Compensation payable for the early termination of a lease agreement is one of the issues most likely to lead to disputes between lessors and lessees. A clear understanding of its legal nature, the conditions for its application, the method of calculating compensation, and the competent authorities responsible for resolving disputes enables the parties to proactively mitigate legal risks while safeguarding their lawful rights and interests throughout the performance of the lease agreement.

I. Overview of issues relating to compensation payable for early termination of a lease agreement

In practice, many lease agreements contain provisions requiring the payment of contractual sanctions, compensation for damages, or forfeiture of the security deposit if one party unilaterally terminates the agreement before the agreed expiration date. However, not every claim for compensation is lawful or will necessarily be upheld in the event of a dispute.

Whether compensation is payable depends on the contractual terms agreed upon by the parties, the reason for the termination, the extent of the actual damages incurred, and the provisions of civil law governing unilateral termination of contracts. If the contractual provision is ambiguous, disproportionate to the actual damages suffered, or inconsistent with applicable law, the party against whom compensation is claimed has the right to request a review of the claim or initiate legal proceedings to protect its legitimate rights and interests.

II. Understanding compensation payable for early termination of a lease agreement

1. What is compensation payable for early termination of a lease agreement and what is its purpose?

Compensation payable for the early termination of a lease agreement is a monetary amount that one party is required to pay to the other when it unilaterally terminates the lease before the agreed expiration date, thereby causing damage or adversely affecting the lawful rights and interests of the other party. Such an amount may be agreed upon in advance in the lease agreement in the form of compensation for damages, contractual sanctions, or forfeiture of the security deposit.

The purposes of such compensation include:

  • Compensating the affected party for actual losses incurred (for example, loss of rental income, expenses for finding a new tenant, brokerage commissions, and related costs).
  • Reinforcing the parties' contractual obligations and discouraging arbitrary unilateral termination.
  • Maintaining the stability of the lease relationship, particularly in long-term lease agreements.

Nevertheless, any compensation clause must be based on a lawful agreement and must not contravene applicable laws. If there is no legal basis for the claim or the amount claimed is excessive in relation to the actual damages suffered, such compensation may be subject to judicial review if a dispute arises.

2. When is the lessee required to pay compensation for early termination of a lease agreement?

Pursuant to Article 418 of the Civil Code 2015, a contractual fine is an agreement whereby the breaching party is required to pay a specified sum to the non-breaching party upon a breach of obligations. Accordingly, the lessee is obligated to make such payment only if the lease agreement contains a clause providing for contractual fines or compensation in the case of early termination.

In practice, a lessee is commonly required to pay compensation in the following circumstances:

  • Unilaterally terminating the lease agreement without a lawful ground or outside the circumstances in which unilateral termination is permitted by law.
  • Failing to comply with the agreed advance notice period.
  • Breaching payment obligations or using the leased property for purposes inconsistent with the agreement, resulting in termination of the lease.

The amount of any contractual penalty is determined by agreement between the parties unless otherwise provided by specialized legislation. The parties may also agree that only a contractual fine shall apply or that both a contractual fine and compensation for damages shall be payable. If the lease agreement provides only for a contractual fine and does not address compensation for damages, the breaching party is liable only for the agreed contractual fine.

3. How should the amount of compensation for early termination of a lease agreement be reasonably calculated in practice?

A reasonable amount of compensation for early termination should be determined on the basis of the contractual agreement and the actual damages incurred. Excessive compensation amounts should be avoided, as they may be considered unreasonable or may not be upheld by the Court in the litigation.

In practice, compensation is generally calculated based on the following factors:

  • The remaining rental payments under the lease, after deducting the estimated period reasonably required to secure a replacement tenant.
  • Actual expenses incurred, such as brokerage commissions, advertising costs, repair expenses, and renovation costs.
  • Any contractual fine agreed upon in the lease agreement, if a specific clause exists.
  • Actual damages substantiated by valid documentary evidence, including invoices, brokerage agreements, and repair receipts.

