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Based on Article 114, we can see that penalty clauses are relatively acceptable within Chinese jurisdiction unless the other party claims and the courts find that this amount concerned is excessively high. Unfortunately Chinese Supreme court or other legislative authorities has not yet officially clarify the legal conditions of “excessiveness” within Chinese contract law. However, fortunately there are two sources based on which we can deduce how Chinese courts evaluate the excessiveness of liquidated damages.
First, some judicial interpretations made by China Supreme Court have provided instruction of excessiveness of liquidated damages for some special contracts. One of guidelines is Interpretation of the Supreme People’s Court on the Relevant Issues concerning the Application of Law for Trying Cases on Dispute over Contract for the Sale of Commodity Houses. With regard to liquidated damages in contracts for the sale of commodity houses, Article 16 of this interpretation prescribes that “when the parties request for decrease of excessive liquidated damages, the people’s courts can decrease such agreed amount to 30% of the actual loss”. Although this judicial interpretation only applies to contracts for sale of commodity houses, its influence is seminal.
Subsequent to the adoption of this interpretation, at a National Judges’ Training Meeting Judge Wu Qingbao, chief justice of civil tribunal of China Supreme Court, called on judges to take 120 – 130% of the actual loss as the threshold to evaluate and accordingly decrease the excessive amount of liquidated damages. Thus, it seems that 30% of the actual loss has been nonofficially extended to liquidated damages of other contracts.
According to these two sources, we can find that Chinese contract law in principle does not reject penalty clause. As long as the penalty clause is concluded by the genuine consent of the two parties, it is enforceable due to freedom of contract. Only in the situation where one party claims for excessiveness of a penalty clause, the court can interfere. The amount of penalty clause can exceed that of actual loss; however it may not exceed 30% of the actual loss. Looking at the practice to evaluate excessiveness, it is obvious that Chinese court still adheres to the principle of ‘true’ compensatory remedy for breach of contract. In another word, penalty clause cannot go too far from the critical line of actual damage and otherwise it would be not applicable, even if it is an agreed article.
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