Author: Lawyer Zhu Meicong, December 28, 2016

Abstract: In the current economic situation, situations where contracts cannot be fulfilled normally often occur, and rescission of contracts is usually an effective way to handle the legal relationship between the two parties. However, the legal consequences of contract termination, especially the issue of compensation for damages, have always been controversial in theory. The current laws in China do not have clear provisions on the scope and standards of compensation for damages, and there are often different judgments in judicial practice. This article attempts to explore the issue of compensation for damages after a contract is terminated due to breach of contract, in order to contribute to the improvement of the contract termination system.

Keywords: Contract termination; Compensation for damages; Trust interests; Obtainable benefits

Question raising

In March 2008, a company in Taizhou (Company A) signed a purchase and sales contract for carving machines with a company in Wuxi (Company B). Company B ordered 5 carving machines from Company A at a price of 170000 yuan each, with a total price of 850000 yuan. The contract stipulates the product specifications, quality, payment, acceptance method, delivery date, and penalty. According to the agreement, Company B shall prepay a total of 20000 yuan per unit on the day of contract signing, totaling 100000 yuan. Within 3 days after receiving a written notice of delivery from Party A, Company B shall pay 400000 yuan. On the day of delivery, Company B shall pay an additional 150000 yuan. The remaining 100000 yuan shall be used as a quality deposit, and shall be paid in full once there are no major quality issues within six months after delivery. After paying a prepayment of 100000 yuan, Company B's export handicraft orders have significantly decreased due to the impact of the international financial crisis, and there is no longer a need for carving machines used to produce handicrafts. Therefore, after receiving the delivery notice from Company A, the second payment for the goods has not been made as agreed, and has verbally stated to Company A that the carving machine is no longer needed. Company A has repeatedly requested Company B to continue fulfilling the contract and make payment as agreed, but after receiving the letter, Company B still refuses to fulfill it. In the event that Company B is unable to continue fulfilling the contract, Company A shall notify Company B in writing to terminate the purchase and sales contract signed by both parties, and then file a lawsuit with the court requesting Company B to pay liquidated damages and compensate for losses in accordance with the contract.

In this case, there is no doubt that Company B constitutes a breach of contract, and there is no doubt about the termination of the contract. But this case can raise two theoretical questions: firstly, can contract termination and compensation for damages coexist; The second is how to define the scope and standards of compensation for damages arising from the termination of the contract. This article will only discuss the issue of damages for contract termination due to breach of contract.

1、 Can Contract Termination and Compensation Coexist

There are two main views on the relationship between contract termination and compensation for damages, whether they can coexist simultaneously, based on the legal regulations and theoretical theories of various countries. One is the selectivism represented by Germany. When the debt is not fulfilled, the creditor may choose between terminating the contract or compensating for the damages caused by the non performance of the debt. The two are mutually exclusive and cannot coexist. However, after the modification of German debt law, that is, according to the provisions of the Final Report of the German Debt Law Amendment Commission, Germany has abandoned this view and shifted to the recognition of the coexistence of relief and damages. The second is the dualism represented by France, Japan, Switzerland, and Italy, which advocates that creditors can request compensation for damages at the same time as the contract is terminated, and the termination of the contract does not affect the right of the parties to claim compensation for losses The relationship between contract termination and compensation for damages is stipulated in both the General Principles of the Civil Law and the Contract Law of China. Article 115 of the General Principles of the Civil Law stipulates: "The modification or termination of a contract shall not affect the right of the parties to claim compensation for losses." Article 97 of the Contract Law stipulates: "After the termination of a contract, if the contract has not yet been performed, the performance shall be terminated. If the contract has already been performed, the parties may demand restoration to its original state, take other remedial measures, and have the right to demand compensation for losses based on the performance and nature of the contract, Chinese law recognizes that contract termination and compensation for damages can coexist.

Although there is no significant debate in the academic community regarding the coexistence of contract termination and compensation for damages, there are different understandings of the legal basis for the coexistence of the two. Firstly, there is the theory of compensation for breach of contract damages for non performance of debts, which holds that compensation for damages caused by non performance of debts already exists before the termination of the contract and is not lost due to the termination of the contract. The second is the theory of reliance interest, which holds that the contract is extinguished due to termination, so there is no longer any liability for damages based on non performance of the debt. However, in the event of a breach by one party, the non breaching party will suffer damage caused by believing that the contract continues to exist but does not actually exist, that is, the loss of reliance interest. The dispute between the theory of compensation for damages and the theory of reliance on interests arises from the misunderstanding of the subject matter of contract termination in traditional civil law. Traditional civil law believes that the subject of contract termination is a valid contract, and once the contract is terminated, it will no longer exist as a whole. As a result, there emerged a legal logic contradiction of seeking compensation for damages based on the contract, which no longer exists.