A common and commercially reasonable approach is for the parties to agree upon compensation equivalent to one to three months' rent rather than demanding payment of all remaining rent under the lease term, as requiring the full remaining rental amount may be regarded as disproportionate to the actual damages suffered.

4. When drafting a residential lease agreement, what should be included to ensure that the compensation clause for early termination is clear and legally enforceable?

In particular, the agreement should clearly specify:

  • The circumstances constituting early termination (such as unilateral termination without justification, breach of contractual obligations, or termination due to force majeure).
  • The conditions for the obligation to pay compensation, for example, failure to provide the required advance notice.
  • The amount of compensation or the method of calculation, such as a contractual fine equivalent to a specified number of months' rent or compensation based on actual damages supported by valid evidence.
  • The treatment of the security deposit, including whether it will be forfeited, deducted, or refunded in each particular circumstance.
  • The deadline and method for payment of compensation.
  • Circumstances in which compensation may be waived or reduced, such as where the termination results from the lessor's breach or exceptional objective circumstances.

III. Legal regulations governing compensation payable for early termination of a lease agreement

1. How does current law regulate the validity of clauses governing compensation payable for early termination of a lease agreement?

The Civil Code 2015 contains several provisions governing compensation payable upon the early termination of lease agreements. Article 472 provides that a lease agreement is formed by mutual agreement between the parties. Accordingly, the parties are free to agree upon contractual fine clauses or compensation provisions applicable in the early termination.

Specifically:

  • Clause 1, Article 418 provides that a contractual fine is established by agreement between the parties.
  • Clause 2, Article 418 permits the parties to determine the amount of the contractual fine unless otherwise prescribed by applicable legislation.
  • Clause 3, Article 418 allows the parties to agree that only a contractual fine shall apply or that both a contractual fine and compensation for damages shall be payable.

Furthermore, under Clause 2, Article 419 of the Civil Code 2015, the non-breaching party is entitled to claim compensation for damages, including the benefits that it would otherwise have received and any additional expenses incurred as a result of the contractual breach.

2. What procedures should be followed when collecting compensation for early termination of a lease agreement to ensure valid supporting documentation?

- Executing a written termination or cancellation agreement: Upon early termination, the parties should prepare a written record of termination or cancellation clearly specifying the application of the compensation clause, the amount payable, the reasons for payment, and the legal basis therefor. Such documents serve as important evidence for issuing invoices or receipts and for resolving any future disputes.

- Issuing invoices or payment receipts: The recipient of the compensation (normally the lessor) should issue a valid payment receipt or, if tax obligations arise, a tax invoice. Such documents serve as evidence of the payment and support the accounting records.

- Based on the contractual agreement: The collection of compensation must be based on the relevant contractual provisions, such as the agreed contractual penalty or compensation clause. If no such provision exists, the parties should execute a written supplementary agreement to avoid any future allegation that the compensation was collected without contractual authority.

- Retaining relevant documentary evidence: Documents such as the termination agreement, invoices or receipts, calculations of outstanding rent, schedules of damages, and supporting evidence should be retained for future reference, including internal audits, tax inspections, or court proceedings.

- Providing supporting documents to the other party: Upon receipt of the compensation, the lessor should provide the lessee with valid supporting documents. The more complete and transparent the documentation, the lower the risk of future disputes concerning payments made without proper evidence.

3. Which authority has jurisdiction to resolve disputes relating to compensation payable for early termination of a lease agreement?

If a dispute arises concerning compensation payable upon the early termination of a lease agreement, the following authorities may have jurisdiction:

  • People's Courts: These are the principal authorities responsible for resolving disputes arising from lease agreements where the parties have not entered into a valid arbitration agreement. Pursuant to Clause 3, Article 26 of the Civil Procedure Code 2015, civil disputes falling within the jurisdiction of the Courts include disputes arising from civil contracts.
  • Commercial Arbitration: If the lease agreement contains a valid arbitration clause, the dispute may be resolved by an arbitral institution in accordance with the parties' agreement. According to Clause 1, Article 5 of the Law on Commercial Arbitration 2010, arbitral awards are legally binding and enforceable.

