Vietnam became the 150th official member of the World Trade Organization as of January 11, 2007. Along with the process of building a market economy, renewing various fields of social life, the legal system has been continuously revised, supplemented, and perfected to meet the requirements of renovation and international integration. In the field of finance - banking, the State Bank of Vietnam has utilized various tools, including interest rates, to implement monetary policy through the issuance of legal normative documents within its authority.
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Currently, the lending interest rates are negotiated by credit institutions with customers and are specifically defined in the loan agreement/loan contract/credit contract based on the provisions of the Civil Code 2015, the Law on Credit Institutions 2010 and the guidelines issued by the State Bank of Vietnam. Besides the interest rate issue in loan contracts, penalties for breach of contract also constitute a core part of the loan agreement. Among the forms of civil liability in civil contracts, breach of contract penalties are the most common form. This is a form of civil liability agreed upon by the parties in the contract to compel the party causing the damage to remedy the consequences by compensating for material and spiritual losses to the aggrieved party. In the current practice of entering into civil contracts, most contracts include agreements on breach of contract penalties. However, determining how these terms should be agreed upon to be lawful and protect one's legitimate rights and interests requires more detailed guidance from competent state authorities to effectively implement these provisions in civil contract agreements.
1. Legal Provisions
A contract is an agreement between parties to establish, change, or terminate rights and obligations in a particular matter or field. If a contract in a civil field (such as buying and selling a house or a car, etc.) is made between individuals, it is called a “civil contract.” If a contract involves at least one party with profit-making and commercial purposes and business registration, such as Company A selling products it manufactures to Company B, it is called a “commercial contract.” If a contract pertains to specialized fields with specific laws, the contract will be named accordingly. For instance, a construction contract signed between two companies, governed by the Construction Law, is referred to as a “construction contract.”
A breach of contract occurs when one party violates (one or more) obligations agreed upon in a contract signed by both parties. Penalties for breach of contract are not mandatory but are based on the agreement between the parties. However, this agreement (if any) must be clearly stated in the contract. If the contract does not include this provision, it is considered that both parties do not have an agreement on it.
Breach of contract penalties, or liquidated damages, are agreements wherein the breaching party is required to pay a sum of money to the aggrieved party. The penalty amount for civil contracts is agreed upon by both parties, whereas in commercial and construction contexts, it is based on the value of the breached contractual obligation and may not exceed 8% or 12%.
Article 418 of the Civil Code 2015 stipulates agreements on breach of contract penalties as follows:
"1. A penalty for breach is an agreement between the parties in the contract, wherein the breaching party must pay a sum of money to the aggrieved party.
2. The penalty amount is agreed upon by the parties unless otherwise stipulated by relevant laws.
3. The parties may agree that the breaching party only has to pay the penalty without compensating for damages or bears both the penalty and compensates for damages.
If the parties agree on penalties but not on both penalties and damage compensation, the breaching party only has to bear the penalty."
According to Article 418 of the Civil Code 2015, the parties can agree that the breaching party only has to bear the penalty without compensating for damages or must bear both the penalty and compensate for damages. The parties may also agree in advance on damage compensation and specify an exact amount in the contract.
Given the nature of breach penalties as a preventive measure to avoid and limit violations (before they occur) and as a punitive measure for the breaching party (once the violation has occurred), the law respects and facilitates the parties’ agreement. However, what constitutes a reasonable penalty amount and damage compensation is a matter of significant concern. According to some opinions, to ensure maximum contractual freedom, the current Civil Code does not limit the penalty cap. However, if there is no limit, parties may agree on a very high penalty, theoretically valid, but practically unfeasible, making it difficult for the breaching party to fulfill obligations, thereby rendering the provision ineffective. Thus, competent state authorities need to research and issue guidance on appropriate penalties considering practicalities.
Article 25 of the Circular 39/2016/TT-NHNN dated December 30, 2016, of the State Bank of Vietnam stipulates lending activities by credit institutions and foreign bank branches with customers:
"1. Credit institutions and customers may agree on penalties and damage compensation as prescribed by law if either party fails to perform as agreed in the loan agreement, except as stipulated in Clause 4, Article 13 of this Circular.
2. Credit institutions and customers may agree that the defaulting party only has to bear the penalty without compensating for damages or must bear both the penalty and compensate for damages. If they agree on penalties but not on both penalties and damage compensation, the defaulting party only has to bear the penalty."