To solve this problem, we still need to start with the content of the contract. Xue Xiaodong believes that the content of a contract refers to the rights and obligations of the parties, which can be divided into primitive rights and obligations and remedial rights and obligations. Primitive rights and obligations refer to the rights and obligations set by the parties for the complete performance of the contract. It requires the parties to perform according to the provisions of the contract regarding the subject matter, quality, quantity, performance period, and performance location. The realization of primitive rights and obligations means that the contract has been fully fulfilled. Remedial rights and obligations refer to the remedies for breach of contract taken to achieve the purpose of the contract in the event that the original rights and obligations are not fulfilled. In terms of rights, there are the right to terminate the contract, the right to request breach of contract damages, etc The subject matter of contract termination is the original rights and obligations in the contract, and does not relieve the remedial rights and obligations Therefore, after the termination of the contract, the parties can still request compensation for damages based on the provisions of remedial rights and obligations in the contract or in accordance with the provisions of the law on remedial rights and obligations. In this way, there is no legal logical obstacle between contract termination and compensation for damages, and contract termination and compensation for damages can completely coexist.

2、 Definition of the scope of compensation for damages after contract termination

（1） Contractual benefits within the scope of compensation for damages

The determination of the scope of damages for contract termination is related to whether the interests of the parties involved in contract termination can be fully and appropriately protected, whether the interests of the parties involved can be balanced, and ultimately whether the normative function and purpose of the contract termination system can be realized. It is not important. Therefore, before exploring the scope of compensation for damages after contract termination, it is necessary to first understand the various benefits after contract termination. There are different conceptual expressions for contractual interests in the Anglo American and Continental legal systems.

1. The three types of interests involved in the termination of a contract in the Anglo American legal system. American jurist Fuller, in his article "Reliance Interests in Contract Damage Compensation" published in the 1930s, distinguished the purposes pursued by contract damage compensation into three types: return interest, reliance interest, and expected interest. The viewpoint proposed in this article has been widely accepted in both English and American law. The restitution interest refers to the trust in the defendant's promise, in which the plaintiff delivers certain value to the defendant, but the defendant fails to fulfill their promise. The court can force the defendant to surrender the value he accepts from the plaintiff. The protected benefits here can be referred to as return benefits. Secondly, based on trust in the defendant's promises, the plaintiff changed his situation. We can award damages to the plaintiff to eliminate the damage he suffered due to reliance on the defendant's promise. The benefit protected in this situation can be called the reliance interest. Once again, instead of sticking to the promisee's trust or the promisor's gain, one can seek to give the promisee the value of the expectation formed by the promise, and can actually force the defendant to provide the promised performance to the plaintiff in a specific performance lawsuit; Alternatively, in a damages lawsuit, the defendant may be required to pay the monetary value of such performance. Our goal here is to put the plaintiff in the position they would have been in if the defendant had fulfilled their promise. The interests protected in this situation can be called the expected interest.

2. The losses and benefits suffered by the civil law system. The concept of the scope of compensation for breach of contract damages commonly used in the continental legal system is the loss suffered and the lost interest, which is commonly referred to in Chinese theory as direct loss (reliance interest) and indirect loss (obtainable interest). The loss suffered, also known as positive damage, refers to the reduction of the existing property of the compensation right holder; The lost interest refers to the amount of compensation that the property of the right holder should have increased but not increased. It is generally believed that the return of benefits and reliance on benefits belong to the scope of the losses suffered, while the expected benefits belong to the scope of the lost benefits.

（2） Views on the scope of compensation for damages caused by contract termination in China's contract law and theoretical circles

Article 97 of the Contract Law stipulates that after the termination of the contract, if the performance has not yet been fulfilled, the performance shall be suspended; If it has already been fulfilled, the parties may demand restoration to its original state or take other remedial measures based on the performance and nature of the contract, and have the right to demand compensation for losses. However, there is no clear definition of the scope of this loss, resulting in inconsistency among judges in determining the scope of compensation for damages. There is a significant disagreement in the theoretical community regarding whether the scope of compensation for damages only refers to reliance interests (return interests and reliance interests in the Anglo American legal system, losses suffered in the Continental legal system) or includes loss of obtainable interests (expected interests in the Anglo American legal system, and lost interests in the Continental legal system).