IV. Questions regarding compensation payable for early termination of a lease agreement

1. Where the parties have only an oral agreement, what is the legal validity of compensation payable for early termination of a lease agreement?

Pursuant to Article 119 of the Civil Code 2015, a civil transaction may be established orally unless the law specifically requires it to be made in writing.

Accordingly, an oral agreement regarding compensation payable for the early termination of a lease agreement may still be legally valid. However, in a dispute, the party asserting the existence of such agreement bears the burden of proving its agreed contents. If there is insufficient or inconclusive evidence establishing the terms of the oral agreement, the Court may decline to uphold the claim.

2. What rights does the lessee have under the law if required to pay compensation for early termination contrary to the agreed terms?

If the lessee is required to pay compensation for early termination of a lease agreement in a manner inconsistent with the contractual agreement, the lessee is entitled to refuse payment and request a review of the relevant contractual provisions. If the lease agreement does not expressly provide for such compensation or if the amount claimed exceeds what was agreed upon, the lessee has the right to object to and reject the demand.

If a dispute arises, the lessee may institute legal proceedings before the competent Court to request a determination of the legality of the claimed compensation and to protect its lawful rights and interests. Furthermore, if the early termination results from the lessor's breach of obligations, the lessee is also entitled to claim compensation for damages in accordance with applicable law.

3. What are the legal consequences if one party unilaterally amends the clause governing compensation for early termination of a lease agreement?

A unilateral amendment to a contractual clause governing compensation for early termination, made without the consent of the other party, has no legal effect as a contract may only be amended by mutual agreement between the contracting parties.

Moreover, if such amendment is made in the form of a sham transaction intended to conceal another transaction or evade legal obligations, the transaction may be declared void pursuant to Article 124 of the Civil Code 2015.

Under Article 131 of the Civil Code 2015, if a civil transaction is declared void:

  • It does not create, modify, or terminate civil rights and obligations from the time of its establishment;
  • The parties must restore to each other everything they have received; and
  • The party at fault that causes damage must compensate the injured party.

4. What is the statute of limitations for initiating legal proceedings in disputes concerning compensation payable for early termination of a lease agreement?

Pursuant to Article 588 of the Civil Code 2015 (as guided by Article 5 of Resolution No. 02/2022/NQ-HĐTP), the statute of limitations for filing a claim for compensation for damages is three (03) years from the date on which the person entitled to bring the claim knew or should have known that his or her lawful rights and interests had been infringed.

5. How may a lessor be sanctioned for issuing a false invoice to collect compensation for early termination of a lease agreement?

If a lessor issues a false invoice (an unlawful invoice) in order to collect compensation for the early termination of a lease agreement, such conduct constitutes a violation of the laws governing invoices and accounting documents. Specifically, under Clause 1, Article 28 of Decree No. 125/2020/ND-CP, the use of unlawful invoices is subject to an administrative fine ranging from 20,000,000 VND to 50,000,000 VND.

In addition to administrative sanctions, if the use of false invoices results in serious consequences (for example, constituting the offence of tax evasion under Article 200 of the Criminal Code), the competent authorities may impose further sanctions under tax legislation or other applicable laws, including criminal prosecution where the conduct satisfies the elements of an offence under the Criminal Code 2015 (as amended in 2017).

V. Are you looking for a reputable law firm to assist with issues relating to compensation payable for early termination of a lease agreement?

If you are facing issues concerning compensation payable for the early termination of a lease agreement, are uncertain about the legality of a contractual compensation clause, or require assistance in resolving a dispute, NPLaw is ready to assist.

With extensive experience in advising on and resolving lease agreement disputes, we provide comprehensive legal services, including reviewing contractual provisions, assessing legal risks, representing clients in negotiations, and protecting their lawful rights and interests before the Courts or commercial arbitration tribunals whenever necessary.

The information provided above is for reference purposes only. Should you require legal advice tailored to your specific circumstances, please contact NPLaw Firm for prompt professional assistance.