BREACH OF CONTRACT AND REMEDIES (PART II)
DRAFTING BATTLE-TESTED CONTRACTS
CHAPTER 5
BREACH OF CONTRACT AND REMEDIES
(PART II)
- Common Remedies
Basically, the usual remedies include the following common measures (in addition to other remedies not listed in this section):
– Specific performance.
– Compensation for damages.
– Late payment interest.
– Suspension of contract performance.
– Termination and cancellation of the contract.
– Agreed remedies by the parties: Penalties for breach; liquidated damages.
a) Specific performance
This sanction aims to ensure the contract is performed as agreed. Article 297 of the the 2005 Law on Commerce (amended in 2017, 2019) stipulates: “Specific performance is when the aggrieved party requires the breaching party to perform the contract correctly or use other measures to ensure the contract is performed, and the breaching party must bear the arising costs.”
In practice, once a breach of contract has occurred, it means that the contract has not been performed as agreed, making it almost impossible to demand exact performance as stipulated in the contract, because some content of the contract has been violated, such as late delivery, insufficient quantity, or incorrect quality of goods… Even if the breaching party performs, it cannot be entirely accurate as agreed.
Therefore, to facilitate the breaching party in performing the contract, Article 298 of the the 2005 Law on Commerce (amended in 2017, 2019) stipulates: “In cases of specific performance, the breaching party may be given a reasonable extension to perform their contractual obligations.” The measures to apply this sanction include:
– Remediate the breach to perform the contract as agreed. If the breaching party delivers incorrect goods, incorrect quantity, or quality, they must rectify the defects or deliver replacement goods. The replacement goods in this case must be of the correct type as the delivered goods and meet the agreed quality.
– Replace the agreed goods with different types of goods or monetary compensation. However, to carry out this replacement, the consent of the aggrieved party is required.
– Purchase goods from another entity to replace the correct type of goods specified in the contract, and the breaching party must pay the difference and related costs, if any.
– Self-repair defects of the goods and the breaching party must pay the actual reasonable costs.
b) Compensation for damages
According to Article 303 of the the 2005 Law on Commerce (amended in 2017, 2019), the following conditions must be noted to apply this sanction: There must be a breach of contract, actual damage, and the breach of contract must be the direct cause of the damage.
Obligation to prove: The party requesting compensation for damages must prove the loss, the extent of the loss caused by the breach, and the direct benefit that the aggrieved party would have enjoyed if the breach had not occurred.
Level of compensation: The value of compensation includes the actual, direct loss incurred by the aggrieved party due to the breach and the direct benefit that the aggrieved party would have enjoyed if the breach had not occurred.
Duty to mitigate losses: The party requesting compensation for damages must take reasonable measures to mitigate the loss, including losses to the direct benefits that would have been enjoyed due to the breach of contract. If the party requesting compensation does not take these measures, the breaching party has the right to request a reduction in the value of compensation equal to the loss that could have been mitigated.
c) Late payment interest
This arises when one party has the right to receive payment, and by the due date, the obligated party has not yet paid. The parties apply Article 306 of the the 2005 Law on Commerce (amended in 2017, 2019) as the basis for calculating interest, specifically: “In cases where the breaching party delays payment for goods or services and other reasonable costs, the aggrieved party has the right to request interest on the late payment at the average overdue debt interest rate on the market at the time of payment corresponding to the delay period, unless otherwise agreed or provided by law.”
However, it is important to understand that this interest rate must be limited by Article 357 of the the 2015 Civil Code, which provides for liability due to late performance of monetary obligations. Accordingly, the interest rate arising from late payment is determined by the agreement of the parties but must not exceed the interest rate specified in Clause 1 of Article 468 of this Code, which is not more than 20% per year of the late payment amount.
The common practice applied by the parties is 150% of the bank deposit interest rate of a bank with a stable interest rate or the average interest rate on the market of at least three commercial banks (Vietcombank, VietinBank, and Agribank).
