New Approach of Vietnam’s Courts on Liquidated Damages
Liquidated Damages have become a debated topic in Vietnamese jurisdiction. For a long time, many Vietnamese Courts have argued that such damages were unacceptable. However, is there any change recently?
To answer this question, CNC shall introduce to readers this article undertaken by Mr. Tran Pham Hoang Tung – Senior Associate and Mr. Pham Nguyen Tan Trung – Paralegal.
Download PDF here: PDF – Newsletter_New approach of Vietnam’s Courts on Liquidated Damages
Introduction
Liquidated Damages (or “LD”) Clause is the clause in a contract that stipulates that an agreed amount of compensation may be received by one party for damages caused by the other party’s breach of contract.[1]
LD Clause appears commonly in practice, especially in construction practice. Regarding the construction contracts formed by the FIDIC (the International Federation of Consulting Engineers) Suites of Contracts, there are some provisions stating the delay damages where the Contractor shall pay such damages to the Employer if the Contractor fails to comply with his obligations relating to Time for Completion (Sub-Clause 8.7 FIDIC Red Book 1999, Sub Clause 8.8 FIDIC Red Book 2017). These delay damages provisions in FIDIC Contracts shall be considered LD Clauses.[2]
Under Vietnamese law, Article 13 and Article 360 of the Civil Code 2015 state that for damage caused by breach of an obligation, the obligor must “compensate for the whole damage”, “unless otherwise agreed” or prescribed by law. At first glance, the LD Clause seems to be recognized by the Civil Code 2015. However, the practical application shows that the LD Clause has yet to be governed by any specific legal documents, thereby raising many different opinions about the legality of the LD Clause. In arbitration, arbitral tribunals seem to accept the compensation claims based on the LD Clause. However, the practice in Vietnamese courts shows the opposite trend.
For instance, in a cassation decision in 2016, the People’s Supreme Court argued that LD Clause in the contract shall be determined as a penalty clause in nature, therefore, such “penalty” amount shall not exceed 8% of the breached value as set forth in Law on Commerce 2005.[3] In another cassation decision in 2020, the People’s Supreme Court also argued that the LD Clause in the contract is unacceptable due to the lack of “actual damages” – one of the preconditions for claiming compensation for damages under Vietnamese law.[4]
On the opposite of such trends in Vietnamese courts, however, in an Appeal Judgment of the People’s Court of Ho Chi Minh City in 2022 (“Judgment”)[5], the Court’s argument supported the LD Clause. Notably, this Judgment gave detailed reasonings about the important aspects of the LD Clause that will be presented below.[6]
Case summary
In 2016, the Subcontractor – Plaintiff and the Main Contractor – Defendant concluded Construction Contract No.001. Appendix A01 and Appendix A02 were concluded within a year later.
During the implementation of the contract, disputes between parties occurred at the end of 2017. Among the claims made by parties to the Court, the Main Contractor requested the Court to order the Subcontractor to pay the compensation for damages based on the LD Clause specified in Section 3 of Appendix A02: “…Moreover, if Party B (Subcontractor) delays completing the project by the undertaken schedule which is March 10th, 2017, Party B shall pay a penalty of 300.000.000 VND for each delayed day”.
In 2022, the first-instance Court gave a judgment that partially accepted the Main Contractor’s request for receiving the compensation for damages specified in the LD Clause, based on the recognition of the legality of the LD Clause. Later, both parties appealed the first-instance judgment, however, the judgment given by the appellate Court (the People’s Court of Ho Chi Minh City) kept the findings in the first-instance judgment regarding the compensation for damages based on the LD Clause.
Outline of the case regarding the compensation for damages based on the LD Clause
Summary of the Court’s reasonings
Although the request for compensation for damages based on the LD Clause was only partially accepted, it does not change the fact that the legality of the LD Clause was recognized by the Court in this case.
Specifically, the argument regarding the LD Clause in this Judgment is specified in Finding No [5.3] and [5.5]. The findings shall be summarized as follows:
(1) The Court determines that Section 3 of Appendix A03 constitutes an LD Clause.
(2) The Court determines the scope and nature of such LD Clause. To be specific:
- An LD Clause is a specific agreement on the amount compensationfor damages whose calculation has been predetermined by parties at the time of concluding contract, when neither breach of contract nor actual damage are yet to occur.
- Parties forecasted the level of future damages to be incurred if the Subcontractor fails to comply with the time for completion of the project.
- The purpose of this clause is to compensate for the losses incurred by the Main Contractor.
(3) The Court recognizes the legality of the LD Clause based on the application of practices, analogous laws, fundamentals of civil law, precedents, and equity in accordance with Articles 5, 6, and 14 of the Civil Code 2015. Specifically:
- The LD Clause is consistent with the principle of freedom to reach agreement according to Article 11 of the Law on Commerce 2005.
- Compensation for damages (under Law on Commerce 2005) is a “basic right” of the aggrieved party with the purpose of “compensating for the losses” incurred by the aggrieved party, notwithstanding the existence of the LD Clause.
