Vietnamese rules on compensation for contractual damage

Wednesday 01/03/2018 - 15:32

Nguyen Hong Hai

Deputy General-Director

Department of Civil-Economic Laws, Ministry of Justice

In both legal theory and civil transaction practice, regulations on liability to compensate for contractual damage always play an important role. Theoretically, it is the concretization of the principles of equality, free will, good will, binding of contract, and theories of fault and damage in civil liability. Practically, it is a legal mechanism aiming to heighten the responsibility of parties to fulfill their commitments, prevent infringements and concurrently ensure remediation of damage or other legal risks arising upon breach of contract.[1]

Compensation liability

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The liability to compensate for contractual damage[2] is in substance the concretization of the legal nature of a contract - the exchange and agreement between the parties, which creates a legal consequence and gives rise to civil rights and obligations.[3] Specifically:

(i) Like other contractual civil liabilities, the establishment, performance or termination of compensation liability will be agreed upon and decided by the contracting parties.[4] However, this principle is not absolute but can be limited by and must comply with a law in certain cases,[5] such as when the agreement contravenes the basic principles of Vietnamese civil law; rights are restricted for the reason of national defense and security, social order and safety, social morality, or community well-being;[6] application of the liability to compensate for contractual damage according to a model contract and general transaction conditions, or performance of contracts upon fundamental change of circumstances, etc.;[7]

(ii) Compensation liability aims to ensure performance of civil obligations. From the time a contract becomes valid, the parties must exercise rights and perform obligations toward each other as committed and, if committing breaches, each party will take responsibility for its failure to fulfill or properly fulfill the commitments.[8] Compensation will be paid when breach of contractual obligations (breach of contract) causes damage to the obligee. In this case, the damaged party may request the breaching party to pay compensation or the court[9] to enforce the damaged party’s right to compensation and force the breaching party to remediate consequences caused by its breach.[10]^,[11]

Bases giving rise to compensation liability

The Code has no separate provisions on bases that give rise to the liability to compensate for contractual damage. However, through its general provisions on compensation liability[12] and specific provisions on compensable damage due to breach of contract[13], a general principle can be drawn out, that is in case of damage caused by breach of contract, the obligor must pay compensation to the obligee. According to this approach adopted by the Code, the liability to compensate for contractual damage will arise in the presence of all three conditions: (i) There is a breach of contract; (ii) There is actual damage; and (iii) There is a causal relationship between the breach of contract and the damage caused.[14]

Contract breaches

The obligor will be considered breaching the contract if it fails to perform an obligation on schedule, completely or properly.[15] On that basis, in its specific provisions on civil liability and contract, the Code lists specific cases in which the parties are regarded breaching contracts. Below are some of these cases:

- The obligor is late in performing an obligation (Articles 353, 354.1, 482.4, 548, 550, etc.);

- The obligee is late in accepting performance of an obligation (Articles 355, 359, 550, etc.);

- The obligor fails to perform the obligation to deliver an object, or fails to properly or completely deliver an object (Articles 356, 436.2, 437.2.c, 439, 445.1, 449, etc.);

- The obligor is late in performing the payment obligation (Articles 357, 440, 466, etc.);

- The obligor fails to perform a task or performs a task which it should refrain from performing (Articles 358, 545.3, etc.);

- The obligor is unable to perform an obligation (Article 425);

- The obligor violates the obligation to provide information (Articles 387.3, 443, etc.);

- The obligor causes loss of or damage to the property being the object of the contract (Articles 426, 490.1, 541.3, etc.);

- Either party groundlessly cancels or terminates the contract (Articles 427.5, 428.5, etc.).

In case there is a claim on a breach of contract but the contractual term on the relevant obligation is unclear and the parties cannot reach agreement to clarify it, whether there is a breach of contract should be determined on the principles of contract interpretation laid down in the Civil Code.[16]

Damage caused

Under Articles 13 and 360, compensable damage should be identified first of all based on the agreement of the parties or provisions of a law.[17] If such basis is unavailable, general provisions on damage caused by breach of obligation[18] and specific provisions on compensable damage due to breach of contract[19] will apply. Accordingly, compensable damage includes material damage and spiritual damage.

Thousands of workers of S&H Vina Thach Thanh company in Thanh Hoa province gather to demand social insurance benefits __Photo: Khieu Tu/VNA

Material damage is defined by the Code as assessable actual material losses, including property loss, reasonable expenses for prevention, limitation and remediation of damage, and actually lost income. The obligee may also request the breaching party to compensate for benefits it should have received from the contract; the breaching party will pay expenses arising due to its failure to fulfill contractual obligations other than amounts compensated for the benefits that would have been brought about by the contract.[20]

Moreover, the Code’s specific provisions on contracts also deal with the identification of material damage for which the obligee can claim compensation. For instance, the breaching party must pay a compensation amount equal to the value of lost or damaged property which is the object of the contract and cannot be returned or compensated with another property or cannot be repaired or replaced with another property of the same type (Article 426); the lessor of a property may request the lessee to compensate for the reduction in the value of the leased property, except natural wear and tear (Article 482.1); the trial user or borrower of a property must compensate for the loss or damage of the property (Articles 452.3 and 496.4); or the processor must compensate for damage caused to the ordering party if it delivers processed products late, causing risks to the products (Article 548), etc.

