Liquidated Damages vs. Penalty Damages: Korean Contract Law Basics

Korea Liquidated Damages, Korea Penalty Damages, in Korea
Liquidated Damages v. Penalty Damages in Korea

In Korea, liquidated damage clauses in South Korean contracts may be invalidated if the liquidated damage amount is deemed, by a Korean court of law, as “unduly excessive.” (Civil Act Art. 398(2)). Article 398 of the Civil Act may be found below.  Korean Liquidated damages law is governed by the Civil Act of Korea and related Korean Law.

However, if an agreement, in Korea, notes a “penalty,” the amount of the “penalty is presumed to be determined in advance of the damages” (Civil Act Art. 398(4)) and is presumed valid.  Of course, the difference between “liquidated” and “penalty” damages, thus, would seem critical.  However, presently, in Korea, form is prevailing, in most cases, over substance.

Liquidated damages, according to Korean courts, are damages where the parties contract with the intent to compensate the non-breaching party for the actual damages caused.  While, a penalty is intended to punish a party and, thus, discourage breach.  A penalty, thus, is in addition to actual damages (or liquidated damages – the approximation of actual damages).

Thus, with this understanding by the Korean Legal System, it is not uncommon for courts, in Korea, to consider if the amount of liquidated damages, noted in an agreement, is a reasonable approximation of the actual damages.  Courts, thus, have the power to reduce or even invalidate these liquidated damage clauses.

Courts, in short, have reduced the amount of liquidated damages in numerous cases and have even precluded the availability of liquidated damages when a plaintiff failed to establish a nexus between the established breach and the liquidated damage amount.  However, few cases have invalidated punitive penalty clauses in Korean contracts that, also, included the possibility of actual damages on top of the penalty damages.

The reality may be far from this jurisprudence, but it is always better to accept the reality and work within the reality.  I see too many agreements from many of the ubiquitous Korean law firms with the lack of nuance necessary to get their clients pre-determined damages enforced.  The solution is simple and any decent English-Speaking international lawyer in Korea should know how to draft enforceable damage clauses.

The answer is simple.  The Supreme Court has ruled that a Penalty Clause should not be invalided except in the most exceptional of cases.  The exception is a catch-all clause in the Civil of Act of Korea that prohibits acts that violate “good morals and the social order.”  This vague catch-all has, thankfully, been used by the Korean courts in very few penalty clause cases where Korean lawyers drafted the agreements with care, nuance and the obvious structure.  These clauses are, regularly, enforced in Korean real estate transactions.  Thus, we have a simple solution.  Accept Form sometimes prevails over Substance

Drafting Enforceable Penalty Clauses in Korea

Thus, accept that Form wins over Substance in damage jurisprudence in Korea – in most cases. However, also realize, that the mere mentioning of a “penalty” will, likely, lead a court to hold the clause as a” liquidated damages” clause.  However,  including a penalty clause and a separate compensatory damage clause will, likely, lead to a court upholding the penalty clause and potentially even awarding compensatory damages.  Yes – this penalty clause is merely acting as a liquidated damages clause.  Who cares – deal with the reality and go on to bigger and better things.

We, highly, recommend having a complete review of all your agreements.  We see too many issues. Nuance and not form agreements are necessary for all your agreements including your supplier agreements, vendor agreements, employer agreements, lease agreements, and other agreements with third parties in Korea.
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Sean Hayes may be contacted at: SeanHayes@ipglegal.com.

Sean 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. Sean is ranked, by AsiaLaw for Korea, as one of only two non-Korean lawyers as a Top Attorney. Sean is known for his proactive New York-style street-smart advice and his aggressive and non-conflicted advocacy. Sean works with some of the leading retired judges, prosecutors and former government officials in Korea.

Sean’s profile may be found at: Sean C. Hayes
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Please find Civil Act of Korea Article 398 below:
Civil Act Article 398 (Liquidated Damages)
(1) The parties may determine in advance the amount of damages payable in the event of the non-performance of a contractual obligation.

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

(3) The determination in advance of the amount of damages shall not affect the obligee’s demand for performance or rescission of the contract.

(4) The agreement of a penalty is presumed to be determined in advance of the amount of damages.

(5) Even where the parties have agreed beforehand that something other than money shall be applied as compensation for damages, the provisions of the preceding paragraphs shall apply mutatis mutandis.

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