Disputes over Penalties for Breach and Compensation for Damages in Commercial Contracts in Vietnam
In commercial activities, it is quite common for one party to breach a contract and become liable for penalties or compensation for damages. So, what should businesses in Vietnam know when faced with disputes concerning penalties for breach of commercial contracts or compensation for damages in commercial contracts?
1. Legal Basis and Concepts of Penalties and Compensation for Damages in Commercial Contracts
When a business enters into a contract with another trader for profit-making purposes — i.e., within the scope of a commercial contract — the mechanisms of penalties for breach and compensation for damages are essential legal tools to protect the rights and interests of the non-breaching party.
1.1. Definition of Penalty and Compensation for Damages
According to the Law on Commerce 2005, a penalty for breach is a monetary fine that the breaching party must pay to the non-breaching party, provided that such penalty is stipulated in the contract.
Conversely, compensation for damages refers to the breaching party’s obligation to reimburse the actual losses suffered by the non-breaching party as a result of the breach — including both direct damages and the profits the non-breaching party would have earned if the contract had been properly performed.
1.2. Legal Grounds and Conditions for Application
Penalty for breach: Article 301 of the Law on Commerce 2005 stipulates that the penalty for breach of contractual obligations, or the total penalty for multiple breaches, must not exceed 8% of the value of the breached contractual obligation.
Compensation for damages: Article 302 provides that the breaching party must compensate for the losses caused by its breach of the contract.
Relationship between the two remedies: Article 307 states that if the contract includes a penalty clause, the non-breaching party may apply both penalties and compensation; if not, only compensation can be claimed.
In addition, to claim compensation, the injured party must prove: (i) there was a breach of contract; (ii) actual loss occurred; and (iii) the breach directly caused the loss.
2. Key Considerations and Practical Disputes
Although the law provides a clear framework, in practice, many disputes between commercial parties in Vietnam still involve ambiguities and risks affecting business interests.
2.1. Penalty Limits under Vietnamese Law
Vietnamese law caps the penalty for breach in commercial contracts at 8% of the value of the breached obligation.
However, in practice, many contracts stipulate penalties exceeding this limit, which often leads courts or arbitral tribunals to either reject the excessive portion or only enforce the legal maximum of 8%.
Therefore, businesses should be cautious — while higher penalties may act as a deterrent, they might be deemed invalid or reduced if they exceed the statutory limit.
2.2. Compensation for Damages: Agreement or Risk
It is important to note that a separate clause on compensation is not required for the injured party to claim compensation — as long as a breach and actual damage can be proven.
However, proving the actual damage and lost profits is often challenging in practice. Courts typically reject compensation claims that are excessive or lack concrete evidence.
Thus, businesses should ensure they have proper documentation and evidence of losses. Failure to do so, or to take reasonable measures to mitigate damages, may result in reduced or denied compensation claims.
2.3. Relationship Between the Two Remedies and Contractual Risks
As noted above, penalties and compensation may be applied concurrently if the contract provides for penalties. However, in practice:
If a contract includes only a penalty clause but not a compensation clause, the non-breaching party still retains the right to claim compensation if damages can be proven.
If the contract sets a penalty exceeding the legal limit (for example, over 8%), the entire penalty clause may be invalidated or adjusted by the court — creating significant legal risks for the drafting party.
3. Practical Solutions for Businesses – From Prevention to Dispute Resolution
To minimize risks and prepare for potential disputes over penalties and compensation in commercial contracts, businesses should adopt the following measures.
3.1. Before Signing the Contract: Drafting with Caution
Determine whether the contract falls under the Law on Commerce or the Civil Code, as the applicable penalty and enforcement methods differ.
Clearly stipulate the penalty clause and ensure the amount does not exceed 8% of the breached obligation’s value to maintain enforceability.
Draft detailed compensation provisions, specifying evidence requirements, mitigation obligations, and claim time limits.
Keep complete records: contracts, performance reports, violation minutes, damage reports, and proof of lost profits — essential for substantiating claims later.
3.2. When a Breach or Dispute Occurs: Strategic Response
Immediately issue a written notice identifying the breach and the date of occurrence to preserve legal rights.
Enforce the contractual penalty clause if applicable. Additionally, consider claiming compensation for damages — even if the contract only mentions penalties.
Remember, the injured party has a duty to mitigate losses. Failure to do so may lead to a reduction in compensation.
If the penalty exceeds the statutory cap (e.g., > 8%), be aware that courts or arbitral tribunals may declare the clause partially or wholly invalid. Legal consultation is advisable to assess potential exposure.
When pursuing litigation or arbitration, businesses should clearly establish the cause of the breach, the extent of damages, the causal link, and the exact loss — these are mandatory legal elements for a successful claim.
4. Conclusion
Disputes over penalties for breach and compensation for damages in commercial contracts are among the most common in Vietnam today, especially as commercial transactions become increasingly diverse and complex. Despite having a clear legal foundation, many businesses still lose their rights in disputes due to poorly drafted contracts, misunderstanding of legal limits, or failure to substantiate actual damages.
To prevent such risks, enterprises should proactively draft transparent and well-structured penalty and compensation clauses, supported by clear evidence and documentation throughout contract performance. In case a dispute arises, seeking early advice from experienced commercial lawyers can help businesses assess their rights, obligations, and strategic options — minimizing legal risks and protecting business interests effectively.
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