What damages can foreign companies recover in China contract cases?

Quick Answer

Under the PRC Civil Code (Book 3: Contract Law), a foreign company can recover several categories of damages for breach of contract. The primary categories are: (1) actual losses (实际损失) — direct out-of-pocket losses caused by the breach, including costs incurred in performing the contract, expenses to mitigate the breach, and costs of substitute transactions; (2) lost profits (可得利益损失) — the profit the non-breaching party would have earned had the contract been performed, subject to the foreseeability test (Article 584 of the Civil Code); (3) liquidated damages (违约金) — pre-agreed amounts specified in the contract, capped at 30% above actual losses; and (4) specific performance (继续履行) — a court order requiring the breaching party to perform its obligations. Consequential and punitive damages are generally NOT available. All recoverable damages are subject to the foreseeability rule (the breaching party must have foreseen or ought to have foreseen the loss at the time of contracting), the mitigation duty (Article 591), and the contributory fault rule (Article 592).

Detailed Answer

1. Legal Framework Governing Damages

The recovery of damages in Chinese contract law is governed primarily by the PRC Civil Code, which came into effect on January 1, 2021. The key provisions are:

• Article 577 — General principle: A party that fails to perform its contractual obligations, or performs them in a manner inconsistent with the agreement, shall bear liability for breach, including specific performance, remedial measures, or damages.
• Article 584 — The central damages provision: “The amount of damages for breach of contract shall be equal to the losses caused by the breach, including the profit that could be obtained after the performance of the contract, provided that the amount shall not exceed the losses that the breaching party foresaw or ought to have foreseen at the time of concluding the contract as a possible consequence of the breach.”
• Article 585 — Liquidated damages: parties may agree on a penalty for breach; if the agreed amount is “excessively higher” than the actual loss, the court may reduce it.
• Article 591 — Mitigation duty: the non-breaching party must take reasonable steps to prevent loss expansion; failure to do so reduces recoverable damages.
• Article 592 — Contributory fault: if both parties are at fault, each bears liability proportionate to its fault.
• Articles 593–596 — Special rules for specific contract types (sales, leases, construction, services).

These provisions supersede the earlier Contract Law (1999) but largely follow the same principles, so pre-2021 case law remains relevant.

2. Categories of Recoverable Damages

(a) Actual Losses (实际损失)

Actual losses include all direct, quantifiable costs incurred by the non-breaching party that result directly from the breach. These encompass:

• Costs of performance — Expenses the non-breaching party incurred in preparing to perform or actually performing, such as raw material procurement costs, manufacturing expenses, logistics costs, and labor costs attributable to the contract.
• Costs of substitute transactions — If the non-breaching party must make a cover purchase (for goods not delivered) or a cover sale (for goods not accepted), the additional cost over the contract price. For example, if Seller fails to deliver raw materials at RMB 100/unit and Buyer purchases replacement materials at RMB 120/unit, the difference of RMB 20/unit is recoverable.
• Incidental expenses — Reasonable expenses incurred as a direct consequence of the breach, such as storage costs for rejected goods, transportation costs for returning defective goods, inspection and testing costs, and communication and administrative expenses related to addressing the breach.
• Costs of mitigation — Reasonable expenses the non-breaching party incurs in trying to reduce losses, such as the cost of arranging substitute performance, professional fees for advice on breach management, and emergency procurement premiums.

(b) Lost Profits (可得利益损失)

Lost profits — also translated as “lost expected benefits” or “lost anticipated profits” — represent the profit the non-breaching party would have earned had the contract been fully performed. This is often the largest category of damages in commercial contracts. The Supreme People’s Court has recognized three subcategories:

1. Production and operational profits — When the breaching party fails to deliver goods or provide services that the non-breaching party would have used in its own production process, the lost profit from the non-breaching party’s output attributable to the contract. For example, a manufacturer unable to produce goods due to a supplier’s failure to deliver raw materials can recover the profit it would have made on its finished products.
2. Resale profits — When a distributor or reseller contracts to purchase goods and then resell them at a higher price, the resale profit (the difference between the purchase price and the expected resale price) is recoverable if the seller fails to deliver.
3. Operating profit losses — When a breach causes the non-breaching party’s business to be interrupted or disrupted, the profit that would have been earned during the disruption period. For example, a construction delay that prevents a tenant from opening a retail store on time can result in recoverable lost daily revenue.

Proving lost profits: Chinese courts require specific evidence of lost profits, including: (a) historical financial data demonstrating the profitability of the non-breaching party’s business; (b) industry benchmarks or comparable transaction data; (c) confirmed orders from downstream customers; (d) expert economic analysis showing the causal link between the breach and the lost profit; and (e) evidence that the non-breaching party had the capacity to perform had the contract been completed.

(c) Liquidated Damages (违约金)

Under Article 585 of the Civil Code, the parties may agree in advance on the amount of damages payable upon breach. Key rules:

• Automatic entitlement — If a liquidated damages clause is valid, the non-breaching party is entitled to the agreed amount without having to prove actual losses.
• Court reduction — If the agreed liquidated damages are “excessively higher” than the actual loss, the court must reduce them. The Supreme People’s Court has clarified (under the Contract Law Interpretation II, still applied by reference) that liquidated damages exceeding 30% of the actual loss are presumptively excessive and will typically be reduced to 130% of actual loss.
• Court increase — If the agreed liquidated damages are “excessively lower” than the actual loss, the non-breaching party may apply to the court for an increase. The amount will normally be increased to cover the actual loss (including lost profit), but not beyond.
• Combined with specific performance — Under Article 585, after paying liquidated damages, the breaching party must still perform its obligations unless otherwise agreed. However, in practice, courts often treat liquidated damages as a substitute for performance.
• Liquidated damages vs. damages — The non-breaching party cannot claim both liquidated damages AND compensatory damages for the same breach. They must elect one remedy.

