Among various remedies for handling violations when performing the contract, Fines for breaches are considered one of the most commonly used ones, besides forcible payment of damages. Agreements on Fines for breaches in commercial contracts will help the parties take the responsibility for the contract performance more seriously and also serve as a basis for the aggrieved party to force the violating party to bear a fine to partially remedy the consequences caused by the violation.
Legal provisions on Fines for breaches in contracts
Fines for breaches are stipulated in the Civil Code 2015 (“Civil code”) and the Commercial Law 2005 (“Commercial law”), in which Fines for breaches in commercial contracts of the parties, whereby the violating party must pay a sum of money to the aggrieved party. Thus, to apply this remedy, the parties must have an agreement on Fines for breaches in contracts.
Civil Code and Commercial law respect the parties’ agreement on Fines for breaches, however, certain limits on the level of fines are set out in some particular cases. Clause 2, Article 418 of the Civil Code stipulates that the fine levels shall be agreed upon among the parties unless otherwise prescribed by relevant laws. Article 301 of Commercial law also stipulates that the fine level for a breach of a contractual obligation or the aggregate fine level for more than one breach must not exceed 8% of the value of the breached contractual obligation portion, except for fines in case of incorrect assessment results.
In the commercial field, the parties need to identify and distinguish between the value of the breached contractual obligation and the contract value, whereby the scope of the contract value is broader than that of the contractual obligation under violation. The violating party will have to pay a fine calculated on the value of the violated contractual obligation, not on the value of the whole contract. For example, in a sale contract, when the buyer makes a late payment, the buyer only has to pay a fine for the late payment, not the entire contract value.
Conditions for applying Fines for breaches in contracts
To apply fines for violations in practice, all of the following 03 conditions need to be met:
- The parties have an agreement on Fines for breaches in the contract, the fines may be in force when one or all parties commit one or more acts of contract breach. In case no agreement is reached in the contract, no Fines for breaches can be applied. This is a principled regulation that requires the parties to have an agreement in advance if they want to apply fines for violations. Such agreement may have been available since the parties signed the contract or were supplemented by the parties during the performance of the contract.
In case the agreed fine level exceeds the limit prescribed by law, it will be automatically set equal to the fine level prescribed by law when a dispute arises. In the field of commerce, if the parties agree on a fine exceeding 8% of the breached contractual obligation’s value, the excess will have no effect and the fine will only be determined according to the law.
- One or the parties perform one or more acts of contract breach, and according to the agreement in the contract, the violating party must bear a fine for a such violation when doing so. The agreement on fines for breaches is only considered one necessary condition. However, performing one or more acts of contract breach by one or the parties is another required condition for the fines to arise in practice.
Acts of contract breach are not exempt from liability. Some following exemptions from liability are:
- Occurrence of a liability exemption case as agreed by the parties;
- Occurrence of a force majeure event that occurs objectively, unforeseeable, and cannot be remedied even though all necessary and permissible measures have been applied;
- The violation of one party is entirely due to the other party’s fault. In case the violation is caused partly by the violating party’s fault, they will have to bear the fines corresponding to their fault;
- The violation of one party is for the implementation of a competent state management agency’s decision that the parties could not know at the time of entering into the contract.
The violating party will be obliged to prove the circumstances of their exemption from liability. Otherwise, it means that the violating party is not exempt from liability and will have to pay fines as agreed in the contract instead.
Difference between Fines for breaches in commercial contracts in Civil Code and in Commercial law
- On the application scope: Fines for breaches in Civil Code are applied in the civil field in general, while that in the Commercial Law are applied to commercial business activities taking place mainly between traders, including activities for profit purposes such as goods trading, providing services, investing, commercial promoting, etc. Traders are defined as legally established economic organizations, individuals with independent and regular commercial activities and a sufficient business registration certificate.
- Regarding the level of fines: Civil Code does not stipulate a limit on the level of Fines for breaches unless specialized laws have specific provisions. Accordingly, the parties can freely agree on the fine levels for violations. Commercial law limits the number of fines for breaches, specifically, the fines will be agreed upon by the parties but must not exceed 8% of the value of the breached obligation, except for fines in case of incorrect assessment results.
Are enterprises obligated to agree on Fines for breaches during contract drafting?
Fines for breaches are one of the remedies to handle and settle the violations of one or the parties in the process of establishing, performing, and terminating the contract. Current law does not stipulate that the parties must agree on this remedy, but the agreement of parties in the contract is a required condition to apply this remedy.
The parties should agree on remedies for breaches in the contract to:
(i) Guarantee the performance of the contract;
(ii) Prevent the act of violation from one party;
(iii) Provide the aggrieved party with sufficient proof to ensure their legitimate rights and interests when being infringed.
As mentioned above, if enterprises want to apply the remedy, they need to agree in the contract on the violating acts subject to fines, the level of fines for breaches corresponding to each act, the time limit for paying fines for breaches, etc.
Above is the article “Fines for breaches in commercial contracts”. We hope this article is useful to you.