Overview Of Penalties For Breach Of Contract (part 3)

Overview Of Penalties For Breach Of Contract (part 3)

The concept of conflict of laws is not new, especially in the dynamic law system of Vietnam. The conflict of laws usually refers to an issue subject to two or more different legal instruments in which these legal instruments can provide contradictory instructions/regulations. The conflict of laws regarding contractual penalties is a typical example. 

See more: Overview Of Penalties For Breach Of Contract (part 2).

Within Vietnamese laws, the contractual penalty has been primarily subject to three legal instruments, which are the Civil Code 2015, the Commercial Law 2005 and the Construction Law 2014. To understand how the contractual penalty works under Vietnamese law, please reach out to my previous articles, namely “Overview and Conditions applicable to the Agreement on Penalties for Breach” and “The amount of a contractual penalty and how to determine it in reality”.

Contractual penalties under Vietnamese law and how they conflict with each other

Regarding the contractual penalty, all those legal instruments agree that the contractual penalty shall be available only by a written agreement. By which, the parties reserve the right to negotiate the amount of contractual penalty to impose upon their transaction. However, those legal instruments provide different instructions from each other when it comes to the limitation on the amount of contractual penalty. While the Civil Code allows an indefinite amount, the Commercial Law and the Construction Law set out the limitation on the amount of contractual penalty of 8% and 12%, respectively. 

In addition to the distinctions between those on the limitation on the amount of a contractual penalty, the Construction Law also discriminates which construction works are subject to this provision of the contractual penalty. Specifically, according to Article 146.2 of the Construction Law, the contractual penalty shall not exceed 12% of the value of the breached obligation for construction works using state capital. In other words, although the governing scope of the Construction Law covers all construction relations within the territory of Vietnam, only construction work using state capital is limited to the amount of the contractual penalty. 

However, the Construction Law does not provide any guidance on the maximum amount of a contractual penalty applicable to commercial construction work not using the state budget. In comparison, the Civil Code and the Commercial Law do not impose any discrimination against any subjects regarding the contractual penalty. Consequently, the discrimination among construction works under the Construction Law leads to a degree of ambiguity as to whether the non-state-capital construction works will be subject to the Civil Code or the Commercial Law regarding the amount of a contractual penalty. For example, if both parties to a non-state-capital construction contract are commercial legal entities subject to the Commercial Law, will the amount of contractual penalty be limited to 8% of the value of the breached obligation under Article 301 of the Commercial Law 2005? or will it be depended on the agreement between the parties without any limitation under the Civil Code? 

For years, this has been a hot dispute. To answer this question, we have to clarify a “gray spot” of the laws, which have triggered many hot debates in the legal industry. It is the conflict of laws on the governing scope. 

The conflict of laws on the governing scope

As you may know, the Civil Code is as known as a “big brother” in Vietnamese laws as the Code governs all civil relations in Vietnam. The Code provides a fairly broad and general definition of a civil relation, by which it is enabled to govern almost all transactions under the jurisdiction of the laws of Vietnam. 

In contrast, both Commercial Law and the Construction Law are deemed specialized laws, which only govern a specific subject, commercial relations and construction relations, respectively. Specifically, the Commercial Law governs all commercial relations/activities within the territory of Vietnam or relations to which at least one party is a business entity. The Construction Law governs all construction relations/activities within the territory of Vietnam. 

In practice, those laws are rarely in direct conflict with each other. This could be attributed to a principle of conflict resolution between general laws and specialized laws as prescribed in the Civil Code and the Commercial Law. Theoretically, the concept of this principle is that if there is a discrepancy between the laws regarding a specific issue, the specialized laws on that issue shall prevail, provided that the prevailed one is not inconsistent with the basic principles of civil law prescribed in the Civil Code. Otherwise, the general law will prevail. 

The words of “general law” do not only refer to the Civil Code but to the Commercial Law as well. Though the Commercial Law is deemed a specialized law, the Commercial Law can still be referred to as a general law in the perspective of other specialized laws. Specifically, according to Article 4.2 of the Commercial Law, in the case of specialized commercial activities provided for in other specialized laws, the provisions of such other specialized laws shall prevail. Therefore, when it comes to an issue subject to the Commercial Law and other specialized laws, the provisions of other specialized laws shall prevail over the Commercial Law to apply to that issue. In this case, the Commercial Law is a general law.

