Within the context of construction contracts gradually becoming more complex and diverse with respect to both their forms and content, the application of mechanisms for addressing contractual breaches, particularly those related to the damage compensation, play a vital role in the protection of parties’ legitimate rights and interests. Among which, the two concepts “liquidated damages” and “penalties’ are often mentioned as common legal tools that, while sharing certain similarities pertaining to the objective, are complexly different in the legal nature and approached differently by the judicial system of Vietnam[1]
Notably, the recognition and application of liquidated damage clause in judicial practice in Vietnam remain a debated issue, with some noteworthy developments in recent times[2]. This is especially important when construction contracts of international standards such as FIDIC have become more widely used, which require provisions on liquidated damages to be scrutinized and adjusted to ensure that they are consistent with the legal system of Vietnam.
Regulatory legal framework in Vietnam
Liquidated Damages
The law of Vietnam currently has yet to have explicit and direction provisions on liquidated damages. However, the legal basis for the agreement between parties on the application of this mechanism could be deduced from the general provisions of the Civil Code 2015.
Specifically, Article 360, Civil Code 2025 reads: “With respect to damage caused by breach of an obligation, the obligor must compensate for the whole damage, unless otherwise agreed or prescribed by law”. The phrase “unless otherwise agreed” indicates that the laws allow parties to agree on a separate compensation amount, which might not be entirely based on the actual damage. This is the most crucial argument basis to affirm the legality of liquidated damage clause.
However, the interpretation and application of this clause remain problematic since there is neither detailed guidelines nor consistency in judicial practice. Furthermore, Article 419, Civil Code 2015 has clarified the principle for determining compensable damage, and Article 360 is referred to as a basis for determining the legality of the agreement between the parties.
One notable development is that, in Article 22, Part 4, Appendix III, Dispatch No. 02/2023/TT-BXD, for the first time, it is recognized that there exist two methods for determining damage in construction contracts:
- Damage compensation based on the total actual damage; or
- Damage compensation based on a determined amount (consistent with the civil laws)
The specification of the method “compensation based on a determined amount” could be viewed as a significant progress in the legalization of liquidated damage mechanism within the legal system of Vietnam. However, the interpretation and application of this clause ought to be consistent with the principles of the current civil laws to ensure the transparency, equity, and enforceability in construction contract practice.
Penalties
Different from the liquidated damage, penalty is adequately and explicitly provided by Vietnamese Law. Article 418, Civil Code 2015 provides that penalties are the agreements between the parties in a contract, in which the default parties shall pay a sum to the aggrieved party. The penalty amount shall be agreed by the parties, unless there are limitation provided by the laws.
In the commercial sector, clause 1, Article 301, Law on Commerce 2005 stipulates that the penalty amount shall not exceed 8% of the value of the breached contractual obligation. This stipulation is to ensure the balance between the rights and obligations of the parties while also limiting the abuse of penalty.
For construction contracts, especially state-funded construction, Article 146 of the Law on Construction 2014 stipulates that the penalty amount shall not exceed 12% of the value of the breached contractual obligation. This higher penalty amount reflects the demand for strict progress and investment efficiency management in state-funded projects.
Legal nature and exclusive characteristics
| Content | Liquidated Damage | Penalty |
| Legal Nature | Liquidated Damage is the agreement between parties in the contract on a specific sum that the default parties must pay to compensate the aggrieved party for the damage incurred by the latter; determined prior to the contractual breach.[3] | Penalty is a mechanism of punitive and deterrent nature that aim to pressure parties to comply with their contractual obligations[4]. Unlike damage compensation, penalties are not required to correspond to the actual damage |
| Agreement | Must be specified in the contract | Must be specified in the contract |
| Purpose | A compensation mechanism, not a means of punishment. The main purpose is to | A mechanism of punitive and deterrent nature for contractual breaches. |
| Limitation | The determined amount should not exceed the potential actual damage | Must comply with the limitation of the laws (8% per Law on Commerce, 12% per Law on Construction, or no limitation per the Civil Code) |
| Proof of Damage | No need to prove the actual damage and accompanied details[5] | No need to prove that actual damage has been incurred |
Effects of liquidate damage clause in judicial practice
The Courts’ traditional approach
For a long time, Courts in Vietnam tends to not recognize the concept of liquidated damage clause and often classify them as penalty clause. This approach is apparent in some important decisions such as:
- Cassation Decision No. 15/2016/KDTM-GDT of the Supreme Court in the case between A Service and Technical JSC and Company B determined that the nature of liquidated damage is that of an agreement on penalty. Based on that, the Court apply the limitation of 8% of the value of the breached obligations in accordance with the Law on Commerce. The Court held that the determination of a set sum without any requirement for proof of damage is not consistent with the principles of damage compensation per Vietnamese Law[6].