Article 74 of the Vienna Convention 1980 on the International Sale of Goods (CISG) provides for damage compensation as follows: Compensation for damages resulting from a breach of contract includes losses and profits foregone suffered by the aggrieved party as a result of the breach. This compensation must not exceed the loss and profits foregone that the aggrieved party foresaw or should have foreseen at the time of contract conclusion as a possible consequence of the breach, considering circumstances they knew or should have known. Thus, CISG permits parties to foresee damage compensation at the contract conclusion in addition to other principles (similar to those stipulated in the Commercial Law 2005). Allowing for pre-determined compensation shows a similarity between CISG and the laws of some countries such as England and the USA. Pre-determined compensation must be foreseen at the contract conclusion, and if damage occurs, the proposed compensation must not exceed the pre-determined amount. These foresights sometimes serve to limit the actual compensation. As a member of the Vienna Convention 1980 since November 2015, Vietnam always complies with its international treaty obligations; incorporating CISG's provisions, including allowing pre-determined damage compensation, is an issue of focus.
2. Limitations and Obstacles
The practical implementation of legal provisions on interest rates and breach penalties in credit contracts in recent times has encountered some limitations and issues as credit contracts are executed based on mutual agreements. According to this principle, interest rates, overdue interest rates, and breach penalties are agreed upon by the parties.
It is clear that interest rates, overdue interest rates, and breach penalties are regulated in the Civil Code and other related laws such as the Law on Credit Institutions, and the Commercial Law. However, in the judicial system, there has been no uniform understanding of these legal provisions, leading to inconsistency in adjudicating similar credit contract disputes. Some courts accept calculating both overdue interest and breach penalties, while others only accept overdue interest, rejecting penalties, reasoning that imposing both constitutes “interest on interest” or “penalty on penalty.”
Regarding the timing and calculation of interest to ensure the rights of the enforcement creditor: in essence, this involves determining when the responsibility for delayed enforcement arises. In the absence of guiding documents for the Civil Code 2015, many courts have applied the spirit of Joint Circular 01/TTLT dated June 19, 1997, of the Ministry of Justice, Ministry of Finance, Supreme People's Court, and Supreme People's Procuracy of Vietnam, which guided property adjudication and enforcement (this Circular guided the Civil Code 1995 and is no longer in effect), or have resorted to case law, resulting in inconsistent legal applications.
Article 362 of the Civil Code 2015 stipulates that "the entitled party must take necessary and reasonable measures to prevent or mitigate damages." This presents a disadvantage for the entitled party and, in practice, may be unfeasible, as the obligated party might exploit this requirement to avoid paying damages.
3. Recommendations and Proposals
From the above analysis, it is evident that revising the legal framework on damage compensation is urgent amidst the increasingly diverse and evolving contractual relationships. The author agrees that allowing parties to freely agree on fixed compensation amounts can lead to abuse, particularly in contracts where one party is weaker.
However, limiting contractual freedom for this reason would be regrettable. Therefore, considering practical needs and the requirement to minimize abuse of legal provisions while ensuring uniform application of laws on interest and breach penalties in contracts, we have the following recommendations and proposals:
- Regarding interest rates and breach penalties: Although the Civil Code 2015, the Law on Credit Institutions, and the Commercial Law clearly address these, detailed regulatory guidance on interest rates, overdue interest rates, and breach penalties is lacking, potentially leading to inconsistent legal application.
- Regarding responsibilities for delayed enforcement: The former Joint Circular 01/TTLT dated June 19, 1997, has expired, leaving no replacement guidance. To protect the rights of the enforcement creditor and prevent evasion of obligations by the debtor, it is necessary to incorporate reasonable elements from the previous Circular to guide the determination of delayed enforcement responsibilities in civil disputes in general and credit contracts in particular, in accordance with Article 357 of the Civil Code 2015 and Clause 5, Article 3, Clause 1, Article 30 of the Civil Procedure Code.
- Recommend amending legal provisions to allow parties to agree on fixed damage compensation at the contract conclusion, which can be a specific sum or a predetermined calculation method. Such agreements should be declared void if the foresight is punitive, proposing an excessively large sum compared to the real damage. In contracts between merchants and consumers or weaker parties, such agreements should also be void if the compensation amount imposed on the consumer or weaker party is disproportionately high.
Source: Ministry of Justice
