerce 2005, the availability of both remedies depends on the circumstances and the parties’ contractual agreement:
3.1. The Contract Provides Only for a Contractual Penalty
Where the contract contains a contractual penalty clause but does not provide for compensation for damages, the aggrieved party may only claim the contractual penalty and may not additionally claim damages.
This represents a significant difference from the general rule under Article 418 of the Civil Code 2015.
3.2. The Contract Provides for Both a Contractual Penalty and Compensation for Damages
Where the contract expressly provides for both contractual penalties and compensation for damages, the aggrieved party may apply both remedies simultaneously.
Accordingly, the aggrieved party may:
- Claim the contractual penalty, subject to the 8% statutory cap; and
- Claim compensation for the actual and direct losses arising from the breach, subject to the applicable legal requirements and the obligation to prove such losses.
3.3. The Contract Contains No Provision on Either Remedy
Where the contract contains no agreement concerning either contractual penalties or compensation for damages, the aggrieved party may claim compensation for damages, provided that the statutory conditions are satisfied and the actual losses are properly proven.
However, the aggrieved party may not claim a contractual penalty in the absence of an express contractual agreement.
4. Comparison of the Two Remedies under the Current Law on Commerce
| Criteria | Contractual Penalty (Articles 300–301) | Compensation for Damages (Articles 302–305) |
| Purpose | To deter and penalize non-compliance with contractual obligations. | To remedy and compensate for actual financial losses arising from the breach. |
| Basis for application | Must be expressly agreed upon in advance in the contract. | Arises by operation of law; no prior agreement is necessarily required. |
| Actual damage | No proof of actual damage is required; the existence of a contractual breach is sufficient, provided that a valid penalty clause exists. | Actual damage and the causal relationship must be proven. |
| Monetary limitation | Capped at 8% of the value of the breached contractual obligation. | Covers actual and direct losses and direct lost profits, subject to the statutory requirements and without the 8% cap. |
| Can both remedies be applied simultaneously? | May be applied together with damages only where the contract expressly provides for a contractual penalty and the statutory conditions are satisfied. | May be claimed independently or together with a contractual penalty where the parties have agreed to such penalty. |
Conclusion
Contractual penalties and compensation for damages are two distinct remedies for breach of commercial contracts under Vietnamese law. While a contractual penalty is primarily intended to deter and sanction contractual breaches and must be expressly agreed upon, compensation for damages is intended to restore the aggrieved party for actual losses and lost profits resulting from the breach.
In commercial transactions, parties should therefore carefully draft contractual provisions concerning both remedies, particularly the scope of the contractual penalty, the 8% statutory cap, the types of recoverable damages, evidence requirements, and the duty to mitigate losses.
A properly drafted contractual remedies clause can play an important role in protecting the parties’ legitimate interests and reducing legal uncertainty when contractual disputes arise.
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1. Lawyer Vu Thi Phuong Thanh, Ha Noi Bar Association
Email: vtpthanh@tlalaw.vn
2. Lawyer Tran My Le, Ha Noi Bar Association
Email: tmle@tlalaw.vn
Nguyen Thuy Duong