For example: If Party B delays in making a deposit, paying an advance, paying the contract value, or delivering a guarantee certificate to Party A, then Party B must pay penalty interest at 150% of Vietcombank’s term deposit interest rate for each overdue day on the total late payment amount, but the total late payment interest must not exceed 8% of the late payment amount.
d) Suspension of contract performance
According to Article 308 of the the 2005 Law on Commerce (amended in 2017, 2019), this sanction is applied when a breach occurs that the parties have agreed upon as a condition to suspend the contract performance; or when one party fundamentally breaches their contractual obligations.
Legal consequences of suspension of contract performance: When a contract is suspended, it remains effective. In principle, the contract will continue to be performed once the breach has been remedied and the disagreements between the parties have been resolved. The aggrieved party has the right to request compensation for damages concurrently with the suspension of contract performance. For example, if the seller delivers goods not as agreed, the buyer has the right to suspend payment until the seller remedies the breach within 5 days.
e) Termination and cancellation of the contract
This can be considered an extreme remedy. From breaches of contract, the parties will seek remedies, but the ultimate remedy is contract termination. Unilateral termination and cancellation of the contract both aim to end the performance of an effective contract, and the terminating party must notify the other party of the contract termination.
Cancellation of the contract: According to Article 312 of the the 2005 Law on Commerce (amended in 2017, 2019), this sanction arises when (except for cases of exempted liability specified in Article 294 of the the 2005 Law on Commerce (amended in 2017, 2019): There is a breach agreed upon by the parties as a condition for canceling the contract; one party fundamentally breaches their contractual obligations.
The law allows one or both parties to cancel part or all of the contract. Canceling the entire contract means fully terminating the performance of all contractual obligations for the whole contract. Partial cancellation means terminating the performance of part of the contractual obligations, with the remaining parts of the contract still effective.
Article 314 of the the 2005 Law on Commerce (amended in 2017, 2019) stipulates the legal consequences of contract cancellation:
“1. Except as provided in Article 313 of this Law, after the contract is canceled, the contract is not effective from the time of conclusion, and the parties are not required to continue performing the agreed obligations, except for agreements on rights and obligations after contract cancellation and on dispute resolution.
The parties have the right to claim benefits from the performance of their obligations under the contract; if both parties have obligations to return, their obligations must be performed simultaneously; if the benefit cannot be returned in kind, the obligor must return it in money.
The aggrieved party has the right to request compensation for damages as stipulated in this Law.”
Termination of contract performance: When the contract is terminated, it ceases to be effective from the time one party receives the termination notice. The parties are no longer required to perform their contractual obligations. The party that has performed obligations has the right to request the other party to pay or perform reciprocal obligations.
The aggrieved party has the right to request compensation for damages. The parties should note that these two remedies differ in terms of their conditions and legal consequences:
Conditions for application:
– Cancellation of the contract: There must be a breach of contract (fundamental breach or breach agreed upon by the parties).
– Termination of contract performance: When one party seriously breaches their contractual obligations; as agreed by the parties; as prescribed by law.
Legal consequences:
– Cancellation of the contract: The contract is not effective from the time of conclusion, and the parties are not required to continue performing the agreed obligations, except for agreements on rights and obligations after contract cancellation and on dispute resolution.
– Termination of contract performance: The contract terminates from the time the other party receives the termination notice, and the parties are no longer required to perform their obligations.
Example:
Party A has the right to terminate the contract in the following cases:
– Party B breaches any terms of this contract and does not remedy within 5 (five) days from the date Party A sends the notice;
– More than 5 (five) days from the deadline for completion or handover of the project, and Party B has not completed it;
– Party B does not rectify the defects in the project when requested.
In addition to contract termination, Party B must also refund any amounts that Party A has paid.
Note: To apply the remedies effectively, when drafting the contract, the drafter needs to identify the risks from the breach of contract actions and categorize the risks (high – medium – low). Once the risks are identified, the drafter can propose measures to address them, such as:
– Applying measures to ensure the performance of obligations.
– Dividing the obligations/risks into smaller parts.
– Purchasing risk insurance.
– Or an undesirable measure could be not to enter into the contract. Some contracts with excessive risks may present significant disadvantages if we sign to perform them.
