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Overview Of Penalties For

Breach Of Contract (Part 1)

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 Updated on: 04/08/2021

P.1 – Overview and Conditions applicable to the Agreement on Penalties for

Breach
Abstract: Penalty for breach is a measure to secure the performance of contractual obligations
and applied regularly to civil, commercial and construction transactions for deterrence and
handle of the breaches of contract. The penalty for breach also plays a role of a remedy and
resolution of parts of the consequences and damages. However, the practice shows that not
only business organizations but also jurisdictions face difficulty in determining exactly the
legality and validity of the agreement on penalties for breach as well as the penalty amount.

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penalties for breach of contract (“the Agreement on Contractual Penalty”) and on trends of
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the judicial issuance of awards/decisions of the competent jurisdictions in Vietnam.

1. Overview of the Agreement on Contractual Penalty

The Agreement on Contractual Penalty is one of the prevalent articles/provisions of not only
commercial contracts but also of civil transactions, especially being an indispensable
article/provision of several contracts where it is difficult to prove and determine factual and
direct damages and losses. The Agreement on Contractual Penalty helps the parties avoid
prolonged legal proceedings arising from the process of determination of damages and losses
and of the corresponding amount of compensation. In addition, unlike Compensation for
damages and losses, The Agreement on Contractual Penalty does not just play a role of a
common remedy for consequences but a punishment to deter and remind the parties to fulfill
their obligations agreed and committed in the Contract.

The Agreement on Contractual Penalty has been prescribed by the laws of Vietnam for a long
time from 1989 to the present in the Ordinance on Economic Contracts 1989, the Ordinance on
Civil Contracts 1991, the Civil Codes (1995, 2005 and 2015 version), the Commercial Laws (1997
and 2005 version) and the Construction Law 2014. It can be seen that the regulations on the
contractual penalty are prescribed in the common source of law, i.e. the Civil Code 2015 (“Civil
Code“) (Article 418 of the Civil Code) but also in the specialized sources of law, such as the
Commercial Law 2005 (Article 300 and 301)  and the Construction Law 2014 (Article 141.1 and
Article 146.2).

Despite the fact that the Agreement on Contractual Penalty is prescribed in many sources of
law, the concept and legal mechanism of the Agreement on Contractual Penalty remain
unchanged. Accordingly, Contractual Penalty is always an agreement between the parties in a
contract, in which the breaching party must pay a sum of money to the aggrieved party.
However, for the purpose of imposing the Contractual Penalty in practice, the parties need to
understand the conditions applicable to the Agreement on Contractual Penalty.

2. Conditions applicable to the Agreement on Contractual Penalty

Based on the above nature and concept of the Agreement on Contractual Penalty, we may
come to a conclusion on the applicable conditions as follows:

(1)We
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The invalid contract does not give rise to, change or terminate civil rights and obligations of the

parties as from the time the transaction is made – Article 131.1 of the Civil Code. This means
that the parties shall not be bound by the obligations agreed and committed in the contract,
including the Agreement on Contractual Penalty.

Therefore, only upon the contract takes effect, the Agreement on Contractual Penalty shall be
of full force and effect and legally and contractually bind the parties to each other.

(2) An agreement on penalties for breach of contract must exist

“The existence of an agreement” is considered as a prerequisite condition for imposing the
Penalty for Breach of Contract. This is also a crucial distinction between the penalty for breach
of contract and the Compensation for damages and losses. While an agreement is not a
necessary or sufficient condition for the compensation for damages and losses, the existence
of an agreement is a must if wishing to impose the Contractual Penalty. This has been provided
by the laws, specifically as follows:

Clause 1 Article 418 of the Civil Code stipulates: “Penalty for breach is an agreement
between the parties in the contract, whereby a party breaching an obligation must pay a
sum of money to the party whose rights are breached. “

Article 300 of the Commercial Law stipulates: “Penalty for breach is a remedy whereby the
aggrieved party requires the defaulting party to pay a penalty sum for breach of contract if
so agreed, except in cases of liability exemption specified in Article 294 of this Law. “

Therefore, the Contractual Penalty shall only be imposed if the parties have reached an
agreement on the Contractual Penalty. 