- The aggrieved party must prove that all of 03 preconditions for compensation for damages have been met, namely (i) the breach of contract caused by the other party, (ii) actual damage, and (iii) the actual damage is the result of the breach of contract caused by the other party.
- Regarding the LD Clause, the clause is made based on the assumption that the breach of contract would result in losses for the aggrieved party, the parties forecasted the potential level of damages to give a specific calculation method for the future damages to be incurred, and the parties agreed to “relieve” the aggrieved party from the burden of proof of the actual damages (precondition (ii) and (iii)).Therefore, the aggrieved party shall only prove precondition (i) to receive the compensation for damages specified in the LD Clause.
- The Main Contractor’s request for compensation for damages based on the LD Clause is consistent with the principle of “Parties’rights to decision-making and self-determination” as well as the nature of the compensation for damage.
(4) However, the amount of compensation for damage specified in the LD Clause shall be “reevaluated” if the Court deems that such amount is “grossly excessive” in relation to the actual damages incurred by the Main Contractor to ensure the legitimate interests of the Subcontractor.
Commentaries
In general, the Court in this Judgment relied on the principle of “Freedom to reach agreement” and the principle of “Parties’ rights to decision-making and self-determination” (stipulated in the Civil Procedure Code 2015) to recognize the legality of the LD Clause. Then, the Court accepted the Main Contractor’s request for compensation for damages as specified in the LD Clause with the assessment that this request is consistent with the compensation for damages by law. Notably, the Court has also set out a limitation on the request for the agreed sum specified in the LD Clause, which is the Court’s authority to “reevaluate” the agreed sum if it is deemed “grossly excessive” in comparison to the actual damages.
The findings listed above are the main reasonings of the Judgment and are opposite to the trend of unrecognizing the LD Clause in the judicial practices in Vietnam.[7] This trend has caused manifest difficulties for enterprises in the dispute resolution process since it is difficult for the aggrieved party to prove the actual damages and the correlation between the said damages and the other party’s breach of contract, thus it wastes a tremendous amount of time and cost of the parties.[8] However, by the LD Clause which is fairly common in business transactions, parties could be easier to determine the level of damages caused by the breach of contract, thereby reducing the risk of prolonging dispute resolution procedures. Therefore, the recognition of the legality of the LD Clause is a positive signal for judicial practices in Vietnam.
Aside from the recognition of the legality of the LD Clause, the limitation of such clause is also another noteworthy point in this Judgment. Although the aggrieved party is relieved from the burden of proving the actual damages, it is unreasonable to accept the agreed sum specified in the LD Clause for the other party if such amount is “grossly excessive” in relation to the actual damages, because the original purpose of compensation for damages, in general, is “to compensate for losses”. For that reason, the Court has to “reevaluate” the amount in such circumstances so that it would be more appropriate.[9]
Interestingly, the limitation on the LD Clause is consistent with the Principle of International Commercial Contract (PICC) 2016 – drafted and published by the International Institute for the Unification of Private Law (UNIDROIT) – which is known for its harmonized approach that has taken reference from the legal system of various nations, including both common law and civil law, or in other words, the international standard for the law of contract. Specifically, Article 7.4.13(2) of PICC 2016 specifies that the specified sum may be reduced to a reasonable amount where it is “grossly excessive” in relation to the harm resulting from the non-performance and to the other circumstances. In this situation, the reasonable amount shall be determined based on the interpretation of a reasonable person with the same knowledge and profession who shares similar circumstances.[10]
Summary of the main reasonings given by the Court to accept the request for compensation for damages specified in LD Clause
Unaddressed issues in the Judgment
Aside from the above-mentioned sound reasonings, the findings made in this Judgment still leave many issues unaddressed.
Firstly, the Court did not distinguish an LD Clause from a penalty clause.
In litigation practice, most Vietnamese Courts would argue that an LD Clause is considered a penalty clause in nature. This is why the Court in this Judgment should distinguish an LD Clause from a penalty clause to avoid the confusion between these two concepts.
Simultaneously, regarding the penalty clause, the Court does not sufficiently explain why the content specified in Section 3 of Appendix A02: “…Moreover, if Party B (Subcontractor) delays completing the project by the undertaken schedule which is March 10th, 2017, Party B shall pay a penalty of 300.000.000 VND for each delayed day.” is considered an LD Clause even though the said content does contain the term “pay a penalty”. While it is possible that all context of this clause is not fully indicated in this Judgment, it does not change the fact that this issue is insufficiently elaborated and should have been expanded upon more thoroughly in the Judgment.
Secondly, in which circumstances do Courts execute the authority to reevaluate the amount of compensation for damages if the agreed sum specified in the LD Clause is “grossly excessive” in relation to the actual damages? This question is based on the concerns that the request for the reevaluation of the amount of compensation for damages may be accepted easily by the Court, it would be a risk that the dispute resolution procedure be prolonged since the evaluation of actual damages is a time-consuming and costly process. Moreover, it would make the LD Clause meaningless as the original purpose of this clause is to determine the damage with ease and time efficiency.
