Liquidated Damages v. Penalties in Korean contracts

As a NY 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, often, invalidated.

Korea, however, allows some “penalties” in contracts. Cutting to the chase, this is merely an issue of confusing and overlapping terminology.  But since its confusing, it is 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.   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.

Article 398 of the Korean Civil Act states:

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 attorneys with intimate knowledge of the nuances of Korean law and also Korean business culture.