Penalty Clauses in China Contracts: Are They Enforceable Under International Sales Law?

Tribunal	CIETAC (China International Economic and Trade Arbitration Commission)
Date of Award	2004-09-00
Docket No.	CISG/2004/07
Parties	Chinese Buyer (Claimant) v. Switzerland ( Seller (Respondent)
Goods/Sector	Steel products
Key Issues	Scope of Convention; Interpretation of Convention; Penalty clauses; Agency issues; Fundamental breach; Avoidance; Damages; Foreseeability of damages; Mitigation of loss
CISG Articles	Art. 4, 7, 25, 74, 76, 77, 6

Facts

Claimant AAA Steel Co Ltd of aaa, PRC v. Respondent BBB AG of bbb, Switzerland PARTIAL AWARD AND REASONS THEREFOR MADE PURSUANT TO ARTICLE 57 OF THE CIETAC RULES

Legal Issues

This case raised the following questions under the CISG:

• Did the breach constitute a "fundamental breach" under CISG Art. 25? The tribunal assessed whether the non-performance substantially deprived the injured party of its contractual expectations — the threshold for invoking avoidance remedies.

• Was the injured party entitled to avoid the contract? Under CISG Art. 49/64, avoidance requires both a fundamental breach and proper notice under Art. 26. The tribunal examined whether these preconditions were met.

• How should damages be calculated? The tribunal considered the concrete method (Art. 75, based on cover transactions) and the abstract method (Art. 76, based on current market price) to determine the appropriate measure of compensation.

• Were the claimed losses foreseeable at the time of contracting? Under CISG Art. 74, damages are limited to losses that the breaching party foresaw or ought to have foreseen as a possible consequence of the breach.

• Did the injured party fulfill its duty to mitigate? Under CISG Art. 77, the injured party must take reasonable measures to reduce its losses. Failure to mitigate can reduce the damage award.

Practical Takeaways for International Businesses

1. Define breach thresholds in your contract. CIETAC applies the Art. 25 "fundamental breach" test strictly. Explicit remedies and termination triggers reduce ambiguity and protect both parties.

2. Avoidance requires proper notice. Under CISG Art. 26, a declaration of avoidance must be communicated to the other party. Failing to give timely notice can forfeit your right to terminate, even if the breach is fundamental.