Recent Developments In The Law On Liquidated Damages In Malaysia

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."

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.

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].)
(d) It is open to the defaulting party to raise the defense that the liquidated damages clause, including the sum of damages it stipulates, is unreasonable (see [70]). However, where there is a dispute as to what constitutes reasonable compensation, the burden of proof falls on the defaulting party to show that the damages clause including the sum stated therein is unreasonable (see [71]). To place the burden of proof on the innocent party to show that the clause in question is not excessive would undermine the purpose of including a liquidated damages clause in a contract "which is to promote business efficacy and minimize litigation between the parties" (see [73]).
(e) In determining what amounts to "reasonable compensation" under s. 75 of the Act, the concepts of "legitimate interest" and "proportionality" as enunciated in the UK Supreme Court's decision in Cavendish are relevant (see [66]).
(f) A sum payable on breach of contract will be held to be unreasonable if it is extravagant and unconscionable in comparison with the highest conceivable loss that could possibly flow from the breach in question. In the absence of proper justification, there should not be a significant difference between the level of damages spelt out in the contract and the level of loss or damage that is likely to be suffered by the innocent party (see [68]).

On the facts, the Federal Court held that forfeiture of the deposit in question was not unreasonable compensation to the defendant. The defendant had suffered loss as a result of the plaintiff's delay in completing the purchase of the property, amounting to almost three months; the defendant had a legitimate interest in ensuring the timely completion of the sale (see [84] to [86]). Further, the deposit in question was not disproportionate or excessive and its forfeiture represented something that had been agreed between parties (see [87] to [93]).

On this note, the decision in Cubic Electronics may be read as leading to the implication that if an innocent party does not in fact suffer actual loss or damage, or is unable to prove this, the reasonable compensation it could stand to recover may not amount to much. If no actual loss or damage is suffered, it could be open to a defendant to argue that it should not be liable for anything more than nominal damages.

Peripherally, it should be noted that certain types of contracts for the sale of property would not be affected by section 75 of the Contracts Act. For example, contracts in relation to property that comes under the scope of the Housing Development (Control and Licensing Act) 1966 are governed by a separate regime in that statute for the forfeiture of deposits.

II. Comments in relation to the law on liquidated damages in India

The decision in Cubic Electronics provides an interesting comparison to various decisions of the Indian courts.

Various cases suggest that under Indian law, a claimant may take the benefit of a liquidated damages provision without proving actual loss, although it must show that it has suffered a legal injury and also a claim for compensation must in every case be reasonable. In Fateh Chand, the five-Judge Constitution Bench of the Supreme Court stated:

"Section 74 of the Indian Contract Act deals with the measure of damages in two classes of cases (i) where the contract names a sum to be paid in case of breach and (ii) where the contract contains any other stipulation by way of penalty. […] The measure of damages in the case of breach of a stipulation by way of penalty is by s. 74 reasonable compensation not exceeding the penalty stipulated for. In assessing damages, the Court has, subject to the limit of the penalty stipulated, jurisdiction to award such compensation as it deems reasonable having regard to all the circumstances of the case. Jurisdiction of the Court to award compensation in case of breach of contract is unqualified except as to the maximum stipulated; but compensation has to be reasonable, and that imposes upon the Court duty to award compensation according, to settled principles. The section undoubtedly says that the aggrieved party is entitled to receive compensation from the party who has broken the contract, whether or not actual damage or loss is proved to have been caused by the breach. Thereby it merely dispenses with proof of "actual loss or damages"; it does not justify the award of compensation when in consequence of the breach, no legal injury at all has resulted, because compensation for breach of contract can be awarded to make good loss or damage which naturally arose in the usual course of things, or which the parties knew when they made the contract, to be likely to result from the breach." (Emphasis in bold added.)

The Constitution Bench further stated (at [15]):

"Section 74 declares the law as to liability upon breach of contract where compensation is by agreement of the parties pre-determined, or where there is a stipulation by way of penalty. But the application of the enactment is not restricted to cases where the aggrieved party claims relief as a plaintiff. The section does not confer a special benefit upon any party; it merely declares the law that notwithstanding any term in the contract predetermining damages or providing for forfeiture of any property by way of penalty, the court will award to the party aggrieved only reasonable compensation not exceeding the amount named or penalty stipulated. […] Use of the expression "to receive from the party who has broken the contract" does not predicate that the jurisdiction of the court to adjust amounts which have been paid by the party in default cannot be exercised in dealing with the claim of the party complaining of breach of contract. The court has to adjudge in every case reasonable compensation to which the plaintiff is entitled from the defendant on breach of the contract. Such compensation has to be ascertained having regard to the conditions existing on the date of the breach." (Emphasis in bold added.)

As such, from the Constitution Bench's decision, it appears that at the very least, a party must establish that it has suffered a "legal injury" following which it is entitled to claim reasonable compensation, although it does not have to establish actual loss.

