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Official Gazette

Friday, September 24, 2021

Penalties for breach of construction contracts

Updated: 16:59’ - 05/03/2020

Truong Nhat Quang & Pham Hoai Huan[1]

The maximum amount of penalty for breach of construction contracts currently varies between relevant laws governing construction contracts, including the 2015 Civil Code (Civil Code), 2005 Commercial Law (Commercial Law) and 2014 Construction Law (Construction Law). In relation to this issue, the Ministry of Construction (MOC) recently issued Official Letter 48/BXD-KTXD dated September 3, 2019 (OL 48) to respond to an inquiry of an enterprise about the maximum amount of penalty for breach of construction contracts in case of private construction works. In the context that there are different regulations of the Civil Code, the Commercial Law and the Construction Law regarding the maximum amount of penalty for breach of construction contract, this article will discuss about two legal issues: (i) principles for resolution of the conflict of laws that regulate construction contracts between the Civil Code, the Commercial Law and the Construction Law and (ii) the maximum amount of penalty for breach of construction contracts (including both state-funded construction works and private construction works).

Nature of construction contracts and legal framework regulating construction contracts

Broadly speaking, construction contract is a special type of contract in the field of construction investment regulated by the Construction Law, civil contract regulated by the Civil Code, and/or commercial contract regulated by the Commercial Law.

First of all, construction contract is a particular type of contract in the specialized field of construction investment and provided in the Construction Law. Hence, construction contracts is regulated by the Construction Law. The Construction Law also defines construction contract as a type of civil contract.[2] Therefore, construction contracts can fall within the scope of regulation of the Civil Code. Even though there is no specific mention in the Construction Law, construction contract is also a type of commercial contract which is governed by Commercial Law from a theoretical perspective.  In principle, commercial contract is also a type of civil contract.  However, unlike other types of civil contracts, a commercial contract has specific conditions on the contracting parties (i.e., the contracting parties shall be both traders or one of the contracting parties shall be a trader) and the purpose of the contract (i.e., profit-making purpose). Therefore, if a construction contract satisfies the conditions on the contracting parties and the purpose of the commercial contract as noted above, it can be considered as a commercial contract regulated by the Commercial Law as well.

In fact, most of construction contracts satisfy the conditions applied for commercial contracts as noted above.  In such case, such construction contracts are subject to both the Civil Code, the Commercial Law and the Construction Law.  The Civil Code, the Commercial Law and the Construction Law all prescribe the maximum amount of penalty for breach of contract. However, there is a difference between these regulations which might lead to a conflict of laws when determining the maximum amount of penalty to be imposed for breach of construction contracts, particularly those for private construction works. In particular, the Civil Code allows contracting parties to reach an agreement on the amount of penalty (without any limits), unless otherwise prescribed by a relevant law[3]. Under the Commercial Law, a penalty for breach of contract must not exceed 8 percent of the value of the contractual obligation which is breached. Meanwhile, the Construction Law stipulates the penalty for breach of contract must not exceed 12 percent of the value of the contractual obligation which is breached with respect to state-funded construction works.[4] The Construction Law does not provide for the limit of the amount of penalty for breach of construction contract with respect to private construction works.

Regarding this matter, an enterprise has sought for the MOC’s opinions on a specific case involving a private construction work in which contracting parties had agreed on the amount of penalty equivalent to 20 percent of the contract value. In OL 48, the MOC opines that contracting parties have the right to apply the agreed amount of penalty for breach of the contract for such private construction works. According to such response of the MOC, it could be understood that for private construction works, the maximum amount of penalty of 8 percent under the Commercial Law is not applicable and contracting parties are free to make an agreement on the amount of penalty for breach of contract in accordance with the Civil Code.

Since the Civil Code, the Commercial Law and the Construction Law prescribe different maximum amount of penalty for breach of contract, the first and foremost question is which law shall prevail to be applicable to construction contracts on the basis of principles of resolution of conflict of laws.

