Proving Actual Loss for Liquidated Damages: A Bygone?

Summary:

1. Strict proof of actual or genuine loss in forfeiting deposits or a claim for damages as compensation is no longer necessary, although it remains a factor in determining the reasonableness of the quantum of liquidated damages imposed.
2. There is no longer a distinction between a “agreed liquidated damages” and “penalty”.
3. The important considerations of whether a forfeiture of a sum or claim for damages as compensation depends on (i) whether there was any legitimate commercial interest in performance extending the prospect of pecuniary compensation flowing from the breach is served or protected by a damage clause, and (ii) whether the provision made for the interest is proportionate to the interest identified.
4. The amount to be forfeited must not exceed the amount stated in the contract.

Factual Background:

Cubic Electronics Sdn Bhd (“Cubic”) owned a piece of land in Mukim Bukit together with plant and machinery on the land (the “properties”). Cubic Electronics was subsequently wound up and the Properties were put up for sale in an open tender exercise. Mars Telecommunications Sdn Bhd (“Mars”) offered RM90 million to buy the Properties. Mars paid RM1 million as the earnest deposit which Cubic’s liquidators accepted and did not proceed with the tender exercise.

Mars’ offer was made in a tender form that complied with the Information Memorandum issued by Cubic. The relevant portion of Cubic’s acceptance letter was that:-

“Please be informed that pursuant to Clause 2.6 of the Info Memo, a Sale and Purchase Agreement (“SPA”) must be executed within 30 days from the date of this Letter of Acceptance unless otherwise extended by the Liquidators, failing which, your part earnest deposit paid of RM1.0 million will be forfeited as agreed liquidated damages and not by way of penalty pursuant to Clause 2.5.3 of the Info Memo.”

Mars did not execute the sale & purchase agreement by expiry date and Cubic’s liquidators threatened to forfeit the earnest deposit as agreed liquidated damages, not by way of penalty. There were 3 subsequent requests from Mars for an extension of time to sign a sale & purchase agreement that was granted with further amounts being requested for the earnest deposits, that Mars paid. However, Cubic’s liquidators refused Mars’ fourth request for an extension of time and forfeited a total of RM3,040,000.00, being the total earnest deposit paid by Mars and RM40,000.00 being the interest.

The Properties were subsequently sold to a third party (“Neraca”) and Mars commenced legal proceedings to (i) terminate the sale to Neraca, and (ii) sought the return of RM3,040,000.00, or alternatively, RM2,040,000.00 (less RM1,000,000.00 that was initially paid).

The High Court dismissed Mars’ claim. The Court of Appeal held that the forfeiture of RM2,040,000.00 was impermissible in light of Selva Kumar a/l Murugiah v Thiagarajah a/l Retnasamy [1995] 2 CLJ 274 and Johor Coastal Development Sdn Bhd v Constrajaya Sdn Bhd [2009] 4 CLJ 569 in that there was no evidence to show the RM2,040,000.00 represented the damage suffered by Cubic as a result of Mars’ breach and it was not a genuine pre-estimate loss as required under section 75 of the Contracts Act, 1950.

Cubic’s appeal to the Federal Court was allowed and Cubic was allowed to forfeit the entire RM3,040,000.00.

Court’s Reasoning:

The Federal Court (“FC”) viewed this case mainly on the treatment to be applied to deposits in light of s. 75 of the Contracts Act, 1950. The FC held that the salient issue was in relation to the additional earnest deposits and interest paid (i.e. RM2,040,000.00).

In adopting the UK Supreme Court’s decision in Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67, Courts must consider (i) whether there was any legitimate commercial interest in performance extending the prospect of pecuniary compensation flowing from the breach is served or protected by a damage clause, and (ii) whether the provision made for the interest is proportionate to the interest identified.

Thus, the FC held that the position adopted by the previous decisions of the FC in Selva Kumar a/l Murugiah v Thiagarajah a/l Retnasamy and Johor Coastal Development Sdn Bhd v Constrajaya Sdn Bhd requiring a strict approach of proving actual loss or damage is no longer necessary, although it remains a factor to consider.

Further, the party intending to forfeit or claim a sum as damages has to show that (i) there was a breach of the contract, and (ii) the contract contained a clause specifying the sum to be paid upon the breach. Once this is established, the defaulting party has to show that the sum to be forfeited or claimed as damages is unreasonable.