Getting to Yes with China Contract Damages

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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 the Chinese counter-party much pay for a breach. We are often asked what is just the right amount 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 a China 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 our client waned and this frustrated our client so much it suggested we dispense entirely with the provision. The below email is our response to that:

I can understand why your [Chinese] supplier is balking at the $350,000 figure we suggested. 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. Choosing this amount in any contract is more art than science. It is not supposed to be a penalty, but rather a realistic assessment of the damages 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 understand your frustration with your dollar figure being rejected, but we virtually always can get reasonable Chinese parties to agree on reasonable contract damages amounts for our China NNN Agreements. It may be a tiny bit tougher here because the Chinese side might be irritated at us for our initially inflated figure, but I remain confident we can all agree on a number and quickly.

I therefore very strongly advise against deleting this language entirely because it is this provision — more than any other — that gives this agreement its teeth. This provision tells the Chinese side the minimum damages it will almost certainly have to pay if it breaches this contract and Chinese companies know Chinese courts enforce these provisions. They also know Chinese courts use these provisions to freeze assets before judgment. With this provision we can go to a Chinese court before trial — literally days after we sue — and get it to freeze your Chinese supplier’s assets. No company wants that, especially Chinese companies which typically do not have much money on hand. This provision is a huge advantage for you and not something you should ever relinquish willingly.

The Chinese company ended up quickly agreeing to $130,000 in liquidated damages/contract damages.

This showed us yet again the importance of NOT putting in an unreasonably high amount for contract damages. It seems whenever our clients push for a higher amount than what our attorneys recommend, the Chinese side resists and problems begin. It is far better to come in with a reasonable amount right off the bat. If the Chinese side resists that, we then know our client has a problem with its Chinese counterpart. But when we start with an unreasonable amount for contract damages, the Chinese side quite correctly can (and almost always does) conclude 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 clients that insist on numbers much higher than we are recommending are disproportionally inexperienced.

We have vowed to push back harder against our clients before going back to the Chinese side with an inflated number.