Liquidated Damages: Why 30% Might Get Cut in Half by Taiwanese Courts

Liquidated Damages: Why a 30% Clause Might Get Cut in Half by the Court!

When signing contracts, many companies habitually include a 'liquidated damages' clause to ensure the other party fulfills their obligations. The amounts can range from a few percent to tens of percent, with clauses for 20%, 30%, or even higher being common in practice. While this might seem like a powerful deterrent, can such agreements always be upheld 100%?

The answer is often: not necessarily. Many business owners or legal personnel may have encountered situations where, despite a clear written contract, the court orders the breaching party to pay significantly less in liquidated damages than what was agreed upon. The underlying reason lies in Article 252 of Taiwan's Civil Code. This provision grants courts the power to 'reduce to a reasonable amount' any liquidated damages that are deemed 'excessive'.

So, what constitutes 'excessive' liquidated damages in the eyes of the court? And how can you draft such clauses to ensure they are respected by the court rather than arbitrarily reduced? This article will analyze court precedents to explain the three key criteria courts typically consider when assessing whether liquidated damages are excessive, and provide practical advice to help you draft more effective liquidated damages clauses.

Why Do Courts 'Reduce' Liquidated Damages? Article 252 of the Civil Code is Key

Many believe that once a contract is mutually agreed upon, its terms should be absolutely respected. However, the law sometimes incorporates principles of substantive fairness and proportionality. Article 252 of the Civil Code explicitly states: 'Where the agreed liquidated damages are excessive, the court may reduce them to a reasonable amount.' This provision acknowledges freedom of contract but empowers courts to intervene and adjust terms when the agreed liquidated damages are clearly detached from reality, potentially leading to exploitation or unfairness.

When assessing whether liquidated damages are 'excessive,' courts do not rely solely on subjective feelings but follow a set of relatively objective standards. These standards can often be inferred from court judgments. If your contract includes high liquidated damages but you want it to be as enforceable as possible, you must understand what courts look for when reviewing these clauses.

Sample clause: "If Party B breaches any provision of Article 2 of this Agreement, Party B shall pay Party A liquidated damages in the amount of New Taiwan Dollars Three Hundred Thousand (NT$300,000)."

If Party B's breach is a minor delay in payment or a small defect in provided documents, and the court deems NT$300,000 to be disproportionate, it may reduce the amount pursuant to Article 252 of the Civil Code.

Criterion 1: The 'Materiality' and 'Circumstances' of the Breach

The first factor courts examine when evaluating the excessiveness of liquidated damages is the severity of the breaching party's conduct. Not all breaches cause the same level of 'harm.' If a breach directly prevents the achievement of the contract's purpose or causes significant damage, higher liquidated damages are more likely to be accepted by the court.

Conversely, if the breach is minor, such as a short delay in performance with a limited duration, or if the breach does not substantially affect the fundamental purpose of the contract, then excessively high liquidated damages appear 'disproportionate.'

In [Judgment 1] (Case No. 114年度員小字第394號), the court considered that the financial advisory services provided by the plaintiff (service provider) were not complex. It found the liquidated damages, set at 15% of the 'desired loan amount,' to be disproportionate to the actual effort expended by the plaintiff, especially since the defendant (loan applicant) ultimately failed to secure the loan due to their own conditions. The court reduced the liquidated damages. This illustrates that courts assess the 'value' and 'difficulty' of the service to determine the reasonableness of the agreed-upon percentage.

Sample clause: "Party A shall complete the development and delivery of Project A to Party B within six months from the signing of this Agreement. If Party A fails to complete within the deadline, Party A shall pay liquidated damages calculated at twenty percent (20%) of the estimated total project price, plus an additional one-thousandth (0.1%) of the total liquidated damages for each day of delay."

If Project A is not complex to develop, or if Party A is only a few days late, the court might consider the 20% rate excessive, especially the penalty for delay, and further reduce it.

Criterion 2: The Proportionality to the 'Consideration' (Value of Performance)

The second important criterion is whether the agreed liquidated damages are grossly unfair in relation to the 'consideration' (the value of the goods, services, or rights) originally stipulated by the parties. In other words, is the liquidated damages amount you demand disproportionate to the value of the goods, services, or rights you were supposed to provide?

For example, if you provide a service worth only a few thousand NT dollars but agree on liquidated damages of tens of thousands, a court is likely to deem this 'excessive.' The court will attempt to measure the value of your original performance to the other party and the costs or labor you incurred to facilitate the contract.

In [Judgment 2] (Case No. 114年度嘉小字第196號), the plaintiff (loan brokerage) and the defendant (loan applicant) signed a service agreement where the plaintiff would assist the defendant in applying for a loan. The court found that the plaintiff's actual labor was limited to 'filling out application forms' and did not involve providing other supporting documents. Furthermore, the plaintiff did not guarantee loan approval. Therefore, the court deemed the plaintiff's actual labor to be minimal and reduced the agreed liquidated damages to NT$500. This clearly shows that courts strictly examine the actual labor or costs incurred by the provider to determine if the liquidated damages are disproportionate.

Sample clause: "Party B agrees to pay Party A a total consultant service fee of New Taiwan Dollars Fifty Thousand (NT$50,000). If Party B fails to pay the service fee as agreed, Party B shall additionally pay Party A liquidated damages equivalent to fifty percent (50%) of the total service fee."

