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Establish terms of deposit and advance payments in the contract

Establish terms of deposit and advance payments in the contract
Establish terms of deposit and advance payments in the contract

A contract is established and executed based on the goodwill of the parties. Usually, at the time of signing, the commitments recorded in the contract are still complied with by the parties. However, in practice, there is no guarantee that the parties will remain strictly implementing the said agreements until the end of the contract. To limit the risks for the company when participating in transactions, the mechanisms on contract penalties, deposits, or advance payments are agreed upon by the parties and recorded in the contract. These terms are also a basis for one party to consider the goodwill and seriousness of the other party in the transaction. However, it should also be noted that, depending on their position in the contract, parties assess the possibility of a violation that may arise, in fact, to choose whether to record the terms on deposit or advance payment or not, since the processing mechanism, as well as the rights and obligations of each party to the deposit and advance, are different.

Deposit in contract

According to regulations, a deposit is considered as one of the measures to ensure the performance of obligations, deposit is only applied if the parties have agreed to state that provision in the contract and there is a deposit in fact, and similar to penalties for breach of contract. Article 328 of Civil Code 2015 provides for deposits as follows:

 “Article 328. Deposit

  1. Deposit is an act whereby one party (hereinafter referred to as the depositor) transfers to another party (hereinafter referred to as the depositary) a sum of money or precious metals, gemstones or other valuable things (hereinafter referred to as the deposited property) for a period of time as security for the entering into or performance of a contract.
  2. Upon a contract being entered into or performed, any deposited property shall be returned to the depositor, or deducted from the amount of an obligation to pay money. If the depositor refuses to enter into or perform the contract, the deposited property shall belong to the depositary. If the depositary refuses to enter into or perform the contract, it must return the deposited property and pay an amount equivalent to the value of the deposited property to the depositor, unless otherwise agreed.”

Accordingly, as mentioned above deposit is one of the measures set out for the parties to ensure the execution and the performance of a contract in accordance with the committed contents. In case a party has a violation, the penalty for the deposit will be applied, except for otherwise agreed.

When applying this term, the parties should understand its purpose – to ensure the benefits of a party when another party fails to fulfill the commitments in the contract. This is to ensure the proportionality of rights and obligations aimed for in a  bilateral contract.

Therefore, if you are the depositor, you need to consider whether this term is applicable to both parties or not. When the party receiving the deposit violates, it should be noted whether the deposit terms are applied to force them to return the deposit and pay a deposit penalty.

On the contrary, if you are the party receiving the deposit, in addition to the deposit penalty, is there any mechanism for deduction to compensate for the violation of the depositor? And the responsibility of the depositor in supplementing to ensure that the amount of deposit is always maintained as originally agreed. This form of deduction of obligations from the deposit is usually recognized by the parties in office leases and real estate leases.

Advance payment (prepayment) in the Contract

One matter that many companies face is misinterpreting and using wrongly the mechanism of handling advance payment as a deposit or compensation for damages. However, it is necessary to understand that advance payment is only an amount paid first or as scheduled, and then the buyer will only be responsible for paying the remaining amount after deducting the said amount. This is the exact opposite of a deposit, since the deposit term will exist in parallel with the payment and the buyer is still responsible for paying in full according to the value committed in the contract. The payment obligation of the buyer will only be deducted from the deposit if the parties agree, however these deductions are usually applied to the final payment. When choosing to apply the deduction, the parties should pay attention to the content of the deduction as well as its time to ensure that the deduction does not affect the function of the deposit clause during the term of the contract.

As mentioned above, the deposit term only applies if the parties explicitly agree to the contract. If the parties only make general recognition in the direction of a prepayment without determining that this amount is a deposit, then there are grounds to assume that the deposit relationship is not established and the issue of a deposit penalty will not be applied when there is a violation. The new provisions stated in Decree No. 21/2021/ND-CP clearly stipulate on this matter, accordingly if a payment is not clearly specified as a deposit or prepayment, it will be considered an advance payment, in particular:

“Article 37. Cases where deposit and advance are unidentifiable

In case a party to a contract hands an amount of money to the other party without identifying whether the money is deposit or advance, the money shall be considered an advance.”

Therefore, if it is considered as a prepayment, this is a normal payment and does not make sense in binding or deterring the other party to fulfill the commitments in the contract.

To eliminate the potential risks as well as to understand this term to apply in the contract negotiation process, company should build a template of deposit terms when the company is either a buyer or a seller, including a deposit processing mechanism. Especially for the manufacturer or lessor whose contract performance period is long, and its payment process is divided into several installments, the provision of deposit terms (including deposit value, deposit duration, maintenance and processing mechanism, and deposit deduction) should be clearly noted. Usually, the deposit is not small, so the process of handling the deposit when a party violates is often easy to arise disputes. If the deposit terms are not clearly stipulated, it is up to the court to understand and resolve this issue.

The article is based on applicable law at the time noted as above and may no longer be appropriate at the time the reader approaches this article as the applicable law has changed and the specific case that the reader wishes to apply. Therefore, the article is only for reference.