- Decision on appeal against cassation No. 11/2020/KN-KDTM dated 09/06/2020, the Supreme Court continued to affirm that, in order for compensation liabilities to arise, the factors that must be proven include: (i) Breach of Contract, (ii) Actual Damage; (iii) Causal connection between breach of contract and the actual damage; and (iv) proof and scale of actual damage incurred furnished by the aggrieved party[7]
These decisions reflect the traditional viewpoint of Courts in Vietnam, which demand that all damage compensation must be based on the actual damage and proven in details. This viewpoint originated from the fundamental principles of damage compensation in Vietnamese civil law.
Changes to the approach: Recognition of Liquidate Damage Clause
The recognition of the legality of liquidated damage clause by Judgment No. 660/2022/KDTM-PT of the People’s Court of Ho Chi Minh City is a monumental development. This is the first time that a Court in Vietnam accepts this mechanism with systematic and sound reasoning.
To simplify, the Court in this case recognized the legality of liquidated damage clause based on the principles of freedom of contract and principle of “Involved parties’ right to decision-making and self-determination” (specified in Civil Procedure Code 2015). Consequently, the Court accept the Contractor’s request for compensation amount based on the liquidated damage clause after assessing that this request is consistent with the nature of damage compensation. Particularly, the Court also set a limitation for compensation request based on liquidated clause by ruling that the Court have the power to “review” the compensation amount and evaluate whether is it “grossly excessive” in comparison to the actual damage.
All of the findings above are the focus of the judgment, as it goes against the prevalent trend of not recognizing liquidated damage clauses in judicial practice in Vietnam[8]. The very trend that troubles enterprises who are entangled in dispute. This is because liquidated damage clause is a fairly common agreement in business transaction and were established based on the premise that the aggrieved party could not accurately determine the actual damage directly resulted from the breach of contract by the default party, and such determination, if possible, would subject the aggrieved party to great loss of time and resources[9].
Therefore, liquidated damage clause would provide parties with a more convenient method for the determination of damage caused by breach of contract, thereby avoid the possibility of prolonging the dispute resolution procedures. The recognition of the legality of liquidated damage clause is a positive signal for judicial practice in Vietnam
Liquidated Damage Clause in FIDIC Contracts and Challenges in Application in Vietnam
The concept of delay damage specified in Clause 8.7 FIDIC Red Book 1999 and Clause 8.8 FIDIC Red Book 2017 has always been a challenge in the application of FIDIC Contracts in Vietnam. This clause aims to protect the rights of the Employer in the event that the Contractor fails to complete the construction in accordance with the committed schedule. However, the application of this clause within the legal system of Vietnam presents significant challenges in both theoretical and practical senses.
Characteristics of Delay Damage in FIDIC
Delay damage in FIDIC carry several exclusive characteristics that distinguish it from traditional damage compensation mechanisms. In FIDIC contract templates, “delay damages” is a typical form of liquidated damage, commonly found in Sub-Clause 8.7 of FIDIC Red Book 1999 and Sub-Clause 8.8 of FIDIC Red Book 2017. This is a fixed sum that the contractors must pay to the Employer for each day elapsed past the date of completion, with the amount agreed in advance in the contract. Employer does not need to prove the actual damage incurred.
Between the two templates, FIDIC Red Book 2017 stands out as an upgrade as it, for the first time, provide an official definition of delay damage in Sub-Clause 1.1.28, which reads “Delay damages mean the damages for which the Contractor shall be liable under Sub-Clause 8.8 [Delay Damages] for failure to comply with Sub-Clause 8.2 [Time for Completion]”. These changes do not only clarify the definition but also demonstrate the tendency of standardize and systematize the provisions in FIDIC Contracts.
Another notable characteristic of delay damages in FIDC is “exclusive remedy”. Sub-Clause 8.7 FIDIC Red Book 1999 specify as follows: “These delay damages shall be the only damages due from the Contractor for such default”. This means that, except for the premature termination of contract, the employer could not request any addition compensation for the actual damage from the Contractor aside from the liquidated damage agreed by the parties.
Legal challenges in application in Vietnam
The fundamental problem of the application of delay damage clause in FIDIC contract in Vietnam lies in the difference between the legal nature of this concept and the legal system of Vietnam. According to the research of legal experts, delay damages in FIDIC is of the same nature as the “delay damages” (liquidated damage) observed in common law system, both of which is a predetermined sum serving as the compensation for potential damage that does not require proof of actual damage.[10]
However, the Vietnamese law follows the civil law model, which set strict requirements for damage compensation. Article 13 and Article 360 Civil Code 2015 explicitly set out the requirements for compensation liabilities to arise, which are: (i) breach of obligation, (ii) actual damage, (ii) connection between the breach of obligation and the actual damage, (iv) attributability of the default party. Particularly, the requirement of “actual damage” creates a legal barrier against the application of delay damage per the interpretation of FIDIC
Cassation Decision No. 10/2020/KDTM-GDT of the Supreme Court has clearly affirmed the following on the proof of damage: “If it is determined that the parties have an agreement on damage compensation, the Court must clarify the all bases that give rise to the compensation liabilities, which comprise… proof and scale of actual damage incurred furnished by the aggrieved party”. In the event that the above finding is applied to delay damages in FIDIC Contracts, this viewpoint would conflict with the nature of delay damage in FIDIC Contracts – which is originally designed to alleviate the burden of proving the actual damage.
