1. Legal Recognition of Liquidated Damages in Vietnamese Law
Liquidated damages refer to a sum of money that contracting parties agree to in advance, which one party must pay if they breach the contract. This concept, common in common law jurisdictions, is also recognized in Vietnam’s civil and commercial legal framework, albeit with certain limitations. In Vietnamese law, the equivalent legal term for liquidated damages is often referred to as a “penalty for breach” or “agreed compensation for damage.” According to Article 418 of the 2015 Civil Code of Vietnam, parties may agree on a penalty clause, under which the breaching party must pay a fixed sum of money. Specifically, Clause 1 of Article 418 states: “A penalty for breach of a contract is an amount of money which the obligor must pay to the obligee for breaching the contract, as agreed by the parties.” This means that Vietnamese law does allow contracting parties to include a clause for pre-determined damages.
However, Vietnamese law draws a distinction between penalties for breach and actual damages. Clause 2 of Article 418 clarifies that parties may agree both on a penalty and on compensation for actual damages, unless otherwise provided by law. Furthermore, Article 419 of the same Code governs compensation for damage, requiring that actual losses and the causal relationship between the breach and the losses be proven. In contrast, penalty clauses (liquidated damages) are not contingent on proof of actual loss, which is consistent with the nature of liquidated damages under international contract practice.
Nevertheless, unlike some common law systems that may strictly enforce liquidated damages clauses regardless of the actual harm, Vietnamese law imposes certain caps and restrictions. For example, under Article 300 of the 2005 Commercial Law (still in effect), the penalty for a breach in a commercial contract must not exceed 8% of the value of the breached contractual obligation. This limitation applies to contracts between merchants or commercial entities, as defined under the Commercial Law. In contrast, civil contracts that do not fall within the scope of the Commercial Law are governed solely by the Civil Code, which does not impose a specific cap on penalties but still requires the penalty amount to be reasonable and agreed upon.
2. Enforceability and Court Interpretation
The enforceability of liquidated damages clauses in Vietnam largely depends on whether the clause was clearly and lawfully agreed upon, and whether it falls within the statutory limitations. Vietnamese courts generally uphold liquidated damages clauses if they are explicit, voluntarily agreed to, and not excessive or punitive in nature. However, courts retain discretion to interpret the reasonableness of the penalty amount, particularly in cases involving consumers or parties with weaker bargaining power.
In commercial cases, courts often enforce the 8% cap under Article 300 of the Commercial Law strictly. For example, in a number of dispute resolutions handled by the Vietnam International Arbitration Centre (VIAC), arbitrators have invalidated penalty clauses that exceed this 8% threshold unless the excess portion can be justified under separate grounds for compensation of actual damages. Similarly, domestic courts will refuse to enforce any portion of the penalty that goes beyond the legal cap, unless the claimant can prove corresponding actual losses.
Additionally, Vietnamese courts may scrutinize whether a clause truly constitutes a penalty (liquidated damages) or an unlawful attempt to impose punitive damages. If a clause is deemed to be punitive rather than compensatory, it may be reduced or disregarded. There is also the issue of unconscionability. Article 122 of the Civil Code allows a court to invalidate part of a contract if it was agreed upon under circumstances of misunderstanding or exploitation of a disadvantaged party. Therefore, a liquidated damages clause that is grossly one-sided or inserted under duress may be struck down.
Importantly, liquidated damages cannot replace all liability for damages. Article 418(3) of the Civil Code permits parties to agree on both a penalty and a requirement to compensate for actual damages. Hence, if parties only agree on a penalty and do not include language excluding liability for actual damages, the aggrieved party may still claim for actual losses in addition to the penalty amount.
3. Practical Use in Business Contracts and Recommendations
In practice, liquidated damages clauses are widely used in Vietnam, particularly in construction, infrastructure, and supply contracts. Foreign investors and multinational companies operating in Vietnam often include such clauses as a way to manage contractual risks and avoid the uncertainty of proving actual losses in court. For example, in construction contracts, parties commonly include daily liquidated damages for delays in completion, typically ranging between 0.05% and 0.1% of the contract price per day, capped at a certain percentage (often around 5% to 10%). Such clauses align with the practices under the FIDIC contract templates, which are also frequently used in Vietnam.
Nonetheless, businesses must be careful when drafting these clauses. First, they should ensure compliance with the applicable legal cap (e.g., 8% under the Commercial Law). Second, they should clearly define the breach events that trigger the penalty, the calculation method, and whether the penalty is in addition to or in lieu of actual damages. Ambiguous drafting may result in enforcement difficulties or judicial interpretation unfavorable to the claiming party.
Furthermore, businesses should assess whether the contract falls under the Commercial Law or the Civil Code. Contracts between companies or professional traders will usually be governed by the Commercial Law, making the 8% cap applicable. Contracts with individuals, or non-commercial entities, such as service or lease agreements with non-traders, may be governed by the Civil Code, which provides more flexibility but also requires clearer justification for enforcement.
Arbitration is another forum where liquidated damages clauses are often tested. Vietnam recognizes and enforces arbitral awards under the 2015 Law on Commercial Arbitration and the New York Convention. Businesses may prefer arbitration because arbitrators with commercial expertise are often more familiar with liquidated damages clauses and international practice. However, even in arbitration, parties must ensure that the clause does not violate mandatory provisions of Vietnamese law, or the award may face difficulties during recognition and enforcement by local courts.
In conclusion, Vietnamese law recognizes and enforces liquidated damages clauses under both the Civil Code and the Commercial Law, but subject to important legal constraints. The 8% cap under the Commercial Law is a key limitation for commercial contracts. While such clauses are a useful tool for managing breach risks, they must be drafted clearly, lawfully, and reasonably. Businesses operating in Vietnam should be mindful of these nuances, seek legal advice when drafting contract terms, and monitor evolving judicial interpretations to ensure enforceability and reduce legal exposure.
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