Update day: July 6 , 2023

Terms of deposit penalty and compensation for damage in the Contract

During the process of signing and implementing contracts, ensuring compliance with terms and commitments is an important factor in ensuring fairness and transparency in commercial transactions. However, it is not always possible to avoid violations or incidents during contract execution. In such cases, deposit penalties and compensation for damage are considered legal measures to protect the interests of the parties in the contract.

In fact, deposit penalties and compensation for damages are common concepts in the field of contract law. However, understanding and correctly applying these two concepts is important to avoid disputes and protect the interests of each party. This article aims to help you understand deposit penalties and compensation for contract damages in contracts, providing insights and guidance for their proper application.

Table of contents:

1. Understanding the terms of deposit penalty and Compensation for damage in the Contract

Deposits and compensation for damages are legal terms that commonly appear in contracts, particularly those related to the purchase and sale of goods and office leasing. In this context, a “deposit” refers to the transfer of money, precious metals, gemstones, or other valuable objects from one party to another as a means of securing the conclusion or performance of a contract. If the contract is concluded and fulfilled, the deposited property is either returned to the depositor or deducted to perform the payment obligations; if the depositor refuses to conclude the contract and perform the contract, the deposited property becomes the property of the deposit recipient; if the deposit recipient refuses to conclude and perform the contract, they must return the deposited property to the depositor, along with an amount equivalent to its value, unless otherwise agreed upon.

Compensation for damages is the obligation imposed on the breaching party to compensate for the damages caused as a result of breaching the contract. The value of compensation includes the actual and direct damages that the non-breaching shall bear due to the breach committed by the breaching party, as well as the direct benefits that the non-breaching party would have rightfully enjoyed if the breach had not occurred. Therefore, the basis for the emergence of liability for compensation for damages is that the party claiming compensation must prove that the party causing the damages has committed a breach of the contract, and this breach is the direct cause of the damages, while also determining the actual damages incurred.

Deposit penalties and Compensation for damages are two distinct legal matters within a Contract, whereby Deposit penalties are applicable when the parties agree to impose penalties based on the term of a deposit, regardless of whether damages have occurred. On the other hand, regarding compensation for damages, the obligation to compensate arises only when the requesting party can prove the fault of the other party, the actual occurrence of damages, and the causal relationship between the conduct and the damages.

2. What to consider when applying the term of deposit penalty and compensation?

We always advise enterprises to be cautious when considering the wording of deposit penalty and compensation terms, as using incorrect terminology can lead to the loss of their rights in case of disputes. One common example we often encounter is the adjustment of the term ‘deposit penalty’ to ‘compensation for damages equal to the amount of the deposit’. In this case, it can be misunderstood whether it is compensation for damages or a deposit penalty.

If we understand it directly based on the recording method, we can see that the current contract states that if one party causes damage, they shall compensate the other party an amount equal to the deposit. However, as we have shared earlier, the essence of compensation for damages should be based on actual losses, in other words, currently, the law does not allow parties to agree on a specific amount of compensation for damages in the contract. This will result in the parties being unable to enforce the provision of “compensation for damages equal to the amount of the deposit” when any violation occurs in practice.

However, when considering the resolution of contract disputes, the judicial authorities, in addition, to reviewing the agreements of the parties in the contract, will also rely on the intentions of the parties at the time of contract formation to determine whether to interpret the above-mentioned provision as a penalty clause or compensation for damages. The remaining issue will depend on the arguments and evidence presented by the party requesting the penalty.

One important point to note is that if a contract includes a term for a deposit, there should also be a term regarding the handling of the deposit amount. According to that, the deposit amount will be used for what purposes, under which circumstances it may be deducted, and the time frame for refunding the deposit after the termination of the contract…In summary, this term needs to be detailed enough to be applicable in practice and sufficient to bind the other party’s compliance with the contract.

Throughout the contract implementation journey, penalties and damages are important tools to ensure fairness and transparency in commercial transactions. However, for these provisions to safeguard the interests of businesses, it is crucial to understand them correctly and accurately reflect them in the contract.

Time of writing: 30/05/2023

The article contains general information which is of reference value, in case you want to receive legal opinions on issues you need clarification on, please get in touch with our Lawyer at info@cdlaf.vn

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