Many months ago, I was in on an email exchange between a couple of our China lawyers regarding a liquidated damages provision in a product development agreement where our client was paying a Chinese manufacturer a lot of money to develop a new product that could be taken into production. Our biggest concern with the product development arrangement was that the Chinese manufacturer would sell the product to others after our client paid the large sum of money to have it developed.  So we wrote the contract to prohibit that and to give that provision added force we put in a liquidated damages provision listing out exactly how much our client would be entitled to in damages were the Chinese manufacturer to violate the non-compete provision forbidding them from making the product for anyone else.
Wikipedia nicely defines liquidated damages as follows:
Liquidated damages (also referred to as liquidated and ascertained damages) are damages whose amount the parties designate during the formation of a contract for the injured party to collect as compensation upon a specific breach (e.g., late performance).

We really like liquidated damages provisions in our China contracts because Chinese courts tend to view contractual liquidated damages provisions very favorably and so long as they are not unreasonable, they will usually be enforced. Most importantly, courts will seize Chinese company assets based on a liquidated damages provision and they will seize these assets before trial. Chinese companies know and fear this. A well-crafted China contract with a well-crafted liquidated damages provision is one of the best tools out there for preventing your Chinese counter-party from breaching your agreement, and that is the primary reason for having a contract in the first place.

In this particular product development contract, we put in a high number for the liquidated damages provision and the Chinese side immediately accepted it. This led co-blogger Steve Dickinson to write the following email:

Yes, _________  [our client] asked for a high number and I put it in at their request. Interestingly, the Chinese side signed with no complaint and with no objection from their Chinese attorneys either. I think that Chinese companies that do not plan to default simply don’t have a problem with contract damage numbers in this kind of agreement. The companies that complain are to be viewed with caution.

In terms of contract damages, it is important to be clear. As with the US, the number is not intended as a penalty. It is intended as an honest effort by the parties to predict damages in advance. If the number is too low, the injured party can ask for more. If the number is too high, the defendant can ask for a reduction. In either case, the validity of the contract itself is not affected.  The advantage of liquidated damages is that it gives you a sum certain when you go to the court to ask for preliminary relief such as seizure of assets. As long as a court is involved, the Chinese companies know that prejudgment asset seizure based on the amount of contract damages is a real risk and this makes them much more compliant in dealing with these issues. Where arbitration is involved, liquidated damages has far less utility, which is yet another reason why international lawyers should not be so quick to jump for having China contract disputes resolved via arbitration.
For more on the effectiveness of liquidated damages provisions in China contracts, check out the following: