As an overview, Vietnam adopts a civil legal system where civil transactions are primarily regulated by written legislations. Remedies for contractual breaches are provided in the Civil Code and some specific laws such as Commercial Law and Construction Law. Meanwhile, in common law systems such as England and Wales, court precedents are the primary source of law, some of which have been codified in legislations such as the Sale of Goods Act 1979. Remedies for a contractual breach in common law system may be, therefore, more well developed over time.

There are some similar remedies for contractual breaches in all jurisdictions like contractual damages. Nonetheless, some specific remedies are only available in civil law system but not common law system or vice versa. Liquidated damages and penalty are examples of this gap and will be discussed in the context of English and Vietnamese law systems.

Contractual damages

Contract damages are the principal remedy for breach of contract under both common law and civil law systems. As a general principle of contract law, the aggrieved party would be entitled to claim for damages to compensate for its losses caused by a breach of contractual obligation of the other party. In order to establish a claim for damages, the aggrieved party would have a burden of proof for (i) the other party’s breach of contract, (ii) losses suffered by the aggrieved party, and (iii) a causal link between the breach and the loss in order to establish a claim for damages. The aggrieved party also has a duty to take reasonable measures to mitigate its losses.

Whilst the essential elements of a claim for damages under both jurisdictions are quite aligned, the scope of loss recovery may be slightly different. Under English law, the basic rule of loss recovery is to put the aggrieved party into the position it would have been in had the contract been performed as agreed. Losses are recoverable if they are reasonably foreseeable (Hadley v Baxendale). Sometimes the award of damages may cover ‘consequential loss’ which is not directly caused by a breach but a consequence of it subject to the foreseeability test in any event. Contractual damages do not generally recover non-pecuniary losses (Addis v Gramophone Co. Ltd.). Contractual damages are stipulated under Vietnam Civil Code 2015 to recover actual and direct losses and direct profits that the aggrieved party would have been entitled had the breach have not occurred (Article 302 of Vietnam Commercial Law 2005), expenses incurred as a result of the non-performance of contractual obligations and damages for non-pecuniary losses (or mental losses) (Article 419 of Vietnam Civil Code 2015). Although there is no remoteness test for loss recovery under Vietnamese law, the stipulated recoverable losses under the Vietnam Civil Code 2015 appear more descriptive and exhaustive.

Liquidated damages (LD)

The process of establishing a claim for damages may be time-consuming, costly and risky because arbitrators or judges may strike down a claim for damages if any of the afore-mentioned elements is not satisfied or disagree with the quantum of loss because of its remoteness. Parties, therefore, frequently insert agreed damages clauses or LD clauses under which the parties agree on the compensation amount payable to the aggrieved party in the event of some breaches. Such amount should represent a genuine pre-assessment of the loss that the aggrieved party would suffer if the other party breaches its contractual obligation (Dunlop Pneumatic Tyre Co. Ltd v New Garage and Motor Co. Ltd.).

From a commercial perspective, an LD clause serves mutual benefits of the contracting parties such as saving the parties the time and cost establishing prerequisite grounds of a claim for damages and disputing over the quantum of loss. It may also be characterized as a limitation of liability for the party in breach by capping the exposure to liability for consequential losses which may not be precisely estimated and quantified at the time of the contract.  Notwithstanding, courts may strike down LD clauses if they are punitive rather than compensatory.

Penalty

A clause is penal if it contemplates to compel a party to perform its obligations by penalizing it for non-performance. The fixed sum payable to the aggrieved party in such case is not a pre-estimate of the loss suffered in the event of breach. How to define whether a clause is a penalty is a matter of construction at the time of the contract. It can be deduced by comparing the payable amount in the event of breach with the actual loss that might be suffered (Lordsvale Finance plc v Zambia).

As mentioned above, the aim of contractual damages or liquidated damages is to compensate for the loss suffered by the aggrieved party but not to punish the party in breach. Under English law, if the amount payable to the aggrieved party is unconscionable or largely disproportionate to the loss, it may be considered punitive to the breaching party and not awarded to the aggrieved party. On the contrary, a penalty is recognized under Vietnamese law and widely applied in commercial context as a remedy upon breach of contract.

Enforceability issues

Enforceability of a penalty clause under English law

The test applicable to validate an LD clause and strike down a penalty clause was originally laid down by Lord Dunedin in the Dunlop case which is treated as the ‘leading authority’ in the law of stipulated damages more than a century ago, then reproduced in sequent cases.

In essence, the following four tests will be applied to classify whether a clause is a penalty (Dunedin test):

  • A clause will be penal if the sum stipulated for is extravagant and unconscionable as compared to the greatest loss that could conceivably be suffered by the aggrieved party.
  • A clause will be penal if the breach is only pertaining to not paying a sum of money, and the sum stipulated in the contract is greater than the sum which ought to have been paid.
  • A clause will be presumed to be penal if the same sum is made payable by way of compensation on the occurrence of one or more of several events, some of which may occasion trifling damage.
  • A clause will not be regarded as penal simply because it is difficult or not possible to pre-estimate the loss on breach.

Recently, the UK’s Supreme Court has reviewed the principles to distinguish a penalty clause and an LD clause under the leading authority, the Dunlop case in the two cases namely Cavendish Square Holding BV v  Makdessi and Parking Eye Ltd v Beavis. The former is relating to a substantial commercial contract and the latter is relating to a low-value consumer contract. By and large, the Supreme Court takes the view that:

  • A clause will not be held a penalty if it provides a payment (or a non-pecuniary obligation) upon an event other than the payer’s breach of contract.
  • There should be a strong enforceability of a clause between properly advised parties of comparable bargaining power.
  • Dunedin test under the Dunlop case to define a penalty clause (i.e. a clause is a penalty where it provides for the payment of a sum that was greater than a genuine pre-estimate of loss) would no longer apply generally.
  • The proper test for a penalty would emphasize the justifying interest of the party seeking to enforce the clause.
  • The penalty rule would continue to apply to clauses where a party shall transfer assets at undervalue as much as to those where a payment will be made.

Even though Dunedin test remains helpful for reference and guidance, the modern test for a penalty clause following the Cavendish case consists of two elements: first, whether the party seeking to enforce such clause has a legitimate interest in its enforcement; second, whether the sum stipulated (or a non-pecuniary benefit) is disproportionate to the legitimate interest. Once the test is positive (i.e. a clause is treated as a penalty), the legal effect of the clause will be considered.  

A penalty has been assumed to be unenforceable or even invalid in its entirety in view of some judges until the Court of Appeal in Johnson v Johnson held that only the sum of the penalty above the actual loss was unenforceable. It suggests that in any case the penalty clause is not avoided but unenforceable and the aggrieved party should be able to claim the actual loss whether it is higher or lower than the penalty sum.

Enforceability of an LD clause in Vietnam

LD is a legal concept that has been well developed in common law system, but it has not been recognized and codified under Vietnamese legislation. Currently there are two different views in interpreting an LD clause from a Vietnamese law perspective.

As a conservative view which is generally taken by the provincial courts in Vietnam, only actual and direct losses are recoverable as long as they are proved by the aggrieved party. In order words, the legal effect of agreed sum clauses without being subject to the principles of contractual damages (i.e. proof of breach, loss and causal link) may be considered by courts. In that event, an LD clause will not be void because it does not fall within the ambit of void transactions as stipulated under Vietnam Civil Code; however, the courts would tend to interpret the agreed compensatory amount in the LD clause as a penalty and apply the doctrine of penalty under Vietnamese law (including the applicable cap as discussed in the next section) to that clause.

A few local courts and arbitrators take a flexible and modern view about LD by referring to the principle of freedom of contract (Article 3 of Vietnam Civil Code 2015). In particular, the breaching party is liable for the total losses that have been suffered by the aggrieved party due to the former’s breach of its contractual obligation unless the parties otherwise agree (Article 360 of Vietnam Civil Code 2015). This provision suggests that the contracting parties have the right to agree on the compensation sum where there is a breach of contract. However, the law does not give any criteria to qualify such agreed compensatory amount. For example, it is uncertain as to whether an LD clause is completely enforceable if the agreed sum payable to the aggrieved party in the event of breach is greater than the actual loss that it could conceivably suffer and whether a simple notice by the aggrieved party to the breaching party to exercise such clause is sufficient for enforcement.

In case the courts interpret that an LD clause is a penalty per se under Vietnamese law, the clause must pass the penalty test under Vietnamese law (Article 418 of Vietnam Civil Code 2015):

  • A penalty is an agreed sum payable to the aggrieved party by the breaching party. It means that non-pecuniary obligation by a party on breach would not be considered a penalty.
  • The penalty sum shall be agreed by the parties in the contract unless stipulated otherwise by relevant legislation. Currently, the penalty sum is capped at 8% and 12% of the value of breached obligation in commercial contracts and construction contracts respectively. If the agreed sum for penalty is higher than the stipulated threshold, the penalty clause would not be avoided but the sum above the stipulated threshold would not be enforced.

If the above two-fold test is positive, the penalty clause is enforceable against the breaching party. The parties may agree on both penalty and damages as remedies in the event of breach. Nonetheless, such agreement must be expressly spelled out in the contract. If only penalty but not damages is agreed in the contract, the aggrieved party will be entitled to the penalty sum but not the contractual damages. If a clause does not pass the penalty test, it would not be enforceable, and the aggrieved party may claim for damages.

Conclusion

Given the enforceability issues of penalty and LD clauses in the United Kingdom and Vietnam, it is vital for draftsmen to consider the construction of each clause in the relevant jurisdiction. Here are some key take-aways:

  • Parties may have a freedom of choice relating to the governing law and dispute settlement. Whether the governing law would be a common law or a civil law and the dispute would be resolved by courts or arbitration should be carefully considered by draftsmen to take the most advantages of remedies on breach of contract and ensure their enforceability from client’s perspective.
  • If the aggrieved party seeks to enforce an agreed sum clause against the breaching party in Vietnam, it should be aware of the stipulated caps that may apply to such clause and insert contractual damages in the underlying contract as a remedy on breach in addition to the agreed sum clause.
  • It may be more straightforward to enforce an LD clause which provides for a non-pecuniary obligation than the one for an agreed sum in Vietnam.
  • If the aggrieved party contemplates to recover a pre-estimate loss or compel the breaching party to perform a secondary obligation in the event of breach under the United Kingdom’s jurisdiction, it must establish its legitimate interest and proportionality with the sum or obligation stipulated.

 

Note: International treaties and agreements such as United Nations Convention on Contracts for the International Sale of Goods have not been considered in the above analysis.