One view is that all damages suffered by the non performing party can be claimed for compensation, including damages for non performance of the debt and damages arising from the termination of the contract, including losses of direct benefits and losses of obtainable benefits Another view is that in the absence of a clear agreement on the standard of compensation for damages by the parties to the termination of the contract, the scope of compensation for damages in the termination of the contract is trust interests, excluding obtainable interests. Scholars who hold the second view believe that: 1. In the event of a breach by one party, the non breaching party has multiple options. They can either demand that the breaching party continue to perform, pay liquidated damages, compensate for losses, or demand the termination of the contract and compensate for direct losses caused by the termination of the contract. Usually, the complying party will choose the most favorable treatment for itself and the most unfavorable treatment for the defaulting party; 2. The obtainable benefits can only arise when the contract is fully fulfilled. If the observant party wishes to obtain the obtainable benefits, they can choose to continue performing the contract and sanction the defaulting party by requiring them to pay liquidated damages, compensate for losses, and other means to protect their own interests. On the contrary, if the non breaching party chooses to terminate the contract, it indicates that they are unwilling to continue performing the contract. The benefits that can only be obtained from the performance of the contract should no longer be supported. So after the claim of the parties to terminate the contract is established, they cannot compensate for the loss of available benefits

The author believes that the second viewpoint mentioned above is inappropriate. Firstly, it stems from a misconception about the subject matter of contract termination, believing that the subject matter of contract termination is the entire contractual relationship. As previously demonstrated, the subject matter of contract termination is only the original rights and obligations in the contract, so there will be no problem beyond the scope of the effectiveness of contract termination. Secondly, it is not that the non defaulting party is unwilling to continue performing the contract, but rather that the serious breach of contract by the defaulting party has resulted in the purpose of the contract being frustrated. When the non defaulting party has sufficient evidence to prove that the defaulting party will not perform the contract, choosing to terminate the contract is a timely and effective remedy taken by the non defaulting party under their own circumstances, which can protect their own interests in a timely and effective manner, so that the benefits that should have been obtained will not be impossible to be realized due to the other party's breach of contract. Although the obtainable benefits may only arise when the contract is fully performed, we should not overlook the reality that the reasons for the incomplete performance of the contract can be attributed to the responsible party, nor should we ignore the fact that "the right holder has made necessary preparations for the realization and acquisition of such benefits, and objectively it has already had the foundation and conditions to transform into reality" ⑥ (P2407).

（3） The scope of compensation for damages after the termination of the contract should include available benefits

The author believes that the scope of compensation for damages after the termination of the contract should include the portion of available benefits, for the following reasons:

1. Meets the purpose of the parties entering into the contract. The purpose of a contract is to achieve certain benefits through the content of the contract, that is, assuming that the contract is fulfilled as scheduled, the rights holder will receive the expected benefits. The purpose of the contract can be achieved through the realization of original rights and obligations or remedial rights and obligations. Termination of a contract is a way of achieving the purpose of a contract through remedial rights and obligations when the parties are unable to achieve the intended benefits through their original rights and obligations. At this point, remedial rights naturally include demanding compensation from the other party for the loss of available benefits.

2. Comply with legal provisions. According to Article 115 of the General Principles of the Civil Law and Article 97 of the Contract Law, the termination of a contract does not affect the right of the parties to claim compensation for losses, and the term "loss" referred to here does not exclude indirect losses, namely loss of benefits, in both theoretical and practical fields;

3. The value of complying with the contract termination system. The legislative purpose and value of the contract termination system lies in comprehensively protecting the interests of the complying parties. In the case of termination of the contract due to the breach of contract by one party, requiring the defaulting party to bear compensation responsibility is a manifestation of the principle of contractual liability that "ensures that the interests of the non defaulting party are not damaged".

4. The principle of honesty and trustworthiness in accordance with contract law. If the contract is terminated, only compensation for restoration to its original state and loss of trust interests can be requested, which clearly violates the principle of good faith. After a party enters into a contract, the appropriate and comprehensive performance of the other party is their most basic expectation. Of course, they may also have reasons to use this expectation as a motivation to enter into a contract with others to seek greater benefits. When this "visible benefit" is lost due to the other party's breach of contract, not supporting the loss of their available benefits is undoubtedly a suspicion of condoning the party's breach of contract and violating the principle of good faith. ⑦

3、 Suggestions for Amending Article 97 of China's Contract Law

（1） Provisions on Compensation for Damage after Contract Termination in the Current Contract Law of China

Regarding the issue of compensation for damages after the termination of a contract, China's Contract Law only provides a very principled provision in Article 97, which reads: "After the termination of the contract, if the contract has not yet been performed, performance shall be terminated; if the contract has already been performed, the parties may demand restoration to its original state, take other remedial measures, and have the right to demand compensation for losses based on the performance and nature of the contract

It can be seen that China's Contract Law adopts overly flexible provisions on the issue of compensation for damages after contract termination, characterized by a high degree of generality, and the legal provisions are too brief and lack practical operability. The consequence is that there is a great deal of controversy over this issue in both theoretical and practical fields. In practice, when facing complex cases, people often become confused and have divergent opinions on how to handle the situation after contract termination. In judicial practice, there are often vastly different judgment results, which puts judges in a dilemma when trying cases and greatly increases the difficulty of applying the law. For the parties and their agents, the unpredictability of the case has also greatly increased. This provision, which ultimately leads to the loss of legal certainty, can be considered a major regret in China's current Contract Law.

