An Exploration of the Application Dilemmas of the Substitute Transaction Rule and Pathways for Resolution

Abstract

Articles 584 and 591 of the Civil Code of the People’s Republic of China and Article 60 of the Supreme People’s Court’s Interpretation on General Provisions of the Contract Section for the first time explicitly establish the substitute transaction rule. They introduce a novel method of calculating damages for breach of contract by allowing the non-breaching party to engage in a substitute transaction and claim the difference between the contract price and the substitute transaction price as expectation damages. This rule provides institutional support for the non-breaching party’s duty to mitigate loss and the pursuit of full compensation, and it reflects a legislative policy that promotes transactional efficiency and risk control. Yet in judicial practice the boundaries of its application, the standards for determining its reasonableness, and its relationship to other remedial methods remain the subject of considerable controversy.

The articulation between the substitute transaction rule and the mechanisms of contract termination and reasonableness review is unclear; when the rule competes with the market price rule and the compensation of lost profits, there are overlaps in the scope of compensation, inconsistent calculation standards and issues of double recovery. Accordingly it is necessary to clarify the prerequisites for applying the substitute transaction rule, to determine its reasonableness through dual assessments of time and market conditions, and to distinguish it from other methods of compensation in order to delineate its scope of application. Building a unified and standardized adjudicatory standard will enhance the efficiency and fairness of the remedy system for breach of contract.