On the construction site of a cultural center of Hai Duong province__Photo: Manh Tu/VNA

Principles of resolution of conflict of laws related to construction contracts between the Civil Code, the Commercial Law and the Construction Law

Since the Civil Code, the Commercial Law and the Construction Law have equal legal effect, there are two principles of resolution of conflict of laws that can be considered for application, including (i) lex posterior derogat legi priori and (ii) lex generalis - lex specialis. The first principle states that given that the regulations are issued by the same authorities, the later issued regulations shall prevail over the previously issued ones. Under the second principle, a specialized law (governing a specific matter) shall prevail over a general law.

Given the relationships between the Civil Code, the Commercial Law and the Construction Law, the separate application of those two principles seems contradictory. Accordingly, if only the first principle is applied, the prevailing order would be the Civil Code, the Construction Law and the Commercial Law. If only the second principle is applied, the prevailing order would be the Construction Law, the Commercial Law and the Civil Code. This contradiction did not arise at the time of adoption of the Civil Code 2005 because the Commercial Law and the Construction Law were adopted after the Civil Code 2005.  Therefore, these principles should be applied simultaneously in order to have an appropriate basis for resolving the conflict of laws regarding this matter.

Principle of lex posterior derogat legi priori

Article 156.3 of the 2015 Law on Promulgation of Legal Documents prescribes the principle of lex posterior derogat legi priori which is applied to resolve conflict of legal documents issued by the same authority as follows: “In case legal documents issued by the same authority provide for different regulations on the same matter, the later issued document shall prevail.”

Basically, this principle applies to legal documents issued by the same authority (e.g., laws adopted by the National Assembly). If no other principles are applied (e.g., specialized laws shall prevail over the Civil Code in accordance with the principle of lex generalis - lex specialis), the Civil Code shall prevail over the laws which are adopted prior to the Civil Code and does not prevail over the laws which are adopted after the Civil Code in case of conflicts of laws. In this case, the Civil Code shall prevail over the Construction Law and the Construction Law shall prevail over the Commercial Law.

Principle of lex generalis - lex specialis

This principle is not prescribed in the Law on Promulgation of Legal Documents 2015 but often provided in specific legal documents. The Civil Code itself prescribes this principle to resolve the conflict between the Civil Code and specialized laws. According to this principle, Civil Code shall be considered as the “general laws” and specialized laws shall be considered as the “private laws”.  In the relationship between the “general laws” and the “private laws”, the specialized laws as the “private laws” shall prevail over the “general laws” provided that such laws do not contravene the fundamental principles of civil law prescribed in the Civil Code[5]; otherwise, the Civil Code shall prevail over the specilized laws. Besides, if a specialized law is silent on a matter which is provided in the Civil Code, the relevant regulations of the Civil Code shall apply.[6]  While the Commercial Law also prescribes this principle[7], this principle is not provided in the Construction Law.

Based on the above-mentioned principles, the following four conclusions can be made to resolve the conflict of laws in the context of construction contracts:

• If the provisions of the Commercial Law and the Construction Law contravene the fundamental principles of civil law prescribed in the Civil Code, the provisions of the Civil Code shall prevail over the provisions of the Commercial Law and the Construction Law;

• If the provisions of the Commercial Law and Construction Law do not contravene the fundamental principles of civil law prescribed in the Civil Code, the provisions of the Commercial Law and the Construction Law shall prevail over the provisions of the Civil Code;

• If the Commercial Law and Construction Law are both silent about a matter which is regulated by the Civil Code, the Civil Code shall apply to such matter; and

• If the Construction Law has specific provisions on a matter, such provisions shall apply. If the Construction Law is silent on such matter and the Commercial Law has specific provisions on such matter, the provisions of the latter shall apply. If both the Construction Law and Commercial Law are silent about such matter, the provisions of the Civil Code (if any) shall apply.

The maximum amount of penalty applicable to construction contracts

Both the Construction Law and Commercial Law prescribe the maximum amounts of penalty for breach of construction contracts which do not contravene the fundamental principles of civil law prescribed in the Civil Code. Therefore, in this case, their provisions on the maximum amount of penalty for breach of construction contracts shall prevail over those of the Civil Code.

