Cancellation of contract and key points to note

Cancellation of contract is one of the most powerful remedies available when a partner seriously breaches its obligations; however, if applied on incorrect grounds, it may turn the “cancelling” party into the breaching party. This article analyses when a breach is considered a “fundamental breach” and the 4 points enterprises must bear in mind to avoid reverse legal risks.

1. When is a breach considered a “fundamental breach”?

In contract risk management, an important principle is that “commitments, once effective, are binding on the parties”. However, when one party breaks the structure of trust through serious violations, the law allows the other party to exercise the right of cancellation of contract as a means of self-protection. At this point, the boundary between an ordinary breach and a “fundamental breach” giving rise to the right of cancellation is by no means a simple legal question.

In the Vietnamese civil and commercial legal system, the principle of freedom to enter into and perform commitments is a core foundation. However, the interests of the aggrieved party are protected through the remedy of cancellation of contract where the counterparty commits a serious breach. Correctly determining the nature of a “fundamental breach” is not only the basis for triggering the right of cancellation but also a prerequisite for avoiding reverse legal risks for the party exercising that right.

Pursuant to Clause 2, Article 423 of the Civil Code 2015, a serious breach means the failure by one party to properly perform its obligations to the extent that the other party cannot achieve the purpose of entering into the contract. The Law on Commerce 2005 also uses the equivalent term “fundamental breach” with a similar meaning. Specifically, Clause 13, Article 3 of the Law on Commerce 2005 provides: A fundamental breach is a breach of contract by one party which causes damage to the other party to the extent that the other party cannot achieve the purpose of entering into the contract.

The core element here is the “purpose of conclusion”. Only where the counterparty’s breach completely defeats the core interests the enterprise expected when signing the contract is the right of cancellation of contract triggered.

Example: In a dispute at the Vietnam International Arbitration Centre (VIAC), the seller delivered a consignment of goods that failed to satisfy inspection conditions for import customs clearance. The Arbitral Tribunal determined this to be a fundamental breach because the buyer could not achieve the purpose of the import contract, namely obtaining goods for its business.

In adjudication practice, a breach of the payment obligation occurs where the buyer fails to comply with the payment terms, rendering the contract between the two parties incapable of further performance. Adjudicating bodies have held that this is also regarded as a breach of a fundamental obligation.

2. Legal grounds for exercising the right of cancellation of contract

Under Article 423 of the Civil Code 2015 and Article 312 of the Law on Commerce 2005, an enterprise has the right of cancellation of contract in the following cases:

• – A breach occurs which the parties have agreed in advance to be a condition for cancellation.
• – One party seriously (fundamentally) breaches its contractual obligations.
• – Other cases as provided by law (such as delayed performance of obligations, incapability of performance, or loss of or damage to property which cannot be replaced).

When a contract is cancelled, in principle, the contract has no effect from the time of its conclusion. The parties must restore the original state and return to each other what they have received.

However, the law recognises the independent existence of certain specific provisions intended to address post-cancellation consequences:

• – Arbitration/dispute resolution agreements: not affected by the cancellation of the main contract. The Arbitral Tribunal retains jurisdiction to resolve disputes arising out of or in connection with the cancelled contract.
• – Penalty and compensation remedies: the parties retain the right to claim penalties for breach (if so agreed) and compensation for actual losses arising from the counterparty’s breach.

3. Points to note – a perspective from law enforcement practice

Cancellation of contract is a decision with very serious legal consequences, as it renders the contract ineffective from the time of conclusion. To avoid the breach “backfiring” on the cancelling party, the party intending to apply this option should note the following 04 points:

3.1. Proactively define “fundamental breach” in the contract

Proactively define “fundamental breach” in the contract
The law currently provides no specific guidance on what amounts to “to the extent that the purpose of the contract cannot be achieved”. That determination rests with the adjudicating body when the parties fall into a dispute they cannot resolve themselves. Therefore, instead of relying on the interpretation of the Arbitral Tribunal or the Court, the parties should specifically enumerate, in the contract clauses, the breaches that will give rise to the right of cancellation. In that case, regardless of whether the breach is “serious” in the ordinary sense, the aggrieved party still has the right to cancel in accordance with the agreement.

3.2. Never overlook the notification obligation

The party effecting the cancellation of contract must immediately notify the other party, pursuant to Article 315 of the Law on Commerce 2005, which provides as follows:
“Notice of suspension of performance, termination of performance or cancellation of contract

The party suspending performance, terminating performance or cancelling the contract must immediately notify the other party of such suspension, termination or cancellation. Where a failure to give immediate notice causes damage to the other party, the party suspending performance, terminating performance or cancelling the contract must pay compensation for such damage.”

Accordingly, the cancellation of a contract must be immediately notified to the other party. If no notice is given and damage is caused to the counterparty, the party proactively cancelling the contract will be liable to pay compensation.

3.3. Managing “post-cancellation” consequences

When a contract is cancelled, the parties must return to each other what they have received. However, the agreements on penalties for breach, compensation for damage and dispute resolution remain effective. The contracting parties should note that a single breach may lead to a “double” consequence: the contract is cancelled while penalties and compensation are borne at the same time.

3.4. Independence of the arbitration clause

A matter the parties need to be aware of is that even where the contract is entirely cancelled, the arbitration agreement continues to exist independently. This ensures that the parties still have a stable dispute resolution mechanism to address the consequences of that cancellation of contract.

Cancellation of contract is inherently a “double-edged sword”. Properly applied, it is a tool that releases the aggrieved party from toxic cooperative relationships. Conversely, where the cancellation is without grounds or procedurally flawed, the aggrieved party itself will become the breaching party and bear civil liability.

Cancellation of contract is a powerful yet risky remedy if the exercising party does not firmly grasp the legal grounds and the evidence of the “fundamental breach”. Proactively anticipating breach scenarios in the contract, strictly complying with the notification process, and collecting and retaining sufficient evidence proving the breach will serve as a shield protecting each party in complex disputes.

Should you require in-depth assistance, please kindly contact:

Consulting – Litigation Lawyer: Hoang Phuong Trang

• – Email: trang.hoang@bizlawyer.vn
• – Tel: +84 868 851 900

Respectfully./.