Answer: Liability for breach of contract refers to the responsibility that a party shall bear to the other party when it violates the obligations stipulated by the contract or the law after the contract is signed. Under the Civil Code, there are two provisions classifying contractual breach liability: Article 577 provides three types—specific performance, taking remedial measures, and compensating for losses; Article 582 provides types such as repair, rework, replacement, return of goods, or reduction of price or remuneration.
Currently, Chinese law and judicial precedents have not provided explanatory guidance on these two clauses of breach liability. We consider that the latter clause is a more specific categorisation related to commercial practice and can be incorporated into the former clause system.
Therefore, we divide contractual breach liability under Chinese law into three categories: 1) The first is specific performance. That is, when the contract is not terminated, the non-breaching party may require the breaching party, who has ceased performance, to continue fulfilling the contractual obligations; 2) The second is compensation for losses clauses. The most typical example is a liquidated damages clause, in which the parties agree on how monetary damages should be paid in case of breach. This clause involves the most complex legal issues in law and practice; 3) The third is Remedial measures clauses: including repair, rework, replacement, and other measures to prevent loss escalation.
The “return of goods” and “reduction of price or remuneration” under Article 582 of the Civil Code can be regarded as breach liability under the second category. Return of goods refers to the responsibility of the seller to compensate the buyer for losses (refund of payment) after the contract for the sale of goods is terminated. Reduction of price or remuneration can also be regarded as liability whether the contract is terminated or not, where the breaching party shall compensate the non-breaching party for losses arising from goods or services not conforming to the contract. Although a deposit (定金) has a performance guarantee function, it also serves as compensation for losses, and is thus included in the category of compensation for losses clauses (the second category).
We discuss, in turn, the setup of protective contractual clauses related to these three types of contract clauses of liability for breach.
First, designing clauses for specific performance. Specific performance allows the non-breaching party to compel the party who has stopped performing to continue performing the contract, rather than withdrawing from the contract due to refusal to perform.
In commercial contract practice, contract parties or their lawyers usually do not list the contract clauses related to the liability of specific performance as part of the liability for breach of contract. This is because, according to the principle that “Pacta sunt servanda”, continuing performance is an inherent obligation that the contract parties should undertake, and only in the exceptional statutory or contractually agreed circumstances in which the obligation of contract performance may be suspended or terminated can the parties be exempted from the responsibility of specific performance.
Therefore, the so-called clauses on liability for breach of contract in this part are turned into how the parties should set and negotiate the clauses concerning contract cancellation and contract suspension in the contract (see “Design of Constractual Clauses on Contract Cancellation” and “Design of Constractual Clauses on Contract Suspension”). Hence, in accordance with commercial contract practice, this part of the content is not included within the scope of the liability for breach of contract clauses.
Second, designing compensation for losses clauses. These clauses specify how a party shall compensate the other for monetary losses caused by the former party’s breach. They can apply both after contract cancellation and when the contract is not cancelled, but losses occur.
Compensation for losses clauses are the most important and widely used in commercial contracts, as they define liability for breach, deter breaches, facilitate smooth contractual performance, and provide both punitive and compensatory functions.
Liquidated damages clauses are the most common type of compensation for losses clause, specifying either a fixed amount or a method for calculating the amount payable by the breaching party (see “How to Design Liquidated Damage Clauses in Commercial Contracts?”).
Key legal considerations for this type of clause include: 1) If a loss due to one party’s breach of the contract cannot be clearly ascertained, the other party should design a reasonable liquidated damages clause to avoid the consequence of a breach without compensation. 2) A fixed amount in a liquidated damages clause must not be excessively higher than the non-breaching party’s loss; otherwise, the breaching party may request the clause to be rescinded, causing it to lose its binding effect. 3) For interest liquidated damages set for delayed payments, the interest must not be excessively high. Interest exceeding four times the loan prime rate agreed in the contract will not receive judicial protection.
4)For minor behavioural breaches (excluding delayed payments), the contract may set reasonable, small or proportionally small liquidated damages for punitive purposes, without being constrained by the rule in the second point that the amount must not excessively exceed the non-breaching party’s loss. When a contract sets a clause for loss of expected profits, the non-breaching party can specify the ground and the quantum method for such loss in the contract, increasing the certainty of compensation for that loss.
Return of goods refers to contract cancellation plus refund, and can include clauses for refund deadlines, return method, and shipping costs. Reduction of price or remuneration applies when goods or services do not meet contractual standards; the non-breaching party may require price reduction or compensation.
Deposits have both performance guarantee and loss compensation functions. If the recipient of the deposit substantially breaches the contract, the payer may cancel the contract and request double return of the deposit; if the payer substantially breaches the contract, the recipient may cancel the contract and forfeit the deposit. Deposit （定金） clauses should not be written as “订金,” as the latter does not bear the same legal effect as the former does, and the amount of a deposit should not exceed 20% of the contract value; otherwise, the exceeding part does not bear the legal effect of a deposit (see “Legal Issues of Deposits”).
Third, designing remedial measures clauses. These clauses include repair, rework, replacement, and other measures to prevent loss enlargement (mitigation). Their purpose is to allow the non-breaching party to require reasonable actions by the breaching party, promoting effective performance and mitigating losses, whether or not the contract is cancelled.
Commercial contracts differ in their characteristics. Parties can negotiate remedial measures that favor themselves, exclude unfavorable measures, and set the order of remedies. To encourage voluntary compliance, clauses may also impose liquidated damages if the breaching party unreasonably refuses to take remedial measures.
Even if the contract does not include such clauses, the non-breaching party retains the right to require appropriate remedial actions under statutory breach-liability provisions.
For enforcement of breach liability clauses when a party still breaches, see “Holding a Party Liable Under Liability for Breach of Contract Clauses”.