Solution for Vietnamese Law
Against the above challenge, a practical solution of transforming the delay damages as the delay penalty per Article 418 Civil Code 2015 has been proposed. This is because penalty only requires agreement on the penalty and does not require proof of damage.
Article 418 Civil Code 2015 provides that penalty is an agreement between the parties in a contract, in which, the default parties shall pay a sum to the aggrieved party. More importantly, this clause does not require the requesting party to prove their actual damaged, which is consistent with the nature of delay damage in FIDIC Contracts
In the construction sector, Article 146 of Law on Construction 2014 stipulates that the penalty amount shall “not exceed 12% of the value of the breached obligation” for state-funded constructions. For other contracts, Law on Commerce 2005 provides a limitation of 8% of the value of the breached obligation. These provisions create a clear legal framework for the application of delay penalty, instead of delay damages
The adjustment of FIDIC Contract so that the delay damages clause is “legalized” into delay penalty would not ensure the legality but also preserve the original purposes. This solution is both flexible and appropriate to the demand of global integration and the peculiarities of Vietnamese law
Contact
For more information, please contact:
CNC VIETNAM LAW FIRM CO., LTD
Address: The Sun Avenue, 28 Mai Chi Tho, Binh Trung Ward, Ho Chi Minh City, Vietnam
Phone: 028 6276 9900
Hotline: 0916 545 618
Email: contact@cnccounsel.com
Website: cnccounsel
Managed by
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Tran Pham Hoang Tung | Senior Associate
Phone: (84) 901 334 192 Email: tung.tran@cnccounsel.com |
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Bui Doan Minh Tri | Lagal Assistant
Phone: (84) 28 6276-9900 Email: tri.bui@cnccounsel.com |
Disclaimer:
This article was prepared to be used for the purpose of introducing or informing clients about issues and/or developments of legal perspectives in Vietnam. The information presented in this article does not constitute advice of any kind and may be subject to changes without prior notice.
[1] Vu Thi Thinh, “Yêu cầu bồi thường thiệt hại ước tính, thiệt hại thực tế trong hợp đồng xây dựng tại Việt Nam” <https://tapchixaydung.vn/yeu-cau-boi-thuong-thiet-hai-uoc-tinh-thiet-hai-thuc-te-trong-hop-dong-xay-dung-tai-viet-nam-20201224000025369.html>
[2] CNC Counsel, “New approach of Vietnam’s Courts on Liquidated Damages” <https://cnccounsel.com/insights/new-approach-of-vietnam-courts-on-liquidated-damages>
[3] CNC Counsel, op. cit.
[4] “Phạt vi phạm trong hoạt động thương mại – một số bất cập và giải pháp hoàn thiện pháp luật” <https://pbgdpl.haiphong.gov.vn/Nghien-cuu-trao-doi/Phat-vi-pham-trong-hoat-dong-thuong-mai—-mot-so-bat-cap-va-giai-phap-hoan-thien-phap-luat-93077.html>
[5] Phan Van Thanh, “Giá trị pháp lý của thỏa thuận bồi thường thường thiệt hại ước tính theo pháp luật Việt Nam” <https://lsvn.vn/gia-tri-phap-ly-cua-thoa-thuan-boi-thuong-thiet-hai-uoc-tinh-theo-phap-luat-viet-nam1622797514-a104767.html>
[6] Pham Thi Cam Ngoc, “Thỏa thuận Bồi thường thiệt hại ước tính trong pháp luật và thực tiễn xét xử ở Việt Nam và nước ngoài”, Journal of Legal Studies (06/2023)
[7] Nguyen Minh Duc, “Thực tiễn pháp luật Việt Nam về thỏa thuận bồi thường thiệt hại ước tính trong hợp đồng thương mại và một số giải pháp xây dựng pháp luật”, Van Hien University
[8] Gian Thi Le Na, “Vi phạm hợp đồng hiệu quả”, PhD Thesis, University of Economics and Law (Vietnam National University), page 101 – 117 (2022) <https://psdh.uel.edu.vn/tien-do-thuc-hien-ncs/tien-do-thuc-hien-ncs-gian-thi-le-na>.
[9] Huynh Trung Hieu, “Ước định bồi thường thiệt hại liệu có được bồi thường?”, thesaigontimes, posted on 26/01/2022 <https://thesaigontimes.vn/uoc-dinh-boi-thuong-thiet-hai-lieu-co-duoc-boi-thuong/>
[10] Luu Tien Dung, Dang Khai Minh, Do Khoi Nguyen, ‘‘Giải thích, áp dụng điều khoản thiệt hại do chậm trễ trong hợp đồng mẫu FIDIC Quyển đỏ theo luật Việt Nam” Journal of Court <https://tapchitoaan.vn/giai-thich-ap-dung-dieu-khoan-thiet-hai-do-cham-tre-trong-hop-dong-mau-fidic-quyen-do-theo-luat-viet-nam8877.html>
