The value of liquidated damage clause in construction contracts

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The value of liquidated damage clause in construction contracts

The liquidated damages agreement is not a new concept, it is becoming increasingly popular and is considered by the parties entering into commercial contracts. Liquidated damage is also commonly applied in construction contracts, especially in major transactions and/or cases in which the actual and direct damages of one party may be difficult to prove. Nonetheless, the effectiveness of this term has not yet been clearly stipulated by the laws in Vietnam. Within the scope of this article, we will review some notable regulations on liquidated damage clauses, their practical application in disputes settlement in Vietnam, and their application under construction contracts.

Some notable regulations on the liquidated damage clause

In principle, the violating party causing damages to either party shall be responsible for compensating the entire damage as prescribed in the Civil Code and this rule is applicable in most legal areas unless otherwise agreed by the parties or stated by the laws. According to the above, it may be assumed that the parties having a contractual relationship may have the right to agree on the liquidated damage clause. However, so far, the provisions on compensation for damage agreed by the parties in advance as mentioned are not clarified by the Civil Code. Besides, there is no provision on the applicable conditions of liquidated damage. Thus, general provisions in the Civil Code and the Commercial Law shall be prioritized for regulating this issue. 

According to the current laws, one party is only liable to compensate the other party for damages arising in the presence of the following conditions: (i) there is a breach of contract, (ii) having actual damage, (iii) there is a causal relationship between the breach of contract and the damage caused, (iv) there is a fault of the breaching party without the event of force majeure. The compensated damages must be actual and direct, comprising physical damages and spiritual damages, such as (1) loss of property, (2) reasonable expenses to prevent, mitigate or remove damage, (3) the actual loss or reduction of income. Additionally, in commercial relationships, the Commercial Law also prescribes other compensable damages including (4) the interest the non-breaching party is deemed to have without the contractual violation; (5) any expenses arising to fulfill its contractual obligations which do not overlap with the amount in item (4). Based on the mentioned provisions, liquidated damage may not be considered as compensable damage since it is not actual, direct and does not have a causal relationship with the breach of contract.

Practical application in settling dispute related to the agreement on predefined compensation damage in Vietnam

Some precedents show that the current viewpoint of Vietnamese courts is not unified. For instance, the Decision No. 15/2016/KHTM-GDT dated 07/09/2016 of the Supreme People’s Court on the “Construction contract dispute” among a Technical and Service Joint Stock Company A (“Company A”) and Company B. On 02/05/2007, a contract was made between Company A and Company B in order to provide a 3B package “Electro-Mechanical Services”, in which Company B was the main contractor and Company A was the subcontractor taking the responsibility for the construction. During performing the contract, Company B stated that Company A violated the contract due to its late payment, hence, Company A was the subject of a fine of 5% from the contract value, in accordance with the Contract Appendix. At the first-instance stage, the court did not accept the claim, and neither did the appellate trial panel; and hence, the first-instance judgment remained upheld. However, after it was reviewed according to the cassation procedures, the Judicial Council of the Supreme People’s Court ascertained that the liquidated damage clause predefined by the parties, equal to 5% of the contract value, was considered as a penalty clause. Accordingly, it was necessary to define the value of the contract breached by Company A in order to define the exact amount of fines Company A had to pay.

In Judgment No. 22/2019/DS-PT dated 06/03/2019 by the People’s Court of Lam Dong Province on the “Construction contract dispute” among plaintiffs including Mr. Cam Van Tr, Mrs. Duong Thi D (“Mr. Tr, Mrs. D”) and the defendant -Construction Joint Stock Company Youth DV (“Company DV”), the courts took the different views. According to the construction contract signed on 02/10/2015, Company DV shall provide private house construction services for Mr. Tr, Mrs. D. During the term of this contract, Company DV failed to comply with the committed work schedule. Therefore, Mr. Tr, Mrs. D filed the lawsuit to request the Court compelling Company DV to compensate for violating the completion schedule from 24/01/2016 to 05/10/2016 (287 days in total) with the compensation amount of (1.450.000.000 VND x 0.1 x 287 days) 416.000.000 VND. Accordingly, the first-instance court did not accept the claim to compensate contractual damage with the amount of 416.000.000 VND. However, the appeal court stated that Company DV had violated not only the completion schedule but also the construction quality. Consequently, the appeal court accepted the claim and request Company DV to compensate contractual damage with the amount of 416.000.000 VND for Mr. Tr, Mrs. D.

The applicable value of this term in the construction contract

Although the legal regulations and courts’ viewpoints have not yet been unified as mentioned above, the liquidated damage clauses are currently a tendency and appear popularly in many construction contracts. Especially, within model terms of the construction contract drafted by the International Association of Consulting Engineers (FIDIC) (hereinafter referred to as the “FIDIC Contract”). the FIDIC Contract is also encouraged by the Vietnam Government in order to be applied in construction projects with state-invested capital. In general, some of the terms are similar to the liquidated dâmge clause in construction contracts, such as: (i) the contractor must compensate investors (or contractee) a definite amount of money for each day of delay multiple by the total number of days of delay, (ii) must compensate an exact amount of money predefined by parties in the contract in case of breaching the construction quality.

In principle, one construction contract may be regulated by the Construction Law, the Civil Code, and even the Commercial Law as it may be signed by the parties being traders in the field of construction. Hence, the provisions related to compensation for damage in general, and the liquidated damage clause in particular in construction contracts are also regulated by the 03 mentioned above laws as the case may be. Inevitably, the legal provisions on the liquidated damage clause and the practical application in disputes settlement in Vietnam as presented in the previous paragraph shall be also applied. 

It can be seen that the liquidated damage clause has not yet been clearly regulated by the laws. It is, however, not a clause that shall be voided in its entirety in accordance with Vietnamese laws. Indeed, this kind of agreement plays a role as a term to ensure the proper performance of the contract parties. I a party breaches the contract, the liquidated damage clause may be used as a legitimate basis for immediately requiring the breaching party to compensate. Besides, the liquidated damage clause also creates an advantage for the party being breached in negotiating processor is a powerful basis for initiating a lawsuit at a competent court or arbitration to settle disputes. Hence, enterprises should take into consideration the role of the liquidated damage clause during negotiating, entering into and performing construction contracts.

If you have any questions or require any additional information, please contact Apolat Legal – An International Law Firm in Viet Nam.

This article is for general information only and is not a substitute for legal advice.