Recent Developments In The Law On Liquidated Damages in Malaysia
Legal Era|September 2019
The operative paragraph of section 75 of the Malaysian Contracts Act, 1950, is identical to section 74 of the Indian Contract Act, 1872…

Introduction

Liquidated damages are a commonplace feature of the contractual landscape in many jurisdictions. Courts in different common law jurisdictions have, however, taken very different approaches to liquidated damages clauses and addressing any perceived injustices that arise out of such clauses. This article examines a recent development in the law on liquidated damages in Malaysia, which is worthwhile comparing to the approach taken in India. The contrasting approaches are significant in light of the similarities in the Contract Acts of the respective countries. The approaches in these two jurisdictions are also compared with that in Singapore, which differs in not having an equivalent statutory codification of its contract law.

The operative paragraph of section 75 of the Malaysian Contracts Act, 1950, is identical to Section 74 of the Indian Contract Act, 1872, providing:

“When a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, or if the contract contains any other stipulation by way of penalty, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract, reasonable compensation not exceeding the amount so named or, as the case may be, the penalty stipulated for.”

Previously, section 75 of the Malaysian Contracts Act was interpreted by the Malaysian courts to mean that a plaintiff or claimant was disentitled from recovering the sum fixed in the contract. A distinction was drawn between cases where (i) although the evidence disclosed a real loss which was inherently not too remote, it was difficult to assess damages, and (ii) cases where damages could be assessed. In the first category of cases, the court or tribunal could award an amount which it considered reasonable and fair. In the second category of cases, the claimant could not rely on the liquidated damages clause, but instead had to prove its loss and damages to the court in order for such damages to be assessed in its favor.

One of the most notable decisions on liquidated damages in recent years in the common law world is that of the United Kingdom Supreme Court in Cavendish Square Holding BV v. Talal El Makdessi [2016] AC 1172 (“Cavendish”). There, the Supreme Court articulated the overarching test as to the validity of a liquidated damages provision as follows (at [32]): “The true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.”

Some of the Supreme Court members drew the following distinction between a secondary obligation (which may be found to be a penalty) and a conditional primary obligation. Lord Neuberger and Lord Sumption (with whom Lord Carnwath agreed) stated in Cavendish at [14]:

“[…] where a contract contains an obligation on one party to perform an act, and also provides that, if he does not perform it, he will pay the other party a specified sum of money, the obligation to pay the specified sum is a secondary obligation which is capable of being a penalty; but if the contract does not impose (expressly or impliedly) an obligation to perform the act, but simply provides that, if one party does not perform, he will pay the other party a specified sum, the obligation to pay the specified sum is a conditional primary obligation and cannot be a penalty.”

Avinash Pradhan

Partner
Rajah & Tann Singapore LLP

The decision in Cavendish was significant as it recast the long-standing authority in Dunlop Pneumatic Tyre Company Limited v New Garage and Motor Company Limited [1915] 1 AC 79 (“Dunlop”) comprising, amongst other things, the following propositions:

(a) The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage.

(b) The question whether a sum stipulated is penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged as at the time of the making of the contract, not as at the time of the breach.

(c) In determining whether a provision imposes liquidated damages or a penalty, a court may consider:

(i) Whether the sum stipulated is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach;

(ii) Whether, if the breach of contract was a failure to pay a sum of money, the sum stipulated is greater than the sum that ought to have been paid;

(iii) Whether the same sum is payable on the occurrence of one or more or all of several events, which vary in the gravity of the damage caused: if so, there is a presumption that a sum is a penalty; and

(iv) Whether the true loss that would be suffered on occasion of breach is impossible to precisely estimate in advance: this does not automatically make the provision in question a penalty clause and in fact it may be in precisely such a situation that parties might agree on a liquidated damages clause.

The Supreme Court in Cavendish recognized that the test in Dunlop would remain sufficient for the purposes of a dispute arising from a straightforward damages clause. However, it considered that the new test it framed was necessary to address the wider variety of allegedly penal clauses that might arise in commercial situations.

Matthew Koh

Senior Associate

Rajah & Tann Singapore LLP

I. The decision in Cubic Electronics

In Cubic Electronics Sdn Bhd v Mars Telecommunications Sdn Bhd [2019] 2 CLJ 723 (“Cubic Electronics”), the issue was whether the forfeiture of deposits the plaintiff had previously paid, upon the plaintiff’s failure to execute a sale and purchase agreement to purchase certain property from the defendant, was valid or penal in nature. The forfeiture was stated, in the relevant clause, to be “agreed liquidated damages and not by way of penalty”.

The Federal Court reconsidered the law on liquidated damages, and in doing so, noted that the relevant Indian and Malaysian statutory provisions were in pari materia, and referred approvingly to several Indian Supreme Court decisions including Fateh Chand v Balkishan Das 1963 AIR 1405 (“Fateh Chand”), Maula Bux v Union of India 1970 AIR 1955 (“Maula Bax”), and Kailash Nath Associates v Delhi Development Authority (2015) 4 SCC 136. The Federal Court concluded (at [45]) that “the principles of law on damages clause are equally applicable in relation to forfeiture of deposits”.

The Federal Court’s decision can be summarized in the following propositions:

(a) There is no necessity for proof of actual loss or damage in every case where the innocent party seeks to enforce a damages clause (see [65]). In so holding, the Federal Court overruled a number of earlier decisions that had effectively held that proof of actual loss is necessary to conclusively prove whether compensation is reasonable.

(b) Section 75 allows reasonable compensation to be awarded by the court irrespective of whether actual loss or damage is proven: thus, proof of actual loss is not the sole conclusive determinant of reasonable compensation although evidence of that may be a useful starting point (at [65]).

(c) The initial onus lies on the party seeking to enforce a damages clause under section 75 to adduce evidence that, first, there was a breach of contract and that, second, the contract contains a clause specifying a sum to be paid upon breach. Once these two elements are established, the innocent party is entitled to receive compensation not exceeding the amount stipulated in the contract irrespective of whether actual damage or loss is proven. See [70].)

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