In this clause, if the service fee is only NT$50,000, but the liquidated damages are set at NT$25,000, the court might consider this percentage disproportionate to the value of the service itself and find room for reduction.

Criterion 3: Reasonable Link to 'Anticipated Losses'

Many companies agree on high liquidated damages to deter breaches or as 'pre-estimated damages' in case of a breach. However, whether this 'pre-estimated damage' amount has a reasonable link to the actual potential losses is a crucial factor for the court's review.

If the liquidated damages are based on a calculation foundation and a reasonably foreseeable scope of loss, courts are more inclined to respect the agreement. Conversely, if the liquidated damages amount appears arbitrary or purely punitive, and far exceeds the potential actual damage, it is likely to be questioned by the court.

For instance, in commercial transactions, if one party's breach could lead to millions in lost revenue for the other, liquidated damages of hundreds of thousands might be reasonable. However, if a breach only causes a few thousand NT dollars in extra expenses, agreeing on tens of thousands in liquidated damages would seem excessive.

In practice, many companies link the calculation of liquidated damages to 'actual losses' or 'calculable metrics.' For example, agreeing on liquidated damages as 'actual losses incurred due to the breach' or 'X% of the total contract price,' and requiring the breaching party to provide supporting evidence. Such clauses, having a clear basis for calculation, are less likely to be deemed exorbitant by the court.

Sample clause: "If Party A fails to complete the service delivery within the timeframe stipulated in this Agreement, Party A shall pay Party B liquidated damages equivalent to ten percent (10%) of the total contract price. These liquidated damages represent the anticipated losses due to delayed delivery and are not punitive in nature."

This clause links liquidated damages to the total contract price and states their nature as pre-estimated damages. Compared to purely punitive liquidated damages, it has a higher chance of being accepted by the court. However, it's still important to consider whether 10% is disproportionate to the actual potential losses, which remains a point of court consideration.

One-Sentence Checklist: Is Your Liquidated Damages Clause Enforceable?

• Does the liquidated damages clause have a clear proportional relationship to the value of the goods or services you provide?
• Can the liquidated damages you've agreed upon reasonably foresee or link to the losses the other party might suffer upon breach?
• Does the calculation method for liquidated damages have a clear basis or formula, rather than being arbitrarily set?
• Does the percentage or amount of liquidated damages align with the 'materiality' of the breach?
• Does the contract clearly state the nature of the liquidated damages (e.g., punitive or pre-estimated damages)?

A Common Myth: Higher Liquidated Damages Are Always Better?

Many believe that higher liquidated damages are a greater deterrent. However, excessively high liquidated damages may be significantly reduced by the court under Article 252 of the Civil Code, rendering the clause ineffective. Worse, if the other party claims the damages are excessive and the court substantially reduces them, you might have to separately claim 'actual damages,' increasing litigation complexity and uncertainty. Therefore, the focus should be on 'reasonableness' and 'appropriateness,' not just the amount.

FAQ

Will liquidated damages exceeding 30% always be reduced by the court?

Not necessarily. While 30% is indeed a high percentage, the court's decision is based on a comprehensive consideration of various factors, including the materiality of the breach, the proportionality to the consideration, and the link to anticipated losses. If the breach is extremely serious and could indeed cause significant damage, a higher percentage might be partially upheld. However, generally, the higher the percentage, the greater the chance of judicial review.

Can I agree on punitive liquidated damages?

Yes. Taiwanese Civil Code generally permits punitive liquidated damages aimed at deterring breaches. However, even for punitive liquidated damages, if the amount is excessive, the court may reduce it to a reasonable sum pursuant to Article 252 of the Civil Code.

If the court reduces the liquidated damages, can I still claim actual damages?

Yes. Article 250 of the Civil Code states that parties may agree that one party shall pay damages for delay in performance. Unless otherwise agreed, this provision does not affect the other party's right to claim compensation for the remaining damages. This means that even if liquidated damages are reduced by the court, you can still separately claim 'actual damages' caused by the other party's breach, provided you can present evidence of the amount of actual damage.

How can I make my liquidated damages clause more robust and less likely to be reduced?

The key is 'reasonableness' and 'calculability.' Try to link the calculation of liquidated damages to the total contract price, anticipated actual losses, or the value of the services agreed upon. Avoid overly vague or purely punitive high amounts. For example, stipulate liquidated damages as 'X% of the total contract price,' or 'actual losses incurred due to the breach, but not exceeding Y% of the total contract price.'

What are 'actual damages'? Do I need to provide proof?

Actual damages refer to monetary losses directly or indirectly caused by the other party's breach. For example, if the other party delays delivery, preventing you from producing on time and causing you to lose anticipated profits from orders; or if defective goods provided by the other party require you to spend extra on repairs or returns. Yes, when claiming actual damages, you must provide relevant evidence (such as invoices, receipts, correspondence, quotations, production records, etc.) to prove the occurrence and amount of the damage.

Is there a simple principle for liquidated damages for SMEs?

For SMEs, the simplest principle is: 'Not excessive, and calculable.' The percentage or amount of liquidated damages should ideally not exceed the scope of losses you anticipate or could realistically suffer. Simultaneously, establish a clear calculation basis, such as linking it to the total contract price or the main costs you incur to fulfill the contract. This not only increases the likelihood of the liquidated damages being upheld by the court but also makes the contract more concretely binding for both parties.