In global commerce, liquidated damages have become a common tool for addressing breaches of contract.

However, in Vietnam, this mechanism has not yet been clearly established in the legal framework, leaving businesses with the question: should it be applied, or approached with caution?

1. Concept and characteristics

Liquidated damages are a prior agreement between contracting parties on a specific sum of money that the breaching party must pay if the contract is violated. Key features include:

• Agreed in advance at the time of contract signing.
• Preventive in nature, allowing parties to anticipate risks.
• No need to prove actual damages, unlike traditional compensation.

2. Legal basis: International and Vietnamese comparison

Foreign law:

• Common Law (UK, US): Recognized as valid, but if the sum is excessive compared to actual losses and punitive in nature, it will be deemed a penalty clause and rendered unenforceable.
• Civil Law (France): Unlike Common Law systems, French law does not draw a strict line between liquidated damages and penalty clauses. Liquidated damages are recognized as valid contractual agreements, but not absolutely. Courts retain the power to adjust the amount to ensure fairness and prevent punitive misuse.

Vietnamese law:

• Article 360 of the Civil Code 2015: The breaching party must compensate for all damages unless otherwise agreed. The phrase “otherwise agreed” is interpreted as an opening for liquidated damages clauses.
• Article 292 of the Commercial Law 2005: Allows parties to agree on alternative remedies beyond penalties or compensation, provided they do not contravene fundamental principles of Vietnamese law or international trade practices.

International treaties:

• Article 74 of the 1980 Vienna Convention (CISG): Permits parties to agree on damages not exceeding the foreseeable loss at the time of contract conclusion, thereby indirectly recognizing liquidated damages.
• TRIPs Agreement: Grants parties the right to request adjudicating bodies to enforce predetermined damages, particularly in intellectual property disputes.

3. Practice in Vietnam

Article 302(2) of the Commercial Law 2005 stipulates:

The value of compensation includes actual, direct losses suffered by the aggrieved party due to the breach, and direct benefits that the aggrieved party would have enjoyed had the breach not occurred.

This emphasis on “actual losses” implies that damages must be proven in reality, not predetermined in contracts. Based on this:

• Courts often require proof of actual damages; otherwise, the clause is treated as a penalty and capped at 8% under Article 301 of the Commercial Law 2005.
• Arbitration tribunals may be more flexible, but if Vietnamese law governs the dispute, they tend to follow the same approach as courts.

Result: Even with prior agreements, businesses risk unenforceability if they cannot provide evidence of actual losses.

4. What should businesses do?

• Foreign enterprises: When contracting in Vietnam, clauses should be tailored to comply with Vietnamese law to avoid invalidation of liquidated damages provisions.
• Vietnamese enterprises: Should not completely exclude liquidated damages clauses, but must apply them cautiously, ensuring amounts are reasonable and appropriate to each transaction.

Conclusion: In the long run, it is necessary to refine Vietnamese law to explicitly recognize liquidated damages (with reasonable controls), thereby fostering a transparent, consistent, and business-friendly legal environment.