China Contracts That Work: Liquidated Damages

his is an old contract.

Our China contract lawyers love liquidated damages provisions (a/k/a contract damage provisions). We love such provisions because they work.

In our experience (and that of other China attorneys with whom we have discussed the issue), putting the right liquidated damages provision in your China contract consistently does the following important things:

  1. Increases the likelihood your Chinese counter-party will abide by your contract.
  2. Increases the likelihood of avoiding litigation if your Chinese counter-party breaches your contract.
  3. Increases the likelihood prevailing quickly in litigation if you do end up needing to sue your Chinese counter-party.
Writing a liquidated damages provision for a China contract is two parts art and eight parts experience. The trick is determining the right amount to assess the Chinese company in damages. You want that amount to be high enough so as to deter your Chinese counter-party from breaching the contract, yet but also low enough so your Chinese counter-party will actually sign the contract and the Chinese court will enforce it. Chinese courts will invalidate or just ignore a contract damages provision if they deem it to be too high. Far too often foreign companies put in an amount that covers lost profits they might lose from a breach, but in doing so they have shot themselves in the foot because no Chinese court will enforce it.

The below email is typical of what our China lawyers often send to our clients after they complain of how the damages provision we put into their contract (be it an NNN Agreement or an OEM Agreement or an IP Licensing Agreement or a China Distribution Agreement or whatever) is too low:

I advise against raising the amount of the contract damages. Even the $350,000 we put in here is fairly high. Note that this is a per event penalty and it is intended to represent a fair estimate of your losses from each breaching event. When the amount of the contract damages is too high, the Chinese side is unlikely to sign the agreement because it will think  you are being unreasonable and or demonstrating your inexperience with how to conduct business in China. Equally importantly, a Chinese Court is unlikely to enforce a much higher amount because it will view it as not having a sufficient relation to the actual damages.
That said, there is nothing “magical” about $350,000. Let’s talk more about what your losses are likely to be and see whether we can come to a number we both like.
What are you seeing out there?