(3) The conclusion time of the Agreement on Contractual Penalty must exist prior to the
occurrence of the breach of contract
Despite the fact that the prevailing law does not provide or mention the conclusion time of the
Agreement on Contractual Penalty, it cannot be understood implicitly and tacitly that the
Contractual Penalty is imposed as long as agreed by the parties. The Contractual Penalty shall
only be imposed if agreed by the parties prior to the occurrence of the breach of contract of
one of the parties.
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aggrieved party for a sum of money once committing a breach of contract as agreed before.
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Therefore, we may come to a conclusion that the Agreement on Contractual Penalty shall be
limited in terms of the conclusion time. Specifically, the Agreement on Contractual Penalty shall
not be imposed on a breach of contract if the agreement is concluded after the occurrence of
such breach. Because such Agreement at that time shall not reflect the nature of the
Contractual Penalty (i.e. a punishment to deter and remind the parties to fulfill their obligations
agreed and committed in the Contract) but only appear to be a remedy and resolution of
consequences and damages caused by such breach. Therefore, this agreement shall not be
deemed a Contractual Penalty but the compensation for damages and losses. 

Moreover, legislators also clearly express their points of view on the nature of the Contractual
Penalty as a measure to secure the performance of contractual obligations rather than as a
remedy and resolution of consequences and damages. Specifically, the regulations on the
Agreement on Contractual Penalty were provided, classified by and listed in the section on
measures to secure the performance of civil obligations (Article 377 – Sub-Section VIII of
Section 5 of Civil Code 1995) and in the section on performance of obligations in the successive
editions of the Civil Code (2005 and 2015).

However, the parties totally reserve the right to discuss and mutually agree on the Contractual
Penalty after the effective date of the contract. As mentioned above, the prevailing law does
not provide or mention the conclusion time of the Agreement on Contractual Penalty.
However, in my perspective, there is no reason to prohibit the parties from additionally
concluding the Agreement on Contractual Penalty to the Contract during the implementation
period of the contract. Therefore, at the conclusion time of the contract, if the parties omit to
agree on the Contractual Penalty, the parties reserve the right to discuss further and
additionally agree on the Contractual Penalty at any time during the implementation period of
the contract, provided that this agreement is concluded prior to the occurrence of the breach
of contract. If the Agreement on Contractual Penalty is concluded after the occurrence of the
breach, such Contractual Penalty cannot be imposed on the breach prior-occurring but only
imposed on the future breach. 

(4) The breach must be in accordance with the Agreement on Contractual Penalty
Obviously, a breach is an indispensable element if wishing to impose the Contractual Penalty
under the Agreement on Contractual Penalty. However, not all breaches of contract may result
in the imposition of the Contractual Penalty. Because in spite of the limitation on the
conclusion time, the Agreement on Contractual Penalty is also limited by the object and scope
of the breach.
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For example, if the parties agree on the Contractual Penalty for being late in the delivery of the
seller, this penalty cannot be imposed Accept and Close
on the buyer. Because the breach of being late in
delivery in this case is limited in terms of the object being the seller and the scope being the act
of delivery with delay. 
Therefore, based on the content of the Agreement on Contractual Penalty, the parties
determine as to whether the breach falls into the scope of the Agreement on Contractual
Penalty or not.  

(5) The breach does not fall into cases of exemption from liability
It is unfair if a party is forced to be liable for its breach of contract due to the deliberate
obstruction caused by the other party or due to natural or artificial events, such as coups, wars,
the changes of laws that occur in an objective manner which are not able to be foreseen and
are not able to be remedied by all possible necessary and admissible measures being taken.
For the foregoing reason, the law has provided cases of exemption from liability where the
parties are not liable for their breach of contract, specifically prescribed in Article 294 of
Commercial Law and Article 351.2 of Civil Code. Accordingly, if a breach of contract is due to
one of the following events: force majeure, fault of the aggrieved party, changes of law that
cannot be foreseen at the conclusion time of the contract, the breaching party shall not be
liable for its breach of contract.

Moreover, one of the basic principles of law is to permit the parties to deliberately conclude
any agreements and commitments as long as not violating a prohibition by law or not contrary
to social morals (Article 3.2 of the Civil Code). Therefore, the parties are able to mutually agree
on cases of exemption from liability for one or both parties in the transaction.

In conclusion, the Contractual Penalty is a prevalent and common punishment in contractual

relations and also plays a crucial role in cases where the amount of compensation for damages
and losses is unable to or difficult to determine. Therefore, in the course of negotiation and
implementation of the contract, the parties should be well aware of the conditions applicable
to the Agreement on Contractual Penalty to be able to impose the penalty in practice: (i) The
contract shall not be void and dull; (ii) an agreement on penalties for breach of contract must
exist; (iii) the conclusion time of the Agreement on Contractual Penalty must exist prior to the
occurrence of the breach of contract; (iv) the breach must be in accordance with the
Agreement on Contractual Penalty; and (v) the breach does not fall into cases of exemption
from liability.

