PENALTIES FOR BREACH IN COMMERCIAL RELATIONS

In commercial relations, contractual penalties are considered an important “shield” helping parties secure committed obligations. In essence, this is a remedy of a deterrent nature, requiring the breaching party to pay a sum of money to the aggrieved party based on a prior agreement. However, the line between successfully applying a penalty and having a penalty request rejected by a jurisdictional body is often very thin if businesses do not fully grasp the legal regulations.

Cases where Contract Penalties Apply

The penalty remedy does not arise naturally but only takes effect when (i) there is an actual act of breach and (ii) there is an agreement between the parties. In the practice of resolving disputes governed by Commercial Law, common cases include:

– Breach of performance obligations: The obligor fails to perform, performs incompletely, or performs incorrectly regarding commitments on quantity, quality of goods, or technical standards of services. For example, delivering goods of the wrong category, origin, or quality not meeting import standards are valid grounds for applying penalties if stipulated in the Contract.

– Schedule breach: Delay in the handover of products or services.

– Breach of commitments: Includes violations regarding payment obligations, information confidentiality, or other obligations agreed upon by the parties as conditions for applying the penalty remedy.

Conditions for Implementing Contract Penalties

From an enforcement perspective, the Arbitral Tribunal or Court only accepts a penalty request when the following prerequisite conditions are met,:

First, the existence of a penalty agreement: This is a necessary and sufficient condition. The law does not allow the application of penalties if the parties do not have a written agreement in the Contract or Contract appendices. However, this agreement does not necessarily have to be in the initial Contract but can be established through transaction documents, correspondence, or emails exchanged subsequently, provided they clearly demonstrate the parties’ intent regarding the application of penalties.

Second, determination of the actual breach behavior: The aggrieved party has the obligation to clearly point out the partner’s breach behavior against the specific regulations and agreements in the Contract.

Third, exclusion of liability exemption factors: The breach behavior must not fall under cases of force majeure, complete fault of the requesting party, or execution of a decision by a competent state authority.

Level of Contract Penalty

In commercial relations: According to Article 301 of the Commercial Law, the penalty level for a breach of a contractual obligation is agreed upon by the parties but shall not exceed 8% of the value of the breached contractual obligation portion (except for penalties in assessment services).

Notes on Combining Remedies

In cases where a partner violates payment obligations, a business has the full right to request a combination of both remedies:

1. Penalty for breach (based on agreement, maximum 8%); and
2. Late payment interest (based on the average overdue debt interest rate in the market pursuant to Article 306 of the Commercial Law).

These are two independent remedies that do not exclude each other and are often accepted by Arbitrators for simultaneous application.

At the same time, it is necessary to clearly state in the Contract the simultaneous application of both “Penalty for breach” and “Compensation for damages” (Damages). Commercial Law stipulates that if parties do not have an agreement on penalties, they are only entitled to compensation for damages; if there is a penalty agreement, both can be applied (but actual damages must be proven).

The above are contents to note when drafting and negotiating Contracts in the commercial sector to maximize the lawful rights and interests of each party and limit risks when disputes arise.

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