What’s the judicial opinion regarding a claim of high liquidated damages?

In commercial transactions, the parties often agree on high liquidated damages in the contract, by which they hope that the counterparty’s behavior could be bound more effectively, and the observant party could obtain maximum relief in the event of a breach of contract. For example, in the “Agreement on Exclusive Purchase of Audio and Video Programs”, Company A and Company B agreed that if the drama failed to be broadcast on the agreed satellite TV channel and time period, Company B had the right to terminate the agreement, and Company A shall pay liquidated damages amount to 30% of the total amount of the payment, which is RMB10.8 million. 

The question is, as long as the parties are willing to agree on high liquidated damages, whether the plaintiff could be supported by the court?

Article 585 of the “Civil Code” stipulates that the parties may agree that if one party breaches the contract, it shall pay a certain sum of liquidated damages to the other party in light of the circumstances of the breach, and may also agree on a method for the calculation of the amount of damages incurred as a result of the breach, …… where the amount of liquidated damages agreed upon is excessively higher than the losses incurred, the people’s court or the arbitration agency may appropriately reduce such amount upon the request of the parties……. It can be seen that if two conditions are met at the same time, that is,  “the agreed liquidated damages are excessively higher than the losses caused”, and if the parties make a request (that is, a request to the judicial authority that the liquidated damages are too high), the liquidated damages may be reduced.  

Then, how to judge “the agreed liquidated damages are excessively higher than the losses caused”?

Article 29 of “Interpretation of the Supreme People’s Court on Several Issues Concerning the Application of the Contract Law of the People’s Republic of China (2)” (Expired) stipulates that if the agreed liquidated damages exceed 30% of the losses, it can generally be determined as “excessively higher than the damage caused”. Article 11 of the “Minutes of the National Courts’ Work Conference on Implementing the Civil Code” (Fa [2021] No. 94) holds the same provisions. Therefore, in practice, many parties have set the liquidated damages at 30% of the contract amount for a long time.  

However, in many cases, such conventions may not be supported.

According to the “Understanding and Application of the Contracts Chapter of the Civil Code”, a court shall determine whether the liquidated damages are too high based on 3 steps, (1) to determine the basic standards of the liquidated damages based on the performance of the contract and the actual losses; (2) in consideration of several factors, such as the degree of fault of the parties, the expected interests, whether the parties are commercial subjects, whether the negotiating ability of the parties is equal, whether the standard contract terms are applicable and so on; and (3) to finally determine from the perspective of the principle of fairness and good faith. For some special circumstances, such as during the new crown epidemic period, the court would also take the impact of the epidemic on contract performance as a factor (See (2021) Hu 0114 Min Chu No. 11430).

For enterprises, the above description may be too abstract and difficult to be understood. Take the case in the beginning for example (refer to (2021) Hu 73 Min Zhong No. 632), the Shanghai Intellectual Property Court ruled that the liquidated damages of RMB10.8 million were too high and were reduced to RMB3.6 million. The court pointed out that in this case, the following facts should be taken into account when calculating the specific amount of liquidated damages: (1) the defendant failed to prove the liquidated damages were too high, and the plaintiff also failed to prove the amount of actual loss or loss of expected benefits due to the defendant’s breach of contract; (2) both parties had changed the royalty fee in the‘Supplementary Agreement 1’, but the payment term, payment ratio and payment terms of each installment shall be subject to the original agreement. According to Article 12.1 of the original agreement, any party that violates the obligations stipulated in this agreement shall be deemed to be in breach of contract, unless there are explicit terms and conditions, it shall pay liquidated damages amount to 10% of the total royalty fee; and (3) the plaintiff failed to prove that the defendant was malicious; moreover, the plaintiff also had fault.

In addition, when the party obliged to pay the money defaults, in practice, some courts will use the LPR (the loan market quoted interest rate announced by the National Interbank Funding Center) as a reference benchmark to determine whether the liquidated damages are too high based on the facts of the case, and theamount of adjustment. A relatively special circumstance is that a party refuses to pay the payment in accordance with the contract for a long time without justifiable reasons which resulting in high liquidated damages, and then such party promises to pay the high liquidated damages, in the case (2018) Zui Gao Fa Min Zai No.303, the Supreme People’s Court pointed out that the court should not reduce the liquidated damages, otherwise it would be contrary to the principles of fairness and good faith.