Liquidated damage clauses are clauses in contracts by which parties agree that a fixed sum is payable upon breach of the contract. Such clauses are useful where it would otherwise be difficult to quantify the damage suffered, and are commonly found in certain categories of international contracts (eg construction contracts).

PRC law, however, does not always give effect to such clauses. Consequently, parties have sometimes attempted to contract around these restrictions under PRC law. A recent lower court decision illustrates a recent attempt that failed.

Introduction

The case in question involved a debt-repayment agreement under which the defendant agreed to repay a debt of RMB208,000 to the plaintiff by a certain date. In the event of default, the defendant agreed to pay the plaintiff damages of RMB100,000. It was further agreed that both parties should waive their rights under article 114 of the PRC Contract Law. Article 114 of the PRC Contract Law is the well-known article dealing with liquidated damages, which allows a party to petition the court for an increase or reduction in the amount of liquidated damages.

The defendant failed to repay the debt by the agreed repayment date. Accordingly, the plaintiff filed a lawsuit. The main question before the court was whether the attempt to contract out of article 114 was valid.

Article 114 of the PRC Contract Law

Article 114 of the PRC Contract Law provides that if the agreed liquidated damage is below the loss suffered, the party concerned may petition the People’s Court or an arbitration institution to increase the amount; if the agreed liquidated damage exceeds the loss suffered, the party concerned may petition the People’s Court or an arbitration institution to decrease the amount.

Judgment

The case came up for hearing before the Suzhou Huqiu District People’s Court. The court ordered the liquidated damage prescribed in the agreement to be reduced to 1.3 times the interest rate on the loan. The court held that the waiver clause that prohibited the defendant from petitioning the court for a reduction in the amount of liquidated damages should be struck down on two grounds.

First, the clause purported to limit the power of the court to adjust the amount of damages which it considered appropriate in light of the seriousness of the breach of contract, pursuant to article 114 of the PRC Contract Law. The right to apply for judicial relief was a fundamental right of both parties to a civil law dispute, conferred by law and could not be restricted or eliminated by way of contract. Secondly, the clause concerned was held to be “against the principle of fairness of the Contract Law”.

Commentary

The first-instance decision from Suzhou Huqiu District People’s Court re-affirms the existing practice of the People’s Court that it may step in to adjust the liquidated damage amount, even though the amount may have been agreed between the parties. It also underscores the fact that provisions to limit the court’s discretion under article 114 have to be drafted very carefully and even then, such attempts may be unsuccessful.