Regarding spiritual damage, the Code says that in case of suffering spiritual damage due to breach of contract, the obligee may request the court to force the obligor to compensate for such damage. If the parties cannot reach agreement, the court will decide on the level of compensation based on the details of the case. This new, reasonable and humane provision enables full compensation for losses incurred by the obligee and ensures fairness in identifying civil liability in general and compensation liability in particular.[21]

Causal relationship between breach of contract and damage

This application condition means that the obligee must prove that the material or spiritual loss it suffers arises directly from the breach of contract. The obligor is not required to compensate for damage that is not a consequence of its breach of contract, such as damage caused due to the obligee’s failure to apply necessary and reasonable measures to prevent damage from occurring or failure to limit damage caused to itself.

Fault

The provisions on fault in the application of compensation liability are perhaps the biggest change in the 2015 Civil Code compared to the 2005 Civil Code regarding application conditions. Specifically, the fault of the breaching party is determined on the principle of presumption[22] and is used as a basis for the breaching party to request exemption from part or the whole of the compensation liability.[23]

On the obligee’s part, if the obligor breaches the contract and causes adverse consequences to the obligee, the breaching party will be presumed to be at fault and must perform civil liability toward the obligee. This principle has created a fundamental change in the burden of proof in legal proceedings, that is the obligee needs only to prove that the damage is actual and caused by a breach of contract, without having to prove the fault of the obligor.[24]

On the obligor’s part, fault is applied on the principle that there is no fault, there is no liability for compensation, unless otherwise agreed upon or prescribed by a law. If managing to prove that its breach of contract is due to a force majeure event or entirely due to the obligee’s fault, the obligor is not required to pay compensation. In addition, with the Code adding the obligee’s responsibility to limit damage for itself, the obligor may also base on the obligee’s failure to apply necessary and reasonable measures to prevent damage from occurring or failure to limit damage to itself to state that the obligee is at fault and not entitled to claim compensation for the damage which it could have prevented or limited.[25],[26]

Scope of compensation

Under Articles 13, 360 and 419 of the Code, the scope of compensation can be determined on the principle of giving priority to the agreement of the parties or to cases in which it is otherwise prescribed by a law.[27]

Agreement may fall into two cases: (i) the parties reach a prior agreement on the scope of compensation in the contract, regardless of actual damage caused (i.e., the parties may reach a specific agreement on the type of compensable damage, level of compensation, grounds for exemption from compensation liability, etc.);[28] and (ii) the parties will, based on the actual damage and breach of contract, reach agreement on the obligor’s compensation for part or the whole of the damage caused, and on the one-off or installment payment of compensation, etc.

In case the parties have no relevant agreement or the law does not otherwise provide, the obligor must compensate for the whole damage caused to the obligee.

Relationship between compensation liability and sanction for breach of contract

Respecting the parties’ will under contracts,[29] the 2015 Civil Code basically inherits all of the 2005 Civil Code’s provisions on the relationship between sanction for breach of contract and liability to compensate for damage caused by breach of contractual obligations.[30] Accordingly, the contracting parties may reach agreement that the breaching party is only subject to sanction but not compensation or is subject to both sanction and compensation. If the parties reach agreement on sanction but not on both sanction and compensation, the breaching party is only subject to sanction.[31]

Termination of compensation liability

The Code contains no separate provisions on termination of the liability to compensate for contractual damage. However, during the application of law, the Civil Code’s relevant provisions on termination of obligations in specific cases may be invoked.[32] For instance, the compensation liability will terminate as agreed upon, when the compensation obligation is fulfilled, or when the obligee exempts the obligor from performing the compensation liability or allows this liability to be replaced or compensated with another civil obligation, etc.- (VLLF)

[1] This article only introduces the provisions of the 2015 Civil Code on liability to compensate for contractual damage. Various theoretical and practical researches into this issue have been made by many others (Assoc. Prof. Dr. Ngo Huy Cuong, Assoc. Prof. Dr. Do Van Dai, Dr. Nguyen Minh Oanh, Dr. Nguyen Minh Hang, Dr. Bui Duc Giang, Bui Thi Thanh Hang, and Do Giang Nam, etc.).

[2] The 2015 Civil Code does not provide a definition of the liability to compensate for damage. Meanwhile, according to Article 307.2 of the 2005 Civil Code, “the liability to compensate for material damage is the liability to offset actual material loss that can be valued in money, including property loss, reasonable expenses for prevention, limitation and remediation of damage, and actually lost or reduced income.”

[3] Articles 385 and 401.

[4] The principle of agreement-based compensation for damage is also recognized in Articles 3, 13 and 360 and other relevant articles of the 2015 Civil Code.

[5] Articles 13 and 360 acknowledge exceptions in the performance of compensation liability when otherwise prescribed by a law.

[6] Generally understood as “public order”.

[7] See also Articles 3, 9, 10, 13, 360, 405, 406 and 420.

[8] Article 401.2.

[9] Or the arbitration.