In this regard, a claimant may arguably rely on the sum stipulated by the parties as a reference point as to what constitutes reasonable compensation if it is difficult to assess the compensation due, provided that the sum is a genuine pre-estimate of losses and not a penalty. In Maula Bax, the three-Judge Division Bench stated (at [6]):

"It is true that in every case of breach of contract, the person aggrieved by the breach is not required to prove actual loss or damage suffered by him before he can claim a decree, and the Court is competent to award reasonable compensation in case of breach even if no actual damage is proved to have been suffered in consequence of the breach of contract. But the expression "whether or not actual damage or loss is proved to have been caused thereby" is intended to cover different classes of contracts which come before the Courts. In case of breach of some contracts, it may be impossible for the Court to assess compensation arising

from breach, while in other cases, compensation can be calculated in accordance with established rules. Where the Court is unable to assess the compensation, the sum named by the parties if it be regarded as a genuine pre-estimate may be taken into consideration as the measure of reasonable compensation, but not if the sum named is in the nature of a penalty. Where loss in terms of money can be determined, the party claiming compensation must prove the loss suffered by him." (Emphasis in bold added.) 

Not dissimilarly, the two-Judge Division Bench in Kailash Nath stated (at [43.1]):

"Where a sum is named in a contract as a liquidated amount payable by way of damages, the party complaining of a breach can receive as reasonable compensation such liquidated amount only if it is a genuine pre-estimate of damages fixed by both parties and found to be such by the court. In other cases, where a sum is named in a contract as a liquidated amount payable by of damages, only reasonable compensation can be awarded not exceeding the amount so stated. Similarly, in cases where the amount fixed is in the nature of penalty, only reasonable compensation can be awarded not exceeding the penalty so stated. In both cases, the liquidated amount or penalty is the upper limit beyond which the court cannot grant reasonable compensation."

These cases suggest that a plaintiff would still need to show that the damage or loss he is claiming in respect of is reasonable. The cases support the proposition that where it is possible to prove that loss is suffered, such proof cannot be dispensed with; it is only where actual damage or loss is difficult to prove that the sum stipulated in the contract can be claimed, provided that it is a genuine pre-estimate of loss agreed upon by the parties and not a penalty. In either case, the stipulated sum is a cap on the amount of compensation that can be claimed.

Accordingly, the Federal Court's decision in Cubic Electronics contrasts with these Indian authorities in the above respects. In this regard, we note that there has also been discussion as to whether the decisions in Fateh Chand and Maula Bax are consistent with that of the Divisional Bench of the Supreme Court in Oil & Natural Gas Corporation Ltd vs Saw Pipes Ltd (2003) 5 SCC 705 ("Saw Pipes"), where it was held that "when parties have expressly agreed that recovery from the contractor for breach of the contract is preestimated genuine liquidated damages and is not by way of penalty duly agreed by the parties, there was no justifiable reason for […] a conclusion that still the purchaser should prove loss suffered by it". It is also apposite to note that the disputed clause in Cubic Electronics provided that forfeiture was "agreed liquidated damages and not by way of penalty", which echoes the above-cited words from Saw Pipes.

That said, it appeared that in Saw Pipes, the party allegedly in breach did not lead evidence to show that the liquidated damages imposed were a penalty or unreasonable; in addition, the exact loss or damage would have been difficult to prove given the nature of the breach in question. Hence, in the circumstances, the Divisional Bench found that there was no reason for the tribunal to not rely upon the contractually stipulated rate of damages. Hence, to the extent that the Divisional Bench decided that no proof of loss is necessary, its decision can arguably be distinguished from the other judgments of the Supreme Court.

In light of the above, it can be seen that following from Cubic Electronics, the approaches of the Malaysian courts and the India courts to the issue of liquidated damages are quite different. This divergence is not without significance given that the law in both these countries is premised on statutory provisions that are in pari materia. These different approaches could no doubt be rationalized by the separate paths that the law in these two countries have taken over the decades, and myriad other considerations that may influence a court's decisions. Nonetheless, it is worth waiting to see if these different approaches of the courts in India and Malaysia to the issue of liquidated damages will eventually be reconciled, or whether this divergence is here to stay (or perhaps, even widen).

III. Comments in relation to the law on liquidated damages in Singapore

It is worth comparing the approach in Cubic Electronics, which now represents the law on liquidated damages in Malaysia, with that in Singapore. Unlike Malaysia and India, Singapore does not have a Contracts Act or equivalent legislation codifying the law on contracts. Hence, the law on liquidated damages is based on judicial pronouncements at common law.

Currently, the law on liquidated damages in Singapore is that as stated in Dunlop. The Singapore Court of Appeal, in Xia Zhengyan v Geng Changqing [2015] 3 SLR 732, shortly before the decision in Cavendish was issued, endorsed again (at [78]) the test set out in Dunlop for whether a liquidated damages clause is penal. To-date, the Singapore Court of Appeal has not yet had the opportunity to directly consider the applicability of Cavendish in Singapore and therefore its status in Singapore is still uncertain. However, there are several High Court decisions that have considered Cavendish on the issue of liquidated damages and penalties.