Moreover, the Commercial Law also provides that the provisions of the Civil Code shall apply to a commercial activity which is not governed by the provisions of the Commercial Law and by provisions of other specialized laws. Therefore, we can conclude that if an issue is subject to the Civil Code, the Commercial Law, and the Construction Law, the principles on the application order of those laws will be as follows:

(i) If the issue is governed by the provisions of the Construction Law, the Construction Law shall prevail;

(ii) If the issue is not governed by the provisions of the Construction Law, the Commercial Law shall prevail; and

(iii) If the issue is not governed by the provisions of the Commercial Law and the Construction Law, the Civil Code shall prevail.

It seems pretty clear when we read out loud these governing scopes with the coherent principles above. However, when it comes to reality, it is not likely to happen in the same way. 

The reality and the perspective of the Court

With respect to the contractual penalty, all those mentioned legal instruments have their own provisions. As per the above principles on the application order of those laws, if an issue/relation falls into the governing scopes of those legal instruments, the Construction Law shall be the first priority over the Commercial Law and the Civil Code. The Commercial Law will take precedence over the Civil Code. Whenever the Construction Law does not provide any guidance or regulation on such issue/relation, it will be governed by the related provisions of the Commercial Law. If both Commercial Law and Construction Law fail to cover that issue/relation, the Civil Code will prevail.

Therefore, following that principle, where the Construction Law does not cover the non-state-capital construction work regarding the contractual penalty, the provision of the Commercial Law on the contractual penalty shall prevail. As a result, the amount of contractual penalty regarding the non-state-capital construction work will be supposed to be limited to 8% of the value of the breached obligation under Article 301 of the Commercial Law 2005.

However, according to the Cassation of the Supreme Court of Vietnam No. 12/2019/KDTM-GĐT regarding a dispute between two commercial legal entities over a construction contract, the Justice Council of the Supreme Court held that “the Construction Law as a specialized law governing construction contracts would prevail to apply to the construction contract in this case. Where the Construction Law does not provide any related provision, then the provisions of the Civil Code shall prevail instead of the Commercial Law.” As a result, the Justice Council overruled the Cassation of the High Court regarding the application of the Commercial Law on the construction contract. However, the Justice Council did not give any rationale for that holding. Moreover, prior to this Cassation, the Ministry of Construction had expressed the same opinion of the Justice Council via a response No. 48/BXD-KTXD dated September 03rd, 2019, that the Civil Code shall prevail instead of the Commercial Law regarding the contractual penalty in the construction contract. 

In my opinion, the rationale behind this opinion may be that the Construction Law defines the construction contract as a civil contract. Specifically, according to Article 138.1 of the Construction Law, the construction contract means a written civil contract between the principal and the contractor to perform a part or all the works of the construction investment activities. This provision of the Construction Law has omitted the principle of conflict resolution between general laws and specialized laws by expressly designating the Civil Code to govern the construction contract instead of the Commercial Law. 

Conclusion

The conflict of laws is not new in the law industry. Many principles on the application order between legal instruments have been promulgated to resolve the issue of the conflict of laws. In Vietnam, one of the notable principles of conflict resolution is the principle of the conflict resolution between general laws and specialized laws.

Although the principle of conflict resolution between general and specialized laws is theoretically quite clear, this principle does not apply to all issues in practice. An exception to this principle is when the specialized law expressly designates another law as the governing law rather than following the order under the principle. The contractual penalty is a typical example of this exception. By which, this principle has been omitted easily when the Construction Law designates the Civil Code as the governing law over construction contracts instead of the Commercial Law. 

In other words, the contractual penalty regarding a construction contract without state capitals will be limited to 12% of the value of the breached obligation, while there is no limitation on the maximum amount of contractual penalties on other construction contracts. In conclusion, for construction contracts in general and contractual penalties in particular, the application of laws will be in the following order: the Construction Law, the Civil Code and eventually the Commercial Law.