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Overview Of Penalties For

Breach Of Contract (part 2)

Home / Articles

 Updated on: 15/09/2021

P.2 – The amount of a contractual penalty and how to determine it in reality

Abstract. As mentioned in the previous article in the series of articles on the Agreement on
Penalties for breach of contract, the contractual breach is one of the commonest remedies for
loss and damages as well as a measure to secure the performance of contractual obligations of
the parties. As such, the contractual penalties should be under the parties’ care as drafting the
agreement on penalties for contractual breach to ensure the most effective imposition of the
contractual penalties. However, the prevailing regulations of laws of Vietnam prescribe
differently from each other on this matter, causing distinct interpretations when it comes to
applying these regulations to reality.

See more_Overview Of Penalties For Breach Of Contract (part 1)

Within the scope of this Agreement on Contractual Penalty article series, the author will
demonstrate the legal provisions as well as the practice of contractual penalty in reality and the
inclination reflected from judicial opinions of competent tribunals in Vietnam on this matter.

1. The amount of a contractual penalty under the laws of Vietnam

The amount of a contractual penalty is one of the most important contents of the Agreement
on penalty for breach of contract. At present, the amount of a contractual penalty is provided
in three different regulations of laws, namely, Civil Code, Commercial Law, and the Law on
Construction. In essence, all these regulations of laws agree that the contractual penalty is a
result of an agreement and the parties reserve the right to negotiate the amount of contractual
penalty to impose upon their transaction.

a. Civil Code 2015

Civil Code 2015 (“Civil Code”) is deemed a general law and can govern any type of transactions
between individuals and legal entities, including commercial contracts, construction contracts,
and other civil transactions. In general, any type of transactions under the jurisdiction of the
laws of Vietnam shall be governed by Civil Code.

Regarding the maximum amount of a contractual penalty, formerly Civil Code 1995 provides
that the maximum amount of a contractual penalty shall not exceed 5% of the value of the
violated obligation. However, from Civil Code 2015 onwards, the parties to a transaction have
the freedom to determine the amount of a contractual penalty without any limitation thereto.
Civil Code 2015 remains the spirit of respect for the right to make commitments and
agreements of the parties on the basis of freedom, provided that such commitments and
agreements do not violate a prohibition by law or are not contrary to social morals.
Accordingly, the prevailing Civil Code permits the parties to a transaction to negotiate with each
other on an amount of a contractual penalty, unless otherwise provided by relevant law. The
phrase “unless other provided by relevant law” is an update of Civil Code 2015 compared to its
edition 2005. This supplementation is reasonable as the amount of a contractual penalty is also
provided in other specialized regulations of laws, such as the Commercial Law and the Law on
Construction.

As the prevailing Civil Code does not govern the maximum amount of a contractual penalty but
permits parties to negotiate on the basis of free, this lack of regulations causes certain
difficulties in the application and handling in reality. As a result, the freedom to negotiate can
lead to a manifestly huge amount of the contractual penalty compared to the actual value of
the violated obligation. In fact, there have been many similar cases where one party, usually
the disadvantaged party to a transaction, commits a breach of contract without any loss or
damage but still is suffered a contractual penalty at the amount that is many times as higher as
the value of the contract or the value of the violated obligation. Currently, the Civil Code of
Vietnam does not propose any specific mechanism to handle cases where an amount of a
contractual penalty is too high or too low in a sense of the ridiculous compared to the actual
value of the violated obligation. Taking the Civil Code of French 1804 amended by the
Ordinance No. 2016-131 as a reference, the parties can agree on the amount of a contractual
penalty on a basis of freedom; however, the judge may moderate or increase the agreed
penalty if such penalty is manifestly excessive or derisory.

Notwithstanding the above facts, we may resort to several regulations of the Civil Code to
modify the amount of a contractual penalty that is too high compared to the value of the
violated obligations. Specifically, one of the basic principles of civil law is that “Individuals and
legal entities must establish, perform and terminate their civil rights and obligations with good
will and honesty”. The imposition of an amount of a contractual penalty that is manifestly and
unreasonably higher than the value of the violated obligation clearly demonstrates a lack of
goodwill to the civil transaction. Moreover, another basis principle is that “all commitments or
agreements shall not violate a prohibition by law or is not contrary to social morals”. Where
one party with higher status to the transaction imposes an unreasonably huge amount of a
contractual penalty, this imposition may be deemed contrary to social morals. In conclusion,
although the Civil Code of Vietnam does not put a limitation on the amount of a contractual
penalty, the parties can cite and apply the basic principles of civil law to modify the agreed
amount of a contractual penalty that is manifestly and unreasonably higher than the value of
the violated obligation or the value of the contract.

b. Commercial Law 2005

Commercial Law 2005 (“Commercial Law”) has a narrow scope of application and shall only be
applied to commercial relations and activities. In contrast to the Civil Code, the Commercial
Law provides that the maximum amount of a contractual penalty to commercial contracts shall
not exceed 8% of the value of the violated obligation.