Example: When the buyer needs to purchase a large-value machinery lot, and the seller (abroad) requires a 30% deposit before starting production, the buyer needs to evaluate the cases where the seller may breach the contract, leading to the buyer not achieving their purpose in entering the contract (acquiring the machinery). The greatest risk for the buyer in this case is that after making the deposit, the seller does not produce the machinery. In this case, the buyer could request the seller to issue an advance payment guarantee through a bank or mitigate the risk by negotiating a lower deposit amount (e.g., 10-15%).
e) Agreed remedies by the parties
Penalties for breach: The aggrieved party requires the breaching party to pay a penalty as stipulated in the contract. According to Article 300 of the the 2005 Law on Commerce (amended in 2017, 2019), the basis for applying the penalty for breach includes: There must be a breach of contract; there must be an agreement between the parties on the penalty for breach. Unlike other remedies, the penalty for breach of contract can only be applied if the parties have agreed on the penalty for breach in the contract; the breach does not fall under exempted liability.
The amount of the penalty for breach of contract is limited by the agreed penalty amount in the contract but must not exceed the penalty cap stipulated by law. The penalty for breaching business and commercial obligations or the total penalty for multiple breaches as agreed in the contract must not exceed 8% of the value of the breached contractual obligations.
In the the 2005 Law on Commerce (amended in 2017, 2019), there is an exception to the penalty cap when the penalty is applied due to incorrect inspection results. Article 266 of the the 2005 Law on Commerce (amended in 2017, 2019) stipulates that in cases of unintentional errors, the trader providing inspection services must pay the customer a penalty as agreed, but not exceeding 10 times the inspection service fee.
Comparing the penalty for breach stipulated in the the 2015 Civil Code, there is a difference between the penalty for breach applied to civil relations and the penalty for breach agreed upon by the parties in a civil contract. Agreement in the contract means that the parties involved in the contractual relationship are free to set the penalty amount without being constrained by legal provisions. This clearly reflects the principle of freedom of contract recognized in civil law.
Additionally, Clause 2 of Article 146 of the the 2014 Law on Construction (amended in 2016, 2018, 2019, and 2020) also provides for the penalty for breach: For construction works using public investment capital or state capital outside public investment, the contract penalty must not exceed 12% of the value of the breached contractual obligations.
Example: If the delivery time for Party B as stipulated in this contract is delayed compared to the delivery deadline (including cases of delay due to Party B refusing to accept goods not in accordance with the contract), Party A must pay a penalty equal to 0.5% of the value of the delayed goods for each day of delay (but not exceeding 8% of the value of the breached goods).
Liquidated damages: There are cases where it is challenging to prove the damage incurred. For example, one party discloses technological secrets causing damage to the other party, but it is difficult to quantify the damage and its monetary value. Therefore, the parties often agree on a specific amount, and when a breach occurs, that amount is compensated without needing proof. This amount can be lower or higher than the actual damage.
This is known as liquidated damages (estimated compensation for damage): Compensation when one party breaches the contract, and the compensation amount is agreed upon by the parties in advance without the need for proof. In practice, liquidated damages were not officially recognized in legal provisions. In the the 2015 Civil Code and the the 2005 Law on Commerce (amended in 2017, 2019), the two monetary remedies acknowledged are compensation for damages and penalties for breach. Liquidated damages resemble these two remedies but are entirely independent.
This clause differs from compensation for damages as it allows the parties to negotiate and agree upon the compensation amount at the time of contract conclusion based on the anticipated damage in the future if a breach occurs. In contrast, the remedy of compensation for damages is only acknowledged when the breach has occurred and caused specific, actual, calculable damage with a causal relationship.
For the penalty for breach remedy, although similar in having a defined limit, liquidated damages function as a remedy to compensate and rectify the losses caused by the breach itself. In contrast, the penalty for breach is a deterrent clause to prevent breaches or handle breaches when one of the parties violates or fails to perform their obligations.
The 2005 Law on Commerce (amended in 2017, 2019) does not address this issue. In practice, through court judgments, the People’s Court does not accept agreements on liquidated damages.
