Penalties for violations and compensation for damages in commercial contracts are two different sanctions allowed by law to apply with corresponding conditions. Therefore, businesses need to understand this difference to ensure their rights.
A commercial business contract constitutes a civil transaction between individuals or organizations engaged in business or commercial activities. This may involve interactions between parties conducting business and other individuals or organizations. It is evident that one of the parties involved in a commercial business contract typically seeks to achieve a profit.
1. Penalties for breach of contract
This sanction is applied when the parties agree to a specific clause in the contract (Article 300 of the Commercial Law 2005). Accordingly, when a party breaches its obligations, it will be fined a sum of money and pay that fine to the aggrieved party.
Regarding conditions, fines for violations, methods, and time of payment of fines, the parties have the right to agree in detail in the contract.
However, the Commercial Law 2005 stipulates that the maximum penalty for violation must not exceed 08% of the value of the breached contractual obligation, except for the case where the parties enter into contracts to provide inspection services or construction contracts. This provision is intended to limit the imposition of this sanction on the party or the use of penalties for violations as a means of legitimizing cash flows.
If the parties agree on a penalty lower than the above-mentioned legal allowance, the fine agreed upon by the parties will be applied. In case the parties only stipulate in the contract the penalty for the violation without specifying the amount of this penalty, when the violation arises, the parties must re-agree on the violation penalty. If the penalty for violation exceeds the provisions of law, then when a dispute arises, a fine of 0.8% of the value of the breached contractual obligation will be applied.
For example: Two enterprises A and B signed a clothing processing contract with a value of VND 5 billion. The two parties agree that A must process the agreed volume of goods within 03 months. Failure to fulfill obligation A will be subject to penalties for breach of this obligation. Due date, A can process half of the volume of goods, equivalent to VND 2.5 billion.
- Case 1: The contract stipulates that if any party violates its obligations, it will be fined 20% of the contract value, equivalent to VND 1 billion.
In this case, A is fined only 8% of the value of the breached contractual obligation, or 8% of the 2.5 billion. If B asks A to pay a fine of VND 1 billion, A has the right to refuse. - Case 2: The contract only stipulates that if any party violates, it will be fined according to the violation penalty prescribed by law.
Accordingly, B is entitled to demand A pay a penalty amount of 8% of the value of the breached contractual obligation, i.e., 8% of the 2.5 billion. - Case 3: The contract stipulates that if any party violates, a fine of 1% of the value of the breached contractual obligation will be imposed.
When a dispute arises, B is only required to pay a violation penalty of 1% of the value of the breached contractual obligation, equivalent to VND 25 million from A.
2. Compensation for damages
The obligation to compensate for damage still arises even if there is no agreement between the parties and when all the following conditions are met:
- Having the breaching of contract, and
- Occurring the actual damages, and
- A breach of contract is a direct cause of damage.
Concerning damages, the law does not limit the maximum value of damages that the breaching party must compensate. However, the parties should note only
- the actual, direct losses suffered by the aggrieved party as a result of the other party’s breach and
- the direct gains that the aggrieved party would have been entitled to have no breach been claimed.
Furthermore, the aggrieved and injured party must prove the actual, direct damages it suffered as a result of the breach of the aggrieved party or the direct benefits that the aggrieved party would have been entitled to had it not been for the other party’s breach.
This means that indirect or direct losses that cannot be proved are not the subject of a claim for damages.
In addition, based on the principle that freedom of agreement is not contrary to law and social morals, the law also stipulates cases of exemption from liability for breach of contract if the parties reach an agreement or when force majeure events occur; violations of one party are entirely the fault of the other; violations of one party shall implement the decision of the competent state management agency which the parties cannot know at the time of entering into the contract.
Thus, in commercial business contracts, specific provisions on sanctions for breach of contract are mandatory requirements to apply. Meanwhile, compensation for damages only requires the type of damage and the burden of proving a causal relationship between the breach and the damage that occurred. In addition, the law allows the parties to apply both types of sanctions to ensure the obligation to perform the contract and protect the legitimate rights and interests of the aggrieved party. Therefore, enterprises can flexibly apply these sanctions to maintain their interests and ensure the purpose of entering into contracts is achieved.