[10] In this aspect, the liability to compensate for contractual damage is similar to a legal liability, which is applied when an illegal act causing damage is committed (in this case it is a breach of contractual rights protected by law) and always brings unfavorable property consequences to the person having such liability, and is to be performed under state coercion.

[11] The obligee may have other choices or may combine compensation with other remedies such as forced performance of obligations, termination of violations, payment of fine for violations, refund of reasonable expenses, or public apology or correction, etc.

[12] Articles 13, 351, and 360 thru 364.

[13] Article 419.

[14] The 2005 Civil Code has no separate provisions on liability to compensate for contractual damage and no clear bases on application conditions, leading to different approaches taken in reality. However, pursuant to Articles 302.1, 307 and 308 of this Code, there are four application conditions, namely (i) There is a breach of contract: (ii) There is actual damage; (iii) There is a causal relationship between the breach of contract and damage caused; and (iv) The breaching party is at fault. This Code also makes similar provisions on liability to compensate for non-contractual damage, stipulating “A person who intentionally or unintentionally infringes upon the life, health, honor, dignity, prestige, property or other lawful rights and interests of individuals or infringes upon the honor, prestige or property of legal persons or other entities and thereby causes damage shall pay compensation.” Resolution 03 dated July 8, 2006, of the Justice Council of the Supreme People’s Court, guiding the application of the 2005 Civil Code’s provisions on compensation for non-contractual damage, also states that the liability to compensate for non-contractual damage will arise only in the presence of all of the following factors: (i) There is actual damage; (ii) There is an illegal act; (iii) There is a causal relationship between the illegal act and damage caused; and (iv) There is an intentional or unintentional fault of the damage causer. So, in light of the 2005 Civil Code, fault is always a condition giving rise to the compensation liability.

[15] Article 351.1. However, there is a natural condition that the breached obligation must belong to a valid contract and the content of the obligation does not fall into the case in which a contract is null and void as prescribed by a law. For instance, if the parties to a property-secured loan contract agree on an interest rate higher than 20 percent per year (the ceiling interest rate prescribed by law) for a loan, then the rate exceeding 20 percent will be null and void (Article 468.1) (The borrower will not bear any liability for not paying the excessive rate because such rate violates the law). In addition, according to the provisions on standard-form contracts and general transaction conditions in Articles 405 and 406, if a standard-form contract contains a term that exempts the liability of the party preparing the standard-form contract or general transaction conditions, increases the liability or eliminates legitimate interests of the other party, such term will be invalid, unless otherwise agreed upon.

[16] Article 404.

[17] Article 4 says that other relevant laws that regulate compensable damage must not contravene the fundamental principles of civil law; if another relevant law makes provisions contrary to this principle or makes no provisions, the provisions of the Civil Code will apply.

[18] Article 361.

[19] Article 419.

[20] There is also another viewpoint holding that reasonable expenses do not include the expense for the defense of interests in legal proceedings. Regarding this issue, Article 168 of the 2015 Civil Procedure Code states that expenses to be paid to interpreters and lawyers will be borne by claimants, unless otherwise agreed upon. Meanwhile, Article 205 of the Law on Intellectual Property says that the owner of intellectual property rights may request the court to force the infringers to pay reasonable expenses for hiring a lawyer.

[21] This provision is only in principle and needs detailed guidance from the Supreme People’s Court or court precedents. The 2015 Civil Code also provides in principle the settlement of consequences of invalid contracts and cancellation of contracts related to personal rights (Articles 131.5 and 427.4).

[22] The 2015 Civil Code actually does not overlook the fault factor.

[23] The 2015 Civil Code also adopts a similar approach in providing bases giving rise to the liability to compensate for non-contractual damage: “A person who infringes upon the life, health, honor, dignity, prestige, property or other lawful rights and interests of another person and thereby causes damage shall pay compensation, unless otherwise prescribed by this Code or another relevant law.” (Article 584.1)

[24] However, there are exceptions stated in Articles 460 and 461 regarding the fault of the property donor, causing damage to the donee.

[25] The 2015 Civil Code’s provisions on fault-related solutions are relatively similar to the provisions of Articles 294 and 303 of the 2005 Commercial Law regarding bases giving rise to the liability to compensate for damage under commercial contracts.

[26] Exemption from compensation liability may also be based on agreement of the parties.

[27] Damage caused by a force majeure event, fault of the obligee, or modification of contract upon fundamental change of circumstances, etc.

[28] Allowing the parties to reach a prior agreement on a specific level of compensation regardless of actual damage helps reduce expenses and encourage the obligor to fulfill its commitments in order to pay greater compensation than agreed.

[29] See “Legal nature of compensation liability” in this article.

[30] However, compared to the provisions of Article 422.3 of the 2005 Civil Code saying “In case the parties have no agreement on compensation for damage, the breaching party is only required to pay fine for breach,” the 2015 Civil Code’s provisions on this issue are more specific and uniform.

[31] This provision is also different from the 2005 Commercial Law, which says that if the contracting parties only reach agreement on sanction for breach, the obligee may still request compensation for the damage caused by breach of contractual obligations.

[32] Articles 372 thru 384.

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