Accordingly, the Commercial Law has put a limitation on the amount of a contractual penalty
that the parties are permitted to agree to impose. However, the Commercial Law does not
provide any guidance on how to determine the value of the violated obligation. In reality, there
are many violated obligations that are very hard to or even impossible to determine or
estimate by money. Therefore, the lack of regulations on such matter can cause inconsistency
or disagreement between the parties on the value of the violated obligation and pose
significant challenges to the jurisdiction due to the lack of grounds for the determination of the
value of the violated obligation.

c. Law on Construction 2014

Similar to the Commercial Law, the Law on Construction 2014 (“Construction Law”) is a
specialized statutory text and has a narrower scope of application compared to the Civil Code.
With respect to the maximum amount of a contractual penalty, Article 146.2 of the
Construction Law provides that the amount of a contractual penalty shall not exceed 12% of
the value of the violated obligation. However, the said maximum amount shall only be applied
to construction works using the state budget.

Not only does the Construction Law omit the determination of the value of the violated
obligation, it also does not provide any guidance on the maximum amount of a contractual
penalty applicable to commercial construction work not using the state budget. Consequently,
where both parties to a transaction are commercial legal entities, it is unclear whether to apply
the Civil Code or the Commercial Law to govern the amount of a contractual penalty. 

In conclusion, the maximum amount of a contractual penalty are substantially different

between the Civil Code, the Construction Law and the Commercial Law. Although the
Construction Law and the Commercial Law are to govern unique relations and prioritized to be
applied when it comes to such relations rather than the Civil Code, the lack of regulations and
guidance on the determination of the value of the violated obligation causes various difficulties
for the parties to agree on impose an amount of a contractual penalty and poses a
considerable challenge to the jurisdiction in determining the maximum amount.

2. Determining the amount of a contractual penalty according to the value of

the violated obligation under the contract
At the present, the laws have not provided yet any regulation or guidance on determining the
value of the violated obligation as well as handling the exceeding amount of the contractual
penalty. Therefore, the determination of the value of the violated obligation shall belong to the
scope of work of the parties, lawyers as well as jurisdiction. In fact, there are obligations that
can easily be determined into money. For example, in the event of sales contracts, where the
seller commits a breach of contract by being late in delivery on time as agreed, the
determination of the value of the violated obligation can be determined based on the value of
the goods being delivered late, thereby determining the maximum amount of a contractual
penalty for such breach.
However, there are cases where the value of the violated obligations cannot be determined.
Specifically, the obligations that cannot be determined into money are usually not the main
obligations of the contract and relate to human labor, such as the obligation to promote and
advertise under the hotel management service agreement. Therefore, the failure to determine
the value of the violated obligation can cause the lack of basis for the jurisdiction to accept the
amount of the contractual penalty being presented by the aggrieved party.

Therefore, the parties can agree on the value of each obligation under the agreement to
ensure the basis for the contractual penalty without wasting time and effort to prove the value
of the violated obligations to the jurisdiction.

Regarding the handling of the amount of the contractual penalty that exceeds the maximum
limit by law, in principle, the lack of regulations can lead to 02 ways of interpretation and
resolution as follows: (1) nullifying all the contents of the agreement on contractual penalty due
to the violation of the permitted maximum amount of the contractual penalty; and (2) similar to
the handling by the Civil Code of the exceeding interest rate, which is only nullifying the
exceeding amount and accepting the maximum amount of a contractual penalty of exactly 8%
of the value of the violated obligations in terms of the Commercial Law and 12% in terms of the
Construction Law. In reality, the jurisdiction tends to embrace the second one when it comes to
contractual penalties exceeding the maximum limit by law. In my perspective, this way of
handling is completely reasonable and consistent with the general spirit of civil laws. This is
also an updated point of the Civil Code 2015 compared to its former versions on how to handle
the amount of the contractual penalty exceeding the maximum limit by law. This approach not
only ensures the right and interests of the entitled party but also breathes an air of equality
and fairness into civil transactions.

In conclusion, apart from the conditions applicable to the agreement on penalties for breach
of contract as mentioned in the previous article, the amount of a contractual penalty shall be a
noteworthy matter for the parties to a contract. The parties need to determine correctly the
governing law for their relations and are well aware of the limitation on the amount of a
contractual penalty mentioned hereof. Moreover, the parties should take into consideration
cases of the conflict of laws between the regulations of laws mentioned in this article,
especially for the sector of commercial construction works not using the state budget. 

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