Development of the law in Malaysia on deposits and Liquidated Agreed Damages clauses

 

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(Note: this blog post discusses the movement of law on deposits pursuant to Cubic Electronics Sdn Bhd (in liquidation) v Mars Telecommunications Sdn Bhd and also Liquidated Agreed Damages under Cubic Electronics, Macvilla Sdn Bhd v Mervyn Peter Guan Yin Hui and Golden Approach v Lau Seng Leong)

Previously, the law provides that for a plaintiff to be entitled to damages, he must prove actual damage (Selva Kumar v Thiagarajah). This rule was laid down by the Federal Court where it held that the strict burden of proof is on the claimant to not only succeed in proving the elements of his case ie breach, negligent or misrepresentation but he must prove that he has indeed suffered to some degree and that damages are reasonable (Section 74 Contract Act 1950).

Unfortunately, this means that even if a contract contains a Liquidated Agreed Damages (LAD) Clause, i.e. a clause that entitles a party to recover money should the happening of some event occur, if the claiming party cannot prove that he has suffered anything, the court will only award nominal damages.

The Federal Court took the opportunity to revisit this area the law encompassing Section 74 –76 Contracts Act 1956 and laid down a different principle of law on burden of proof in Cubic Electronics Sdn Bhd (in liquidation) v Mars Telecommunication.

The facts of the case are as follows:

  1. Cubic electronics was wound up and the assets (more notably are the land and machineries in this case) were put up for sale.
  2. Mars Telecommunication offered to purchase the assets for RM90 million and hence the sale continued by private sale instead of tender exercise.
  3. Mars paid a sum of RM1 million as earnest deposit which according to the conditions of the Memorandum of Sale that the amount would be forfeited should Mars fail to pay the remaining amount within 90 days as LAD instead of penalty. This was accepted.
  4. Mars was not able to meet the 90 days deadline and requested for an extension of time. Mars asked for a total 3 extensions and along with each extension, they paid an earnest deposit which amounted to RM3.04 million in total (including the RM1 million earnest deposit and an addition Rm40,000 being interest).
    1. It is worth noting here that with every extension provided by the Liquidators of Cubic Electronics, the liquidators repeatedly stated explicitly that failure to abide by the extension deadline will result in forfeiture of the relevant sum as LAD and not as penalty.
  5. When failing in their fourth attempt to ask for an extension, the liquidators of Cubic Electronics forfeited the total amount of RM3.04million and the assets were sold to a third party in an open tender (which Mars Telecommunication did not participate).

Aggrieved by the forfeiture of their deposit, Mars brings this claim to retrieve the whole RM3.04 million back if not forfeiture only of the first RM1 million. Cubic Electronics instead counterclaimed for rentals and utilities.

In the High Court, the claim for refund of deposit was refused and counterclaim allowed.

In the Court of Appeal, the court found that only the sum of RM1 mil was forfeitable deposit whilst the remaining should be returned following Selva Kuma and Johor Coastal as there was no evidence to show that the amount was suffered by the breach and neither was it a genuine pre-estimate of loss under Section 75.

In the Federal Court, the court held that the whole of RM3.