Just noticed that an article I wrote with Chris Carr (an international business law professor at Cal Poly) is now live on Supply Chain Management Review. The article is entitled, China Supply Chain Contracts: The Contract (Liquidated) Damages Provision and I just love the subtitle the magazine has given it: A well crafted and reasonable liquidated damages provision is one of the best leverage tools out there for preventing your Chinese counterparty and supplier from breaching their agreements. That’s the primary reason for having a written contract in the first place.

So true. Chris and I use this article to highlight the importance of contract damages in your China contracts:

China contract damages. What to do?
China contract damages. What to do?

Chinese courts tend to view contractual liquidated damages provisions very favorably and so long as they are “harmonious” and not unreasonable, they will be enforced. If the number is too low from actual damages the injured party/plaintiff can ask for more. If the number is too high from actual damages, the defendant can ask for a reduction. In either case the validity of the contract is not affected. In our OEM agreements we have found these clauses to be a very effective tool in particular to “encourage” the Chinese supplier to comply with shipping dates and quality specifications.

Most importantly, if the Chinese counterparty breaches the contract, a liquidated damages provision provides a specific damage amount to discuss when you contact the breaching party. Chinese courts can seize Chinese company assets based on a liquidated damages provision and they can seize these assets before trial (prejudgment attachment of assets). Chinese companies know and fear this, so this can be a great leverage tool. Stated differently, a well crafted and reasonable liquidated damages provision is one of the best leverage tools out there for preventing your Chinese counterparty and supplier from breaching the agreement, and that is the primary reason for having a written contract in the first place.

The toughest issue China lawyers face in drafting a contract damages provision is figuring out the amount to put into that provision:

Here, an analogy we sometimes use is the American children’s story “Goldilocks and the Three Bears” – not too much, not too little, but just right.

A well-crafted liquidated (contract) damages provision in China is the “just-right” amount of damages should there be a breach. We are sometimes asked what the “just-right” amount? This generally depends on two things: (1) the specific facts of your situation, deal and industry; and (2) what the Chinese side will/will not agree to.

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In summary, it’s a balancing act. It the amount is set too high, a Chinese court may throw it out. If it’s too low, your Chinese manufacturer may not fear the clause enough and then violate the agreement. Pick an amount that is reasonable, balanced and fair to both sides.

For more on China contract damages provisions, check out China Commercial Contracts: Writing the Contract Damage Provision.