Law and regulation of consequential damages clauses in the energy sector in China

As the general term “consequential loss” is typically one of common law, there are many meanings that may be attributed to it worldwide but that would cause confusion under the civil law jurisdiction of the People’s Republic of China (PRC). For instance, the use of English terminology when discussing PRC law causes ambiguity, especially the Hadley v Baxendale 1 (1854) 9 Exch. 341. “consequential losses” definition in relation to “special circumstances”. Such terminology should be avoided and has no place in Chinese law.

Article 113 of the 1999 Contract Law of the PRC (“PRC contract law”) provides that the measure of damages shall be “the amount of compensation for losses [which] shall be equal to the losses caused by breach of contract”, which includes “benefits receivable after the performance of the contract” provided that such damages “shall not exceed the probable losses caused by breach of contract which was foreseen or ought to have been foreseen by the breaching party at the time of conclusion of the contract.” The term “consequential loss” is therefore not legally defined under statute law  and is not recognised under the laws of the PRC. Instead, PRC law stipulates that recoverable loss must be foreseeable or ought to have been foreseeable to result in any damages stemming from a breach, in the sense that a causal relation between the breach of contract and the damages must exist. Thus, recoverable “consequential loss” under PRC law would need to have a causal relation to the breach in question to fall within the scope of Article 113. 

In accordance with the 2009 Explanation of the PRC Contract Law issued by the Legal Committee of the Standing Committee of the National People’s Congress (“the Explanation”), the recoverable scope of loss should be stipulated under the relevant laws or be agreed by both parties. If there is no stipulation under law or in an agreement, all losses may be deemed recoverable, including what is traditionally known as “indirect” losses. The Explanation provides that an “indirect” loss in this context refers to the loss of a foreseeable acquirable benefit, which can be considered in this context as “consequential loss.” 

The Explanation goes on to stipulate that the test of foreseeability is based on the same principles as provided under Article 74 of the United Nations Convention on Contracts for the International Sale of Goods (“CISG”), whereby “damages for breach of contract by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach.” Article 74 sets out three limbs to the foreseeability test:

1. that the subject of the foreseeability requirement shall be the breaching party.
2. that the time to determine foreseeability of loss shall be the point of conclusion of the contract, rather than the time of breach of the contract.
3. that, under the relevant facts the breaching party knew or ought to have known, that the foreseeable loss was a possible consequence of a breach of the contract. 

The 2009 Guiding Opinions of the Supreme Court on Several Issues Concerning the Trial of Cases of Disputes over Civil and Commercial Contracts under the Current Situation (“Guiding Opinions”) provides further clarification under Article 9 as to what losses fall within a foreseeable acquirable benefit, including losses of production profits, losses of operational profits and losses of resale profits.

Subject to certain limitations, an exclusion of liability clause may be enforceable under the general principle of freedom of contract in PRC law. 

The only current limitation to exclusion of liability clauses under contract law is covered by Article 53 of the PRC Contract Law, which provides that a contractual provision would be invalid if it purports to exclude liability for physical injury to the other party or excludes property damage to the other party as a result of deliberate intent or gross negligence. By not expressly stating that indirect or consequential losses cannot be excluded in a contract, it can be implied under PRC law that such exclusion clauses, save for the exceptions above, are permitted.

In the case of (2018) Jing 02 Min Zhong No. 4810, the judges of the Second Intermediate People’s Court of Beijing Municipality of the PRC dismissed the appellant’s claim that “pure commercial losses are beyond the protectable scope of PRC civil law”, ruling that “there is no rule under PRC civil law expressly prohibiting the claim for pure commercial losses”. An exclusion of liability clause would therefore be helpful in ensuring that such losses are excluded should the courts find that the “pure commercial loss” in the respective transaction or matter falls within the scope of recoverable loss.