- Coordinating Remedies
Multiple remedies can be applied for a single breach of contract, and the parties need to be clear on the conditions for combining these remedies. This is also considered the best guidance for the parties in performing the contract.
Remedy of specific performance: Article 299 of the the 2005 Law on Commerce (amended in 2017, 2019) stipulates:
– During the time of applying the specific performance remedy, the aggrieved party has the right to request compensation for damages and penalties for breach but may not apply other remedies.
– If the breaching party does not implement the specific performance remedy within the time specified by the aggrieved party, the aggrieved party may apply other remedies to protect their legitimate interests.
Relationship between penalty for breach and compensation for damages: If the parties have no agreement on the penalty for breach, the aggrieved party only has the right to request compensation for damages. If the parties have agreed on the penalty for breach, the aggrieved party has the right to apply both the penalty for breach and compensation for damages.
Compensation for damages remedy: This can be combined with other remedies when the conditions for compensation are met. One party does not lose the right to request compensation for damages for losses caused by the other party’s breach of contract even if other remedies have been applied.
Example: The parties can agree on combining remedies as follows:
If the seller does not deliver the goods on time, the buyer, at their unilateral discretion, may implement one of the following remedies:
– Request compensation for damages, penalties for breach, and unilaterally terminate the contract.
– Purchase from a third-party supplier and request the seller to compensate the price difference.
– Request the seller to continue delivering the goods within a maximum of 5 days and compensate for the losses arising from or related to the delayed delivery.
Note: When drafting contracts, consider the following:
– If the partner does not fulfill their obligations, what options are available to remedy the situation?
– Among those options, which one should be prioritized?
– Lastly, how much is enough? A contract with excessive remedies may not necessarily be a good contract.
SUMMARY OF CHAPTER 5
- Breach of Contract
When drafting this clause, the following issues need to be clarified: breaching any obligation in the contract, breaching other agreements in the contract, breaching legal provisions.
– Fundamental and non-fundamental breaches of contract: This distinction is significant in deciding which remedies to apply when a breach occurs.
– Drafting techniques: The parties can apply the following two methods:
– Method 1: The drafter should communicate and ask the client’s expectations: “When entering into this transaction, what does the client expect the most?” and the thinking process is that the situations where the other party prevents the client from achieving their expectations are considered breaches of contract.
– Method 2: For more complex contracts or fields unfamiliar to the drafter, the drafter can use the “storytelling” drafting technique.
- Remedies
There are various types of remedies: Prescribed by law (no agreement required); by agreement (require agreement to be applied); Remedies that can still maintain the contract; Remedies affecting contract performance.
– a) Events Triggering Remedies: To activate the remedies, the following general provisions are required:
– The contract must be effective.
– There must be a breach of contract.
– There must be actual damage.
– There must be a causal relationship between the breach and the actual damage.
– b) Common Remedies: Basically, the usual remedies include the following measures (in addition to other remedies not listed in this section):
– Specific performance.
– Compensation for damages.
– Late payment interest.
– Suspension of contract performance.
– Unilateral termination and cancellation of the contract.
– Agreed remedies by the parties: Penalties for breach; Liquidated damages.
– c) Coordinating Remedies: Multiple remedies can be applied for a single breach of contract, and the parties need to be clear on the conditions for combining these remedies.
Note:
When drafting contracts, consider the following:
– If the partner does not fulfill their obligations, what options are available to remedy the situation?
– Among those options, which one should be prioritized?
– Lastly, how much is enough? A contract with excessive remedies may not necessarily be a good contract.
If you need more consulting, please Contact Us at NT International Law Firm (ntpartnerlawfirm.com)
You can also download the .docx version here.
“The article’s content refers to the regulations that were applicable at the time of its creation and is intended solely for reference purposes. To obtain accurate information, it is advisable to seek the guidance of a consulting lawyer.”
LEGAL CONSULTING SERVICES
090.252.4567NT INTERNATIONAL LAW FIRM
- Email: info@ntpartnerlawfirm.com – luatsu.toannguyen@gmail.com
- Phone: 090 252 4567
- Address: B23 Nam Long Residential Area, Phu Thuan Ward, District 7, Ho Chi Minh City, Vietnam