Reasons to recognise compensation for liquidated damages provision in Vietnam

During the execution of civil and commercial transactions, disputes between both parties may arise when one party’s legitimate rights and interests are infringed, resulting in loss. The damage calculation is the basis for the infringing party to adequately compensate the party whose legitimate rights and interests are infringed. However, since the nature of the transactions is getting more and more complicated, it can be difficult to calculate the exact amount of damage that occurs. Therefore, the laws of many countries around the world have recognised the compensation for liquidated damages provision as a tool to help the party whose legitimate rights and interests have been infringed to receive a reasonable compensation, as well as shortening the disputes resolution process. However, this sanction has not yet been officially acknowledged under the prevailing law of Vietnam. In this article, we will clarify the reasons to recognise the compensation for liquidated damages provision in Vietnam.

 What is liquidated damages?

The compensation for liquidated damages provision is a sanction for claiming damages compensation in both common and civil law systems. The agreement on liquidated damages is usually a provision in the contract in which the parties agree on an adequate amount of compensation for damages that one party may receive if the other party breaches the contract. Normally, the compensation for liquidated damages provision will be enforceable if the court finds that:

i, It is difficult to determine the specific amount of damages for compensation from contract violation ; an

ii, The compensation for liquidated damages must be reasonable and reflect the actual or foreseeable damages.

Regulations on compensation for liquidated damages in accordance with the prevailing law of Vietnam

The compensation for liquidated damages provision is recognised in international treaties such as CISG or the UNIDROIT Principles, and some other international treaties that Vietnam is a member. Accordingly, contracting parties have the right to apply this provision to transactions that meet the required conditions in such international treaties.

In Vietnam, the regulation regarding compensation for liquidated damages provision is not clearly specified in any legal document. However, this sanction can be applicable under the following legal basis:

• For civil transactions: Article 360 of the Civil Code 2015 stipulates that in cases of damages caused by a breach of obligation, the party with the obligation must compensate for the entire damage, unless otherwise agreed or specified by law. Therefore, in civil transactions, the agreement on compensation for damages is valid and the parties can come up with the estimation based on the transaction value.
• For commercial transactions: Article 302 of the Law on Commerce 2005 defines the compensation for damages to include the actual value of loss, directly suffered by the infringed party due to the violation of the infringing party, and the direct benefit which the infringed party should have received if there was no violation. Therefore, the infringed party can get their compensation, and the compensation can only be resulted from the actual, direct loss and the direct benefits that should have been received; the infringed party has the obligation to prove the loss and such direct benefits, concurrently.

Overall, the regulations regarding compensation for liquidated damages provision in Vietnam have not been recognised and specifically stipulated under the prevailing law. In practice, there are many disputes relating to liquidated damages have not been recognised at the competent court of Vietnam due to the lack of legal basis.

Why does compensation for liquidated damages provision need to be recognised in Vietnam?

Compensation for liquidated damages provisions are commonly used in international commercial contracts, as they provide some certain benefits in resolving disputes when there is a contract violation act. Thus, recognising liquidated damages compensation provision in Vietnam is in need due to the following reasons:

Firstly, when one party breaches the contract, it is very difficult for the infringed party to come up with the exact damages amount and provide evidence for such amount in many cases (including lost revenue, reduced profits, expected profits that the infringed party could have received without the breach of contract or intangible damages such as intellectual property rights, reputation, business secrets, etc.).

Secondly, it takes a lot of time and expense for the infringed party to collect evidence for proving the damaged amount.

Thirdly, when a Vietnamese party negotiates or executes contracts with foreign partners, there might be a situation where the foreign partners want to negotiate compensation for liquidated damages provision to mitigate the consequences of any damage that may occur. If Vietnam does not promulgate regulations for such sanction, it will cause disadvantages for Vietnamese party during contracts negotiation phase. In addition, in case Vietnamese parties do not thoroughly understand the nature of this sanction, it is possible that the counterparty will come up with agreements that affect the interests of Vietnamese parties during contract performance phase.

Finally, recognising the liquidated damages compensation provision will further diversify the remedies for breach of contract, enabling the parties to the transaction to freely choose the appropriate sanctions according to their needs. Recognising the liquidated damages compensation provision does not eliminate other sanctions such as compensation for damages or penalties for violations, but aim to diversify the existing system of sanctions to increase the efficiency of contract negotiation and implementation.

Therefore, in commercial contracts, the parties often negotiate for a specified amount or a percentage of the contract value as compensation for liquidated damages, or a formula with agreed variables to help the parties easily and quickly determine the extent of damages.

The compensation for liquidated damages provision aims to enhance and promote free trade in the market and attract foreign investment into Vietnam. In Vietnam, one of the biggest concerns of the judicial authorities in recognising this sanction is the possibility that one party to the contract benefits illegal and imposes too heavy a sanction, leading to unfairness to the other party in a civil or commercial relationship (which does not place as much emphasis on punishment and deterrence as in the criminal or administrative laws relationship). However, the Principles of International Commercial Contracts  (PICC) drafted and promulgated by the International Institute for the Unification of Private Law (UNIDROIT) has taken a harmonized approach based on reference to the laws of many countries, both common law and civil law. Accordingly, PICC recognises an agreed-upon payment in the event of a breach of contract without considering the actual damages in order to facilitate the compensation for liquidated damages. PICC also regulates that the compensation for liquidated damages should be reconsidered and be fixed into a reasonable amount if the contracting parties agree on an “surprisingly high” value. This is to prevent the contracting parties from taking advantage of using this provision in commercial transactions.

Above is an overview of the compensation for liquidated damages provision that Phuoc & Partners shares with readers. If you have any difficulties related to the legal field, please contact us. Phuoc & Partners is a professional consulting firm established in Vietnam and currently has nearly 100 members working in three offices in Ho Chi Minh City, Hanoi and Danang. Phuoc & Partners is also rated as one of the leading consulting firms specializing in business law in Vietnam that has leading practice areas in the legal market such as Labour and Employment, Taxation, Merger and acquisition, Litigation. We are confident in providing customers with optimal and effective service.