The regulations of the Construction Law implicitly refers to construction contracts with respect to state-funded construction works and private construction works.  If the above four conclusions are applied to determine the maximum amount of penalty for breach of construction contracts, the following conclusions can be made:

• With respect to construction contracts for state-funded construction works, since the Construction Law (as the specialized law regulating construction contracts) specifically provides the maximum amount of penalty for breach of contract (i.e., equivalent to 12 percent of the value of the contractual obligation which is breached), the provisions of the Construction Law shall prevail over the Commercial Law and Civil Code; and

• With respect to the private construction contracts, since the Construction Law is silent on the maximum amount of penalty for breach of contract, the Commercial Law (as a specialized law regulating this matter which do not contravene the fundamental principles of civil law prescribed in the Civil Code) shall prevail over the Construction Law and the Civil Code.  Under the Commercial Law, the maximum amount of penalty of 8 percent of the value of the contract obligation which is breached shall be applicable to construction contracts satisfying requirements to be commercial laws (including construction contract for private construction works as well).  Under this analysis, the clarification of the MOC under OL 48 appears to be inconsistent with principles of resolution of conflict of laws provided under the Law on Promulgation of Legal Documents 2015, the Civil Code and the Commercial Law.

Conclusion

The interpretation by the MOC in OL 48 once again raises the importance of defining and applying the principles of the resolution of conflict of laws, in particular, between the Civil Code, the Commercial Law, and the Construction Law. It is undeniable that a specific legal matter may be subject to many/various legal documents at the same time and conflict of laws incurred between legal documents on the same issue is inevitable. However, the unification of methods of determining and applying conflict resolution principles will play an important role in the proper and appropriate determination of provisions of the law to be prevailing/predominant for the application in each specific case. In practice, conflict of laws in many cases is extremely sophisticated and onerous to handle even when the principles of conflict resolution have already been applied.

The opinions presented in this article attempt to generalize conflict resolution principles in the context of the relationship under a construction contract. However, since the Civil Code is effective within a limited period, and there is no or limitation in case law in practice, these opinions are mainly a theory-based analysis of relevant provisions of the law and in need of further development and codification when the case law after the effective date of the Civil Code becomes more available.-


[1]  Truong Nhat Quang, Managing Partner, YKVN Law Firm
Pham Hoai Huan, LL.D., Ho Chi Minh City Law University
[2]  Article 138.1 of the Construction Law stipulates: “Construction contracts are civil contracts established in writing between principals and contractors to perform in part or wholly the work in construction investment activities.”.
[3] Under Article 3 of the Civil Code, five fundamental principles of civil law include: (i) no discrimination, (ii) freedom of agreement, (iii) goodwill and honesty, (iv) no infringement upon public interests, and (v) self-liability.
[4] Under Article 3 of the Civil Code, five fundamental principles of civil law include: (i) no discrimination, (ii) freedom of agreement, (iii) goodwill and honesty, (iv) no infringement upon public interests, and (v) self-liability.
[5] Under Article 3 of the Civil Code, five fundamental principles of civil law include: (i) no discrimination, (ii) freedom of agreement, (iii) goodwill and honesty, (iv) no infringement upon public interests, and (v) self-liability.
[6] Clauses 2 and 3, Article 4 of the Civil Code stipulates:
“2. Other relevant laws that regulate civil relations in specific fields must not contravene the fundamental principles of civil law prescribed in Article 3 of this Code.
3. In case another relevant law makes no provisions or makes provisions which, however, violate Clause 2 of this Article, the provisions of this Code shall apply.”
[7] Article 4 of the Commercial Law: “1. Commercial activities must comply with the Commercial Law and relevant laws.
2. Particular commercial activities provided for in other laws shall comply with the provisions of such laws.
3. Commercial activities which are not provided for in the Commercial Law and other laws shall comply with the provisions of the Civil Code.”

 

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