Thirdly, the Courts did not take into account the possibility that the agreed sum specified in the LD Clause is deemed “derisory” in relation to the actual damages, thereby leaving the question of whether or not the Court shall “reevaluate” the amount of compensation for damages in such situations.
In this Judgment, the Court only affirms its authority to reevaluate the amount of compensation for damages if the agreed sum is considered “grossly excessive” to protect the legitimate interests of the party who breached the contract. It leads to the question about the similar authority of the Court where the agreed sum is considered “derisory”.
Some jurisdictions have recognized such authority of the Courts. For example, in Article 1231-5 French Civil Code, Courts could either decrease or “increase the amount” if the agreed sum is considered obviously excessive or “derisory”.[11]
Unaddressed issues in the Judgment
Conclusion
Despite the existence of this Judgment that recognizes the LD Clause, it does not mean the Vietnamese law has officially recognized the liquidated damages, since this Judgment has yet to be nominated for Vietnamese “precedents” by the Supreme Court. Thus, the other Courts are not bound by this Judgment in the future case involving the LD Clause. It remains a topic of debate in Vietnam regarding the compensation for damages specified in the LD Clause.
Therefore, when drafting the commercial contract with litigation as the dispute resolution, the parties should negotiate a penalty clause instead of an LD Clause (along with the other remedies recognized clearly by Vietnamese law). Similarly, for the construction contract formed by the FIDIC Contracts, the “delay damages” provision should be altered by an “delay penalty” (for instance, Sub-Clause 8.7 FIDIC Red Book 1999, Sub-Clause 8.8 FIDIC Red Book 2017) where litigation is the agreed dispute resolution.[12]
Notwithstanding the above, with the sound reasonings as demonstrated, this Judgment could be seen as a great leap forward in Vietnam’s judicial practices regarding the LD Clause. Therefore, there is also the possibility of this Judgment being nominated for Vietnamese precedents in the near future.
Furthermore, the unaddressed issues in this Judgment as mentioned are expected to be addressed by other Courts in the future case involving the similar circumstances.
Written by:
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Senior Associate Tran Pham Hoang Tung
Phone: (84) 901 334 192 Email: tung.tran@cnccounsel.com |
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Legal Assistant – Pham Nguyen Tan Trung
Phone: (84) 347 924 900 Email: trung.pham@cnccounsel.com |
[1] 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, Tạp chí Luật học số 6/2023, <https://tapchi.hlu.edu.vn/SubNews/Details/25862>
[2] Le The Hung, Tran Pham Hoang Tung, Nguyen Huy Nhat Duy, FIDIC – Construction Law International – October 2023 (Vietnam), International Bar Association (2023) <https://www.ibanet.org/fidic-clint-october-2023?fbclid=IwAR2WcRBtmXeb2xt1xKNMw_6LvWUPtnWbdlCfIvwh7wGobQNNSYCQRaJf96s>.
[3] Cassation Decision No. 15/2016/KDTM-GDT dated September 7th, 2016 of the People’s Supreme Court on “Disputes on construction contract”.
[4] Cassation Decision No. 10/2020/KDTM-GDT dated August 14th, 2020 of the People’s Supreme Court.
[5] Judgment No. 660/2022/KDTM-PT dated November 10th, 2022 by the People’s Court of Ho Chi Minh City on “Disputes on construction contract”.
[6] As liquidated damage is the focus of this article, only relevant information of the judgment shall be summarized.
[7] Gian Thi Le Na, Efficient breach of contract, Doctoral Thesis, University of Economic and Law (VNU-HCMC), page 101 – 117 (2022) <https://psdh.uel.edu.vn/tien-do-thuc-hien-ncs/tien-do-thuc-hien-ncs-gian-thi-le-na>
[8] Du Ngoc Bich, Góp ý điều khoản phạt hợp đồng và mối liên hệ với bồi thường thiệt hại trong dự thảo Bộ Luật Dân sự (sửa đổi), Democracy and Law Journal – Ministry of Justice, October 07th, 2015, <https://danchuphapluat.vn/gop-y-dieu-khoan-phat-hop-dong-va-moi-lien-he-voi-boi-thuong-thiet-hai-trong-du-thao-bo-luat-dan-su-sua-doi>.
[9] Huynh Trung Hieu, Ước định bồi thường thiệt hại liệu có được bồi thường?, Saigon Times Online, January 26th, 2022 <https://thesaigontimes.vn/uoc-dinh-boi-thuong-thiet-hai-lieu-co-duoc-boi-thuong/>.
[10] See more: https://www.unidroit.org/instruments/commercial-contracts/unidroit-principles-2016/
[11] See more: https://www.legifrance.gouv.fr/codes/article_lc/LEGIARTI000032010131
[12] Le The Hung, Tran Pham Hoang Tung, Nguyen Huy Nhat Duy, FIDIC – Construction Law International – October 2023 (Vietnam), International Bar Association (2023) <https://www.ibanet.org/fidic-clint-october-2023?fbclid=IwAR2WcRBtmXeb2xt1xKNMw_6LvWUPtnWbdlCfIvwh7wGobQNNSYCQRaJf96s>.
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