In iTronic Holdings Pte Ltd v Tan Swee Leon and another suit [2016] 3 SLR 663, the High Court considered the distinction drawn in Cavendish between conditional primary obligations and secondary obligations, with the penalty rule only regulating the latter and not the former. The Court then held (at [173]), on the facts, that the defendant's obligation to repay certain sums to the plaintiffs was "better characterized as a conditional primary obligation which crystallizes upon the occurrence of an event, that is, the failure of MCPL to list by 30 June 2012". Upon this event, the defendant simply became obliged to repay sums he had borrowed, and additional sums payable "were intended as interest to compensate – even if rather generously – the plaintiffs for the loss of use of money".

In Allplus Holdings Pte Ltd and others v Phoon Wui Nyen (Pan Weiyuan) [2016] SGHC 144, the plaintiffs sued the defendant for breach of Clause 1 of a settlement agreement by making payment of a certain tranche of payment, to the sum of S$500,000, late by 25 days. The plaintiffs claimed, pursuant to a liquidated damages clause, the sum of S$2.5 million plus 12% per annum interest. The High Court noted that the law in Singapore remains that articulated in Dunlop, and therefore applied the test in Dunlop. For completeness, however, the High Court also applied the test in Cavendish, and concluded that either test led to the conclusion that the clause in question was penal. The damages provided for in the clause could not be said to be a genuine pre-estimate of the highest damage that could flow from the breach and was also out of all proportion to any legitimate interest that the plaintiffs could have in upholding the settlement agreement.

In Nanyang Medical Investments Pte Ltd v Leslie Kuek [2018] SGHC 264, the plaintiff had acquired shares in the 3rd defendant for the consideration of S$1.5 million, and the parties had entered into other agreements, including call option agreements. Under the call option agreements, the 1st and 2nd defendants were entitled to purchase the plaintiff's shares in the 3rd defendant for $1 upon the plaintiff's failure to refer at least sixty patients to the 3rd defendant within a stipulated period. The High Court held that this entitlement to purchase the shares for $1 in the call option agreements did not constitute a penalty because the provisions in the call option agreements created a conditional primary obligation, and therefore the penalty rule could not apply to invalidate them. The plaintiff did not have a contractual obligation to refer sixty patients within the stipulated time, and as such its failure to do so was not a breach: rather, it triggered the defendants' entitlement to purchase the shares for S$1 and a conditional primary obligation on the plaintiff to transfer his shares to the 1st and 2nd defendants for S$1.

In Leiman, Ricardo and another v Noble Resources Ltd and another [2018] SGHC 166, which concerned a clause in a settlement agreement, which conferred on the 1st plaintiff an entitlement to exercise certain share options in the event that after leaving the defendant company's employment, he did not act to the detriment of that company. The Court considered the decision in Cavendish and affirmed the principle that if the non-defaulting party has a legitimate interest it is seeking to protect, this militates against finding that the clause in question is a penalty. Hence, the clause in question was not a "straightforward damages clause" (see [197]), but was not a penalty for several reasons. First, the clause conferred on the 1st plaintiff an entitlement that he did not have to begin with (see [211]). Second, the detriment imposed by the clause was not out of proportion with the primary interest that the company was seeking to enforce, i.e. regulation of the 1st plaintiff's conduct after he left its employment; it would be unfair if the 1st plaintiff were permitted to breach the settlement agreement and yet enjoy the benefits that it conferred on him (see [213]). Third, on the facts, the company had justifiably concluded that the 1st plaintiff had acted against its interests after leaving its employment (see [276]).

In Seraya Energy Pte Ltd v Denka Advantech Pte Ltd and another suit (YTL PowerSeraya Pte Ltd, third party) [2019] SGHC 2, the High Court surveyed prior High Court decisions that had considered Cavendish and reiterated that the position in Dunlop and not Cavendish represents the current law in Singapore. Nonetheless, the High Court also proceeded to consider the position in Cavendish, starting with examining if the obligations in question were primary or secondary ones, and concluded that the provision was penal. The Court held that there was no legitimate interest in the imposition of such payment obligations (see [192]), which the court said were "plucked out from the air" and not a genuine pre-estimate of damages, but rather to deter breach by the other party (see [197] to [208]).

In view of the above decisions, it can be seen that the absence of a statutory statement of the law on liquidated damages and penalties has impacted the development of the law in Singapore in this respect. Without the statutory language of "reasonable compensation", the law in Singapore has developed with greater reference to Lord Dunedin's decision in Dunlop as well as, more recently, concepts of legitimate interest and proportionality as articulated in Cavendish. (This is notwithstanding that the Singapore Court of Appeal has not yet pronounced on the scope of applicability of Cavendish in Singapore.)

That said, given the Federal Court's decision in Cubic Electronics, which held that concepts of "legitimate interest" and "proportionality" in Cavendish are relevant in determining what amounts to "reasonable compensation" under s. 75 of the Act, it may well be that the difference between the positions in Malaysia and Singapore are more linguistic than substantive. It could be said that there are only so many ways to skin the cat of penalty clauses, and that fundamentally the same broad principles underlie the law in these jurisdictions.

Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.