Liquidated Damages, Penalties, and Confusion in Korean Contracts

As an American attorney, it’s a bit strange for me to read a Korean contract and see how the word “penalty” is used. In the United States (as well as other common law jurisdictions), when a contract contains a “penalty,” the clause is invalidated. Korea, however, allows “penalties” in contracts. Cutting to the chase, this is merely an issue of confusing, overlapping terminology. But since its confusing, its worth explaining.

To start with, a bit of background on liquidated damages. Liquidated damages refer to damages the amount of which the parties designate during formation of a contract as compensation for non-breaching parties in the event of breach. to collect as compensation. In the US and other common law jurisdictions, liquidated damages clauses are invalidated if the purpose is to punish the breaching party, rather than to compensate the injured party. These clauses are referred to by the court as “penalties.”

Now, contrary to what one may think upon reading a Korean contract, Korean law is not all that different. Article 398 of the Korean Civil Act establishes the legal basis for liquidated damages clauses in Korean contracts.

The law states the following:

1) Parties may determine in advance the amount of damages payable in the event of the non-performance of an obligation.

 2) Where the amount of damages determined in advance is unduly excessive, the court may reduce the amount to a more reasonable and appropriate sum.

So yes, Korean courts will invalidate liquidated damages clauses stipulating excessive damages, just as US courts. Just because Korean contracts use the word “penalty” does not mean Korean courts will allow a liquidated damages clause providing for excessive damages. If anything, Korean courts like to keep damages low, compared with US courts.

Basically, the differences between usage of the word penalty in US law and Korean law is yet another reason anyone entering into a contract with a Korean party needs to attorneys with intimate knowledge of the nuances of Korean law and culture.
Sean Hayes may be contacted at: SeanHayes@ipglegal.com. Sean Hayes is co-chair of the Korea Practice Team at IPG Legal. He is the first non-Korean attorney to have worked for the Korean court system (Constitutional Court of Korea) and one of the first non-Koreans to be a regular member of a Korean law faculty. He has, recently, been ranked as one of only two non-Korean attorneys as a Top Attorney working in Korea by AsiaLaw.