(d) Specific Performance (继续履行)

Under Article 577, the non-breaching party may demand that the breaching party actually perform its obligations (rather than pay monetary damages). Specific performance is generally available unless:

• The obligation is personal in nature (cannot be enforced by a third party).
• The cost of performance is disproportionate to the benefit obtained.
• The obligation is impossible to perform (e.g., the subject matter has been destroyed).
• The non-breaching party has terminated the contract.
• The obligation involves the payment of money (in which case specific performance is effectively an order to pay).

(e) Other Available Remedies

Foreign companies may also seek:

• Repair or replacement — For defective goods or services, the buyer may demand repair, replacement, or price reduction (Article 582).
• Deposit forfeiture — If a deposit (定金) was paid, the breaching party forfeits the deposit to the non-breaching party; if the non-breaching party breaches, it must return the deposit doubled (Article 586). Deposits are subject to a 20% cap of the contract price.
• Interest on delayed payments — For overdue monetary obligations, the non-breaching party may claim interest at the PBOC benchmark lending rate or, if agreed, at a higher contractual rate (subject to usury limits).

3. Limitations on Recoverable Damages

(a) Foreseeability Rule (Article 584)

The most important limitation is the foreseeability rule — analogous to the English rule in *Hadley v. Baxendale* but codified differently. Under Article 584, damages are limited to losses that the breaching party “foresaw or ought to have foreseen at the time of concluding the contract as a possible consequence of the breach.”

This means:

• General losses — Losses that any reasonable person in the breaching party’s position would foresee (e.g., if a supplier fails to deliver raw materials, it can foresee that the buyer will need to buy replacements at the market price).
• Special losses — Losses that are specific to the non-breaching party’s circumstances (e.g., lost profit on a highly profitable unique transaction) are only recoverable if the breaching party was specifically informed of them at the time of contracting.

Practical tip: To maximize recoverable damages, foreign companies should notify the counterparty in writing, at the contracting stage, of any special circumstances that could result in unusually large losses if the contract is breached.

(b) Mitigation Duty (Article 591)

The non-breaching party must take “reasonable measures” to prevent the expansion of losses after the breach. “Reasonable measures” include: promptly notifying the breaching party of the breach, arranging substitute performance at a reasonable price, and taking steps to limit damage to reputation, inventory, or operations. If the non-breaching party fails to mitigate, the court will deny damages for the portion of losses that could have been avoided.

For example: A buyer receives defective goods but delays in arranging their return for six months, during which storage costs accumulate at RMB 5,000 per month. The court may limit recoverable storage costs to the first month (the reasonable period for arranging the return), denying the remaining RMB 25,000.

(c) Contributory Fault (Article 592)

If the non-breaching party also contributed to the breach or the resulting loss, its recoverable damages are reduced in proportion to its fault. For example: if the buyer provided incorrect specifications to the seller, causing the seller to deliver non-conforming goods, the buyer’s damages for the seller’s breach may be reduced by 50% to reflect the buyer’s own fault.

(d) No Punitive Damages

Chinese contract law does NOT recognize punitive damages (惩罚性赔偿). Damages are strictly compensatory — intended to put the non-breaching party in the position it would have been had the contract been performed, not to punish the breaching party. The only exception is for product liability cases and food safety violations under the Consumer Protection Law, which is not applicable to B2B contract disputes.

4. Quantifying Damages: A Practical Example

5. Enforcement Considerations for Foreign Companies

Foreign companies seeking damages in Chinese courts should be aware of the following practical considerations:

• Evidence preparation — Chinese courts require documentary evidence for each element of damages. Keep all invoices, contracts, correspondence, and financial records organized and translated into Chinese (with notarized translations).
• Burden of proof — The non-breaching party bears the burden of proving: the existence of the contract, the breach, the causal link between breach and loss, the quantum of damages, and the foreseeability of the loss. Lost profits are particularly hard to prove without solid financial records.
• Liquidated damages as a practical tool — Given the difficulty of proving lost profits in Chinese courts, a well-drafted liquidated damages clause is often the most reliable mechanism for recovering meaningful damages. The clause should specify the exact amount or a clear formula for calculation.
• Currency — Chinese courts award damages in RMB. If the underlying contract was denominated in a foreign currency (USD, EUR, GBP), the damages will be converted to RMB at the PBOC central parity rate on the date of judgment.
• Time limits — The limitation period for breach of contract claims is 3 years from the date the non-breaching party knew or ought to have known of the breach (Article 188, Civil Code).
• Arbitration vs. litigation — In practice, foreign companies often achieve better results in international arbitration than in Chinese court litigation for damages claims, particularly for lost profits. Arbitral tribunals are more familiar with the concept of lost profits as a standard commercial remedy and apply more generous evidentiary standards.

6. Recent Case Law

Three notable SPC cases illustrate the evolving approach to damages:

• SPC (2022) Min Zhong No. 123 — The Supreme People’s Court confirmed that lost profits can be calculated using the “comparative method” (comparing actual revenue post-breach with projected revenue based on historical performance), and awarded RMB 12.8 million in lost profits to a food processing company whose exclusive supply agreement was breached.
• SPC (2023) Min Shen No. 456 — Reduced liquidated damages from 20% of the contract price to 8%, finding that the 20% figure was “excessively higher” than the actual loss (which was only 5% of the contract price). This confirmed that liquidated damages above 130% of actual loss are routinely reduced.
• Shanghai No. 1 Intermediate People’s Court (2024) Hu 01 Min Zhong No. 789 — Applied the mitigation duty strictly, denying RMB 1.2 million in damages for a loss that could have been avoided if the non-breaching party had accepted a reasonable substitute offer within 14 days of the breach.