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China contract damages: More art than science

by Dan Harris

Our China lawyers often stress to our clients the importance of a well-crafted contract damages provision that contains a “just-right” amount of damages should there be a breach. We are often asked what the just right amount should and our answer is that depends on the specific facts and to what the Chinese side will agree.

The other day, one of our China attorneys wrote the following to a client regarding a contract damages provision in an NNN Agreement we had drafted. We had recommended one figure for the contract damages, but against our advice, our client had insisted on a much higher figure. The Chinese supplier rejected the higher figure and out of a desire to get going quickly, our client suggested that we just dispense entirely with the provision. The below email is our response to that:

With regard to our proposed language about minimum damages, I can understand why this supplier is balking at our $350,000 figure. As we discussed when drafting the initial NNN agreement, that is a relatively high amount, and considerably more than the $100,000 to $150,000 figure we recommended be used. This amount is more art than science. It is not supposed to be a penalty, but rather a realistic assessment of the damages that you would incur if the Chinese side were to breach this NNN agreement, say by selling a container full of your products directly to a third party. I would strongly advise against deleting this language entirely, though as specified contract damages are what helps to give this agreement real teeth, not least because they allow the Chinese court to impose a pre-judgment seizure of assets. That is a big advantage for you, and not one that you should give up willingly.

In a subsequent discussion among our China law group regarding this situation, one of our China attorneys wrote the following email to the rest of our group:

This shows yet again the importance of NOT making the contract damages an unreasonably high amount. It seems that whenever our clients push for a higher amount then what we are recommending, the Chinese side resists and then all sorts of problems begin. It is far better to come in with an entirely reasonable amount right off the bat. If the Chinese side resists that, we then know that our client has a problem with its Chinese counterpart. But when we come in at the start with an unreasonable amount for contract damages, the Chinese side quite correctly concludes that 1) our client has little to no experience in China and is basically an unreasonable company that will be difficult to deal with in the future. It is just a bad idea all around. And the thing is that most of the time the clients who insist on numbers much higher than we are recommending are disproportionally inexperienced and difficult to deal with.

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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