（2） Characteristics of the provisions of Anglo American law on the scope of compensation for damages caused by contract termination

The provisions of the Anglo American Contract Law on compensation for damages caused by contract termination not only clearly establish three calculation methods: expected interest, reliance interest, and free gain, but also take into account the specific losses, non monetary losses, and other factors of the victim. The characteristic of its relevant regulations is that the design is very rigorous, the regulations are very clear and detailed, and the operability is strong, which is worth learning from in China. Firstly, both British and American contract laws stipulate that when a contract is terminated due to breach of contract, the aggrieved party can demand compensation for the reliance interest, and the innocent party can demand full compensation for the loss of their expected interest. ⑧ For the calculation method of expected interest, Article 347 of the Second Restatement of Contract Law of the United States stipulates, This provision stipulates that the amount requested by the aggrieved party based on expected benefits shall be calculated by the following method: (1) the impairment of the contractual benefits that can be obtained under the condition of full performance caused by the defaulting party's failure or incomplete performance; Add (2) incidental or inevitable other losses caused by breach of contract; Subtract (3) the costs or other losses avoided by the injured party due to not having to perform. That is to say, compensation=(reduction in contract value+other losses) - avoided costs - avoided losses) For trust interests, there are also specific provisions defining trust interests and specifying calculation methods. As stipulated in Article 349, compensation received by the aggrieved party due to reliance on interests, including expenses incurred in preparation for performance or performance, and any losses reduced by the aggrieved party due to performance of the contract, as evidenced by reasonable inevitability of the defaulting party.

（3） Legislative Suggestions on Article 97 of China's Contract Law

As a norm guiding people's behavior, the law should only make clear and specific provisions, and the above practices of British and American law are worth learning from in China's Contract Law. China's Contract Law should be further improved on the basis of absorbing advanced international experience and local judicial practice. Article 97 of the Contract Law should supplement or add other provisions to provide more detailed provisions on the legal consequences of contract termination, in order to enhance the operability of the law and provide good institutional support for the development of the market economy.

The author suggests that Article 97 of the Contract Law should clearly stipulate that after the contract is terminated, the scope of the parties' demand for compensation for losses includes the benefits that could have been obtained if the contract had been performed normally. At the same time, Article 97 can refer to the approach of Article 104 of the original Contract Law (Proposed Draft) and add a second paragraph, which clearly stipulates the specific components or calculation method of compensation for losses. For example, when the contract is terminated, unless otherwise provided by law or agreed by the parties, the creditor may request compensation for damages arising from the termination of the contract, including the necessary expenses incurred by the creditor in concluding the contract; The necessary expenses incurred by the creditor in preparation for believing that the contract can be fulfilled; Losses caused by creditors losing the opportunity to enter into contracts with others; The losses caused to the creditor by the debtor's refusal to fulfill the obligation to return the goods when the creditor has already fulfilled its contractual obligations; The necessary expenses incurred by the creditor for returning the debtor's property when the creditor has already received it. For the loss of expected benefits, an operational calculation method can be established, such as the calculation method for the amount of expected benefits in Article 347 of the Second Restatement of the United States Contract Law mentioned earlier.

Reference:

【1】 Cai Lidong: "Reconstruction of Contract Termination System", published in Law and Social Development, Issue 5, 2001.

【2】 Xue Xiaodong: "New Discussion on the Subject Matter of Contract Termination", published in Journal of Gansu University of Political Science and Law, February 2004, Issue 72.

【4】 Yuan Xiaoliang: "Analysis of Three Disputes over Contract Termination", published in the second issue of "Application of Law" in 2004.

【5】 Gao Ping: "Analysis of Compensation for Damage after Contract Termination", published in Law Journal, 2006, Issue 1.

【6】 Wang Liming: "Theory and Practice of Civil and Commercial Law", Jilin People's Publishing House, 1996 edition.

【8】 Li Xianbo: "Research on the System of Contract Termination in the UK and the United States", Peking University Press, 2008, cited from P.S. Adia: "Introduction to Contract Law" translated by Zhao Xudong, He Shualing, and Deng Xiaoxia: Law Press, 2002 edition, page 747.

【9】 Li Xianbo: "Research on the System of Contract Termination in the UK and the United States", Peking University Press, 2008 edition. Cited from Xu Gang, Song Yue, and Qin Yu: "Case Law of Contracts in the UK and the United States", Law Press, 1999 edition, p. 189.