CMS Guide to Consequential Loss 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]  “consequential losses” definition in relation to “special circumstances”. Such terminology should be avoided in contracts and has no place in PRC law.

Article 584 of the 2020 Civil Code of the PRC (the “PRC Civil Code”) 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 foreseen or ought to have been foreseen to result in any damages stemming from a breach, in the sense that a not only a causal relation between the breach of contract and the damages must exist, but that chain of causation must not be unpredictable for a reasonable person. Thus, recoverable “consequential loss” under PRC law would need to have a causal relation to the breach in question and must have been predictable by a reasonable person, to fall within the scope of Article 584 of the PRC Civil Code.

Article 584 of the PRC Civil Code establishes that compensation for breach of contract shall equal the resulting losses, including lost profits that would have been earned through contract performance. The 2023 Supreme People’s Court’s Interpretation of Several Issues Concerning the Application of the General Principles of Contract Part of the Civil Code of the PRC (the “PRC Civil Code Contract Part Interpretation”) further provides in Article 63 that, when determining the losses that a breaching party could have foreseen at the time of entering into a contract as stipulated in Article 584 of the PRC Civil Code, the People’s Court must consider a range of factors, including the contracting parties, the content of the contract, the type of transaction, trade practices, and the negotiation process. The court shall determine the losses based on what a party in the same or similar situation as the breaching party could have foreseen or should have foreseen at the time of entering into the contract.

The PRC Civil Code Contract Part Interpretation provides further clarification under Article 60 as to what losses fall within a foreseeable acquirable benefit, including losses of production profits, losses of operational profits and losses of resale profits, minus the expenses and other reasonable costs incurred by the non-breaching party in entering into and performing the contract.

Article 60 of the PRC Civil Code Contract Part Interpretation grants two approaches to calculate the recoverable loss:

• If the non-breaching party exercises the right to rescind the contract and conducts a substitute transaction in accordance with the law, the loss can be determined based on the difference between the substitute transaction price and the contract price.
• If the price of the substitute transaction significantly deviates from the local market price at the time of the substitute transaction, or the non-breaching party does not conduct a substitute transaction, the loss can be determined based on the difference between the market price at the place where the contract is performed at the time of the breach and the contract price.

The calculation of the recoverable loss is further summarised in the Interpretation of the Civil Code of the People's Republic of China, one of the series of books published by the Legislative Affairs Commission of the National People’s Congress:

The recoverable loss = total foreseeable acquirable benefits - unforeseeable losses - extended losses – losses caused by non-breaching party - benefits received by non-breaching party as a result of breach of contract - necessary costs

Furthermore, Article 63 of the PRC Civil Code Contract Part Interpretation stipulates that, in addition to lost profits that would have been earned through contract performance, the non-breaching party may also claim expenses incurred when fulfilling contractual obligations to third parties - traditionally categorized as “indirect losses” along with lost profits. The People’s Court will uphold such claims if the breaching party had foreseen or could have foreseen these losses when entering into the contract.

To summarise, the term “consequential loss” is not legally defined or recognised under the laws of the PRC. Therefore, it is not recommended to use such a term in PRC law-governed contracts.

As stated in Question 1, it is not recommended to use the term “consequential loss” in PRC law-governed contracts. Having said that, PRC law does not prohibit the use of this term, and in practice, it does appear in some contracts, especially if the contract is originally derived from a foreign law-governed contract. When “consequential loss” appears in a PRC law-governed contract, 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 civil law is covered by Article 506 of the PRC Civil Code, 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, we do not recommend simply using the term “consequential loss” in the agreement and assuming it carries the same meaning as it does in other jurisdictions. Instead, we suggest expressly setting out each type of liability to be excluded, one by one, in clear and specific terms. 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 PRC Civil Code Contract Part Interpretation.

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 584 of the PRC Civil Code even without any exclusion of liability clause being necessary.

Under the PRC legal system, courts generally do not classify or apply different rules to types of loss based on expressions such as “consequential loss,” as is common in some other legal systems. Instead, the courts focus on the following factors:

• Clarity and specificity of the clause: If a clause clearly excludes certain losses that are causally related to the breach and were foreseeable, the courts will generally respect the parties’ true intent and uphold such exclusions. However, if the clause uses terminology drawn from other legal systems (e.g., “consequential loss”) without clearly defining it in the context of PRC law, the courts may view the language as ambiguous and limit its enforceability.
• Compliance with Article 506 of the PRC Civil Code: Exclusion clauses must not violate mandatory provisions of law, such as those prohibiting the exclusion of liability for personal injury or for property damage caused by intentional misconduct or gross negligence — see further details in Question 2.
• Unreasonable exclusion in standard terms: If the clause is part of a standard form agreement and it unreasonably excludes key rights or increases the liability of the other party, it may be deemed invalid under Article 497 of the PRC Civil Code.

Specifically, under Article 497 of the PRC Civil Code, the term shall be null and void if a party uses general terms and conditions (“Standard Clauses”) to:

• exempt or reduce itself from its liabilities, increase the liabilities of the other party, or restrict the primary rights of the other party unreasonably; or
• exclude the primary rights of the other party.

Therefore, liability exclusion clauses should never be included in Standard Clauses

In summary, PRC courts do not assess the enforceability of a clause solely based on whether it uses terms like “consequential loss” or whether it includes other heads of loss alongside “consequential loss”. Instead, they take a holistic approach, considering the clarity of the clause, its compatibility with PRC law, and whether it infringes upon the fundamental rights of the other party. Therefore, when drafting exclusion clauses, it is advisable to use terminology consistent with the PRC legal framework and to clearly specify the types of losses intended to be excluded, in order to enhance the clause’s validity and enforceability.

Under PRC law, a contractual exclusion of “consequential loss” typically only limits the scope of damages claims and does not automatically affect the right to seek non-damages remedies such as contract termination, restitution, or other forms of relief.

Specifically, Article 577 of the PRC Civil Code provides that where one party fails to perform its contractual obligations or fails to perform them as agreed, the other party may require: continued performance, remedial measures, or compensation for losses. An exclusion of liability clause generally applies only to the damages remedy—particularly to the scope of compensable losses—and does not restrict other forms of contractual liability such as continued performance or remedial measures. In addition, non-damages remedies like rescission, elimination of adverse impact, or restoration of reputation are separate civil liabilities under the Civil Code and are not affected by limitations on compensatory damages.

In practice, the effect of a typical clause excluding consequential loss clauses is generally confined to limiting the scope of damages. Only where the contract explicitly excludes all forms of relief—and where such exclusion does not violate mandatory provisions of law (i.e. the mandatory restrictions explained in question 4 above)—might non-damages claims be affected.

In practice, PRC courts tend to interpret exclusion clauses narrowly. If the clause excludes only consequential loss, it will not prevent the innocent party from exercising rights such as contract termination or seeking other non-damages relief. Even if consequential loss is excluded by contract, the injured party may still lawfully pursue non-damages remedies, unless expressly excluded under the contract. It is advisable, during contract negotiation and drafting, to clearly distinguish between damages and non-damages remedies to avoid unintended limitations on rights.