The Model Form Confidentiality Agreement (version 2007) published by the Association of International Petroleum Negotiators is often used by Chinese parties when conducting cross-border M&A in the oil and gas industry. This model form document includes a template exclusion of liability clause that excludes “loss of profits, or incidental, consequential, special, or punitive damages, regardless of negligence or fault”. However, this model contract is based on the laws of England and Wales and therefore would not be the best indicator for how typical Chinese exclusion of liability clauses are structured.

In light of the above, it would be advisable for a company looking to insert an exclusion of liability clause that excludes “consequential losses” to ensure that it uses terms accepted under PRC law. This would mean that, in order to cover all bases of loss with little ambiguity, the exclusion of liability clause should refer to excluding losses that were foreseen or ought to have been foreseen with a causal link to the breach – including foreseeable acquirable benefits such as loss of production, operational and resale profits, in accordance with the Guiding Opinions.

As explained above, “consequential loss” is not a defined term under PRC law, but is most often interpreted as “foreseeable acquirable benefit”. Given that interpretation, if “consequential loss” is included in an exclusion of liability clause, this would typically involve excluding losses of profit, production, operational or resale profits.

The exclusion clauses should be fact-specific. Only foreseeable losses are recoverable under PRC law. Therefore, the exclusion of liability clause would only seek to exclude foreseeable losses. Any unforeseeable losses would be unrecoverable under Article 113 of the PRC Contract Law.

The general requirements on exclusion of liability clauses can be found under Article 53 of the PRC Contract Law. It provides that the following exclusion clauses in a contract shall be null and void:

• those involving personal injury to the other party.
• those involving property damage to the other party as a result of deliberate intent or gross negligence.

The courts do not construe the potential heads of loss in respect of the types of loss, but they would calculate the actual amount of the total recoverable damages. Exclusion of liability clauses can therefore contain exclusions for all heads of losses, including foreseeable and causal losses, other than those mentioned in Article 53, as there is no de facto reasonableness test on exclusion of liability clauses contained within the PRC Contract Law.

In the event of ambiguity as to the scope of agreed exclusions, there are no specific legal rules or approaches to construe the exclusion clauses, apart from the general rules of PRC law on how to construe contractual clauses. According to Article 142 of the General Rules of the PRC Civil Law, the meaning of an expression of intent that is made to a certain party shall be interpreted according to the literal meaning of words used and in combination with the relevant articles, nature and purpose of the act, usual practices, and the principle of good faith.

As a special rule applicable to general terms and conditions (“Standard Clauses”), under Article 40 of the PRC Contract Law, if a party uses Standard Clauses to exempt itself from its liabilities, increase the liabilities of the other party or exclude the primary rights of the other party, the term shall be null and void.

There are two kinds of injunctions under PRC law: the preliminary injunction and an injunction during or after court proceedings. 

In accordance with Article 101 of the PRC Civil Procedure Law, a preliminary injunction shall be issued by a competent relevant People’s Court prior to filing a lawsuit or applying for arbitration, upon application of an interested party. To fulfil the requirements of a preliminary injunction, the circumstances must be urgent and the lawful rights and interest of the interested party shall be irreparably damaged if the preliminary injunction is not issued.

Article 100 of the PRC Civil Procedure Law provides parties with an avenue to obtain an injunction during court proceedings. Parties may be granted an Article 100 injunction if they are unable to enforce a judgment which is to be or has already been granted or if they have suffered further damage.  

The Article 100 injunction may prevent a party from selling property or it may order or prohibit certain conduct. The people’s court may also order an Article 100 injunction, despite receiving no application to do so, if it deems that the circumstances are necessary.

According to Articles 100 and 101 of the PRC Civil Procedure Law, the court will issue an injunction in only two circumstances: 1) where an interested party whose legitimate rights and interests, due to an emergency, would suffer irreparable damage if the party fails to petition for property preservation promptly; or 2) where the judgment may become impossible to enforce or if the judgment may cause damage to a party because of the conduct of the other party. 

The fact that an innocent party suffers from a loss that was excluded will not constitute an urgent circumstance or frustration to enforcement. It is therefore very unlikely that the innocent party would succeed in getting an injunction from the court.