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The effective China contract: Liquidated damages

by Dan Harris 

Our China lawyers love liquidated damages provisions (a/k/a contract damage provisions). We love such provisions for the simple reason that 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. This is an old contract.Increases the likelihood that your Chinese counterparty will abide by your contract.
  2. Increases the likelihood of your being able to avoid litigation if your Chinese counterparty breaches your contract.
  3. Increases the likelihood of your being able to prevail quickly in litigation if you do end up needing to sue your Chinese counterparty.

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 counterparty from breaching the contract, yet you also want it to be low enough so that your Chinese counterparty will actually sing the contract and so that a Chinese court will enforce it. Chinese courts will often simply invalidate or just ignore a contract damages provision if they deem it to be too high. Far too often American companies will put in a way too high amount “needed” to cover any potential 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 have 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 would not advise our raising the amount of the contract damages, and even the $350,000 we have 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 they will think that 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.

Dan Harris is founder of the Harris & Moure law firm, a boutique international law firm focusing on small and medium sized businesses that operate internationally. China is the fastest growing area for the firm. Dan writes as a source of China legal and business information.

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