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Application Of Penalty For Breach And Interest On Delayed Payment In Commercial Transactions

Application Of Penalty For Breach And Interest On Delayed Payment In Commercial Transactions

“In the midst of the COVID-19 pandemic outbreak, the business operation of enterprises has been severely damaged not only by the drop of sales and clients, but the monetary remedies and compensations paid by enterprises for breaching contracts as a result of the pandemic. In terms of monetary remedies, besides damages, enterprises may be subject to penalty for breach and/or interest on delayed payment. Thus, in this article, we will focus on analyzing two regulatory tools which are used in majority of cases when it comes to contractual breaches.”

Penalty for breach

What is a penalty for breach?

By law, the existence of a penalty for breach allows the breached party to claim a sum of payment as a penalty for the breach of the contractual obligation of the other party as previously agreed by the parties under the terms and conditions of the contract. By reviewing this definition, we can see that, unlike the grounds of damages and interest on delayed payment claims, the penalty for breach is only available to the breached party if the parties have previously agreed on the application of penalty for breach in the contract. A breach by a party shall not unconditionally enable the application of penalty for breach.

Indeed, the penalty for breach is considered as a supplementary tool to enhance the commitment of the parties regarding the performance of their contractual obligation. In other words, regardless such a breach did or did not cause the actual damage to the parties, the penalty for breach shall be activated upon the advance agreement about its application by the parties.

What are the rates of penalty for breach?

By law, the maximum rate of penalty for breach that the parties are allowed to apply is 8% of the value of the breached obligation, except the rate applicable to transactions on construction which is up to 12%. Theoretically speaking, the penalty for breach is not based on actual damage, which makes it hardly possible to have other ways to determine the rate of penalty for breach other than an advance agreement of the involved parties, thus, the law only lays down a maximum rate to be applied.

The agreement on the application of a specific penalty will be agreed upon by  taking the some criteria into consideration, such as liability of the counterparty,cruciality of the contract, the expected level of commitment that the parties wish to achieve, etc.

How to apply the penalty for breach?

It should be noted that the rate of penalty for breach is only applied on the value of the breached obligation. In many cases, the value of the breached obligation may be the whole or a part of the contract value. The below examples shall provide a closer look at this point.

Example 1: A buyer and the seller have signed a sales contract with a value of VND 10 billion, paid in one installment on July 15, 2021. Under the contract, the parties agree on a penalty for breach clause at the rate of 8% of the value of the breached obligation. After July 15, 2021, the seller has not yet received any payment from the buyer despite having fully fulfilled the delivery obligation. In this case, the buyer has been late to pay the entire contract value to the Seller. Thus, the amount of penalty for breach the buyer must pay is 8% * VND 10 billion = VND 800 million.

Example 2: the same buyer and seller above, this time, the parties agree to divide the payment into 2 installments: 1st Installment on 15 July 2021 and 2nd Installment on 30 July 2021, each Installment is of 50% of the contract value equivalent to 5 billion VND. The bBuyer has paid the 1st installment; however, the buyer failed to make the 2nd installment due to financial difficulties. In this case, the amount of penalty for breach applied to the Buyer is: 8% * VND 5 billion = VND 400 million.

 

Interest on delayed payment

What is interest on delayed payment?

By law, if a party is late in paying for the goods or the services fee and other reasonable expenses, the other party has the right to claim interest on the delayed payment. Specifically, unlike the penalty for breach that can be applied to most of the contract violations, interest for delayed payment can only be applied in case of breach of the payment obligation. However, it should be noted that the application of either penalty for breach or late payment interest will not affect the application of the other as long as these remedies are performed in compliance with the law and the agreement of the parties.

What are the interest rates?

In most cases, the interest rate on delayed payment will be determined according to the average overdue debt interest rate in the market at the time of payment corresponding to the late payment period, unless otherwise agreed. From this regulation, it can be understood that the interest rate can be determined through two main methods: (i) by agreement between the parties or (ii) based on the average overdue debt interest rate in the market at the time of payment.

As agreed by the parties

Currently, the Commercial Law does not stipulate the interest rates applicable to delayed payments. However, this does not mean that the parties are free to set any interest rates. As a general code governing civil transactions, the Civil Code 2015, sets forth the maximum interest rates applicable to civil transactions. These rates are applicable to delayed payments. Hence, the maximum interest rate the parties are allowed to apply is 20% per annum.

The average overdue debt interest rate

As analyzed above, interest on delayed payment can be applied even if it has not been previously agreed by the parties. In this case, the problem of determining the applicable interest rate will arise. By law, “Average overdue debt interest rate in the market at the time of payment” is a rather general concept and leads to many difficulties in determining the actual interest rate. Stemming from that reality, in the Precedent No. 09/2016/AL, the Supreme Court has introduced a method of determining this interest rate by “taking the average overdue interest rate of at least three banks in the place of contract performance. Although this determination has certain limitations when choosing the banks where there are more than three banks such as Ho Chi Minh City, the method proposed by the Supreme Court has  partly solved the problem about difficulties in determining interest for delayed payment.

In addition, a problem to note when determining interest for delayed payment is that it is calculated only based on the amount of principal delayed payment, not on compensation for damages, payment for the penalty of breach…

In general, although at the time of signing the contract, the parties always expect that the performance of the contract can proceed smoothly and achieve the benefits as agreed. However, as a matter of fact, it is almost inevitable that risks may arise in the course of doing business. Therefore, anticipating unexpected situations when performing a contract, as well as having appropriate regulations such as applying penalty for breach and interest on delayed payment, in order to best protect the interests of the concerning parties in these situations are extremely important. Furthermore, these remedies also help the parties to the contract have a higher level of commitment when participating in the transaction.

SUMARY TABLE
 Penalty for breachInterest on delayed payment
Legal basisCommercial Law 2005, Article 300, Article 301Commercial Law 2005, Article 306
DefinitionPenalty for breach is the conduct that the breached party requests the breaching party to pay a monetary fine for breach of contract if such penalty is agreed by the parties in advance.

In case the breaching party is late to pay the goods or service fees and other reasonable expenses, the breached party has the right to claim interest on the delayed payment according to the average overdue debt interest rate in the market at the time of payment, unless otherwise agreed or otherwise provided by law.

ApplicationUpon advance agreement of the parties.The existence of delayed payment of a party
RateMaximum of 8% of the value of the breached obligation.By agreement between the parties. In the absence of such an agreement, the average market overdue interest rate at the time of payment corresponding to the delay period will be applied.

 

Dated: 13 July 2021

The article is based on applicable law at the time noted above and may no longer be relevant at the time the reader approaches this article due to the change in applicable law and the specific case in which the reader wishes to apply. Therefore, the article has only reference values

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