Issue 021221 – Penalty and compensation for the violation of the construction contract under the provisions of Construction Law

Dear Valued Clients,

Compensation for damage and penalty for violation of the contract are two common sanctions in civil contracts. However, for each different field, the regulations on compensation for damage and penalty for violation of the contract will be governed by separate specialized laws. In this article, we will focus on sharing the legal provisions related to compensation and penalty for the violation of construction contract.

I. OVERVIEW OF THE PENALTY FOR VIOLATION AND THE COMPENSATION FOR DAMAGE

1. Penalty for violation

Pursuant to Clause 1 Article 418 of the Civil Code, the penalty for violation (the “Penalty”) is understood as an agreement between the parties in a contract whereby the breaching party must pay a sum of money to the aggrieved party.

2. Compensation for damage

Pursuant to Article 13 of the Civil Code, the compensation for damage (the “Compensation”) means that individuals or legal entities whose civil rights have been infringed are compensated for all damage, unless otherwise agreed by the parties or otherwise provided for by law.

3. Construction Contract

Pursuant to Clause 1 Article 138 of the Construction Law, a construction contract means a civil contract agreed in writing between the principal and the contractor to perform part or all of work in construction investment activities.

Based on the above definition, it can be seen that a construction contract is a type of civil contract and is governed by the Civil Code. On the other hand, a construction contract is usually entered into by at least one party, the subject is a trader and the purpose of the contract is to make a profit, so the construction contract is also a commercial contract and subject to the regulation of the Commercial Law.

Thus, a construction contract will be governed by the Civil Code, the Commercial Law and the Construction Law at the same time. This can lead to a conflict of laws if a legal issue is regulated differently between the legal documents.

II. PENALTY AND COMPENSATION FOR THE VIOLATION OF A CONSTRUCTION CONTRACT UNDER THE PROVISIONS OF CONSTRUCTION LAW

1. Penalty for violation

1.1. Settlement of legal conflicts about the level of penalties for violations

Currently, there is no consensus on the level of penalties for violations specified in the legal documents of Vietnam. Specifically, Article 301 of the Commercial Law stipulates that the penalty level for violation shall be agreed upon by the parties in the contract but must not exceed 8% of the value of the breached contractual obligation. For the Construction Law, the maximum penalty is 12% of the value of the breached contract and only applies to the case of construction works using state capital. Unlike the two legal documents mentioned above, the Civil Code does not limit the maximum penalty left to the parties to agree in the contract. Therefore, the parties may face difficulties in determining the fines for violations in construction contracts in accordance with the provisions of the law.

In this regard, we will explain two basic principles when a conflict of laws occurs as follows:

• The later promulgated legal documents principle: This principle is understood that in case legal documents promulgated by the same agency have different provisions on the same issue, the provisions of the latest legal documents shall apply (Clause 3 Article 156 of the Law on Promulgation of Legal Documents);
• The general and specialized law principle: This principle is understood that in case a general law (eg Civil Code) and a specialized law (eg Commercial Law, Construction Law) govern the same legal issue, if the provisions of the specialized law do not contrary to the legal provisions in the general law, then, the provisions of the specialized law shall prevail.

The two principles (i) and (ii) need to be used flexibly and in coordination to avoid conflicts.

When applying the above two principles to resolve the conflict of laws in this case, it can be seen that the provisions on penalties in the Construction Law and the Commercial Law are not contrary to the basic principles of the Civil Code. Therefore, contracts governed by the Construction Law and the Commercial Law will prioritize applying the penalty under these two laws.

1.2. Level of penalty for violations in construction contracts

With the resolution of the above-mentioned conflict of laws, the level of penalty in a construction contract will be understood as follows:

• Contracts for state fund constructions

Pursuant to Clause 1 Article 146 of the Construction Law, for state fund constructions, the contract penalty must not exceed 12% of the breached contract value.

• Contracts for non-state fund constructions

Currently, the Construction Law does not have direct provisions related to the level of penalty for non-state fund construction contracts. However, construction contracts normally also be governed by the Commercial Law (as mentioned in Section I.3), the maximum penalty for a non-state fund construction contract will be 8% of the value of the breached contractual obligation (Article 301 of the Commercial Law).

2. Compensation for damage

2.1. The cases applied for compensation

The Construction Law has set out several cases where the violating party must compensate for damage caused by the breach of a construction contract as follows:

• The cases that the contractor must compensate for the principal[1]:
  • The quality of the work is not guaranteed as agreed in the contract or the completion time is extended due to the contractor’s fault.;
  • Due to the contractor’s cause, causing damage to people and properties during the warranty period.
• The cases that the principal must compensate the contractor[2]:

• • Due to the contractor’s cause, the contract work is interrupted, delayed, and risky, and the machine, equipment, materials and components are in stock for the contractor;
  • The principal provides documents and necessary conditions for the work that are not in accordance with the agreements in the contract, causing the contractor to re-construct, suspend or modify the work;
  • In case the construction contract stipulates that the principal provides materials, equipment, and other requirements but fails to provide them on time and according to the prescribed requirements;
  • The principal is late in payment as agreed in the contract.
• Other cases related to the obligation to compensate for damage caused by the breach of construction contract

• • In case a party fails to perform the contractual obligations or performs a contractual obligation inconsistently with the provisions, after performing the obligation or applying remedial measures, it must also be responsible for compensating if the aggrieved party suffers other damages, the level of compensation must be equivalent to the loss of the aggrieved party;

• • In case a party breaches the contract due to a third party’s cause, the violating party shall be responsible for the breach of the contract before the aggrieved party. Disputes between the violating party and a third party shall be resolved in accordance with the law.

2.2. Level of compensation

The Construction law does not specify the level of compensation when breaching a construction contract. Therefore, applying the analytical method to the penalty, the level of compensation can be adjusted by the Civil Code or the Commercial Law.

• Regulations on Civil Code
  • Article 360 stipulates: “In case the damage caused by a breach of an obligation, the obligor must compensate for all damage, unless otherwise agreed upon or otherwise provided by law”.
  • Clause 2 Article 419 stipulates: “The obligee can claim damages for benefits he or she would otherwise have enjoyed as a result of the contract. The obligee may also require the obligor to pay expenses incurred due to the failure to fulfill the contractual obligations which do not overlap with the compensation for damages for the benefits brought by the contract.”.
• Regulations on the Commercial Law

Clause 2 Article 302 stipulates: “The value of compensation includes the value of the actual and direct loss suffered by the aggrieved party caused by the violating party and the direct benefits that the aggrieved party would have enjoyed if there were no violation “.

Based on the above provisions, the calculation of the level of compensation will depend on the actual and direct damage value that occurs in each specific case.

As usual, we hope you find this Legal Article useful and look forward to working with you in the future.

Kind regards,

ENT Law LLC

The full version of this Legal Article can be found here.

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[1] Clause 4 Article 146 of the Construction Law.

[2] Clause 5 Article 146 of the Construction Law.