Question:
In the sales contract between my company and our partner, there is an agreement on a penalty for breach amounting to 15% of the contract value in the event that either party fails to fulfill their delivery obligations. However, I have been informed that Vietnamese law imposes a limit on the penalty for breach of contract. Could you please advise what this legal limit is and whether the penalty clause would be invalid if it exceeds the prescribed limit?
Answer:
SB Law provides legal advice to the client as follows:
Pursuant to Article 418 of the Civil Code 2015, the regulations on penalties for breach of contract are as follows:
“Article 418. Agreement on penalties for breach
1.A penalty for breach is an agreement between the parties in a contract, under which the breaching party is required to pay a sum of money to the non-breaching party.
2.The penalty amount is determined by mutual agreement of the parties, except where otherwise stipulated by relevant laws.
3.The parties may agree that the breaching party shall only be subject to the penalty for breach without having to compensate for damages, or that the breaching party shall be subject to both the penalty for breach and compensation for damages.
In cases where the parties have agreed on a penalty for breach but have not agreed on whether the breaching party must also compensate for damages, the breaching party shall only be liable for the penalty for breach.”
Therefore, the penalty for breach of a civil contract is determined by the parties' mutual agreement and is not limited in terms of value, as long as it does not contravene fundamental legal principles or other mandatory regulations. This is to respect the parties' freedom of will and their ability to freely determine the terms of the contract. In practice, to ensure clarity and avoid future disputes, the parties should specify the penalty amount, the method of application, and the relationship between the penalty for breach and compensation for damages in the contract terms.
According to Articles 300 and 301 of the Commercial Law 2005, the regulations on penalties for breach of commercial contracts are as follows:
A penalty for breach is when the non-breaching party requires the breaching party to pay a penalty for the breach of the contract, provided that the contract contains such an agreement, except in the following cases of exemption from liability:
- There is an exemption from liability as agreed upon by the parties;
- A force majeure event occurs;
- The breach by one party is entirely caused by the fault of the other party;
- The breach by one party is due to the execution of a decision made by a competent state authority, which the parties could not have known at the time of entering into the contract.
The breaching party has the obligation to prove the cases of exemption from liability.
The penalty for breach of contract, or the total penalty for multiple breaches, is determined by mutual agreement of the parties, but shall not exceed 8% of the value of the breached contractual obligation, except in cases of erroneous inspection results:
- If a service provider in the inspection business issues an erroneous certificate of inspection due to their unintentional fault, they must pay a penalty to the client. The penalty is agreed upon by the parties, but shall not exceed ten times the inspection service fee.
- If a service provider in the inspection business issues an erroneous certificate of inspection due to their intentional fault, they must compensate the client for the damages incurred from the inspection request.
- The client has the obligation to prove the erroneous inspection results and the fault of the service provider in the inspection business.
Thus, the penalty for breach of a commercial contract is determined by the agreement of the parties but shall not exceed 8% of the value of the breached contractual obligation.
An agreement on a penalty of up to 15% of the contract value exceeds the 8% limit set out in Clause 2, Article 301 of the Commercial Law.
If the penalty exceeds the legal limit, the excess amount will not be legally enforceable. The court or commercial arbitration (if there is a dispute) will only recognize the maximum penalty of 8% of the value of the breached obligation. The excess will be considered invalid.
Therefore, you need to carefully consider the scope of applicable law in the contract (if the contract specifies the governing law). If the Vietnamese Commercial Law applies, you should adjust the penalty to comply with the legal limits to avoid the risk of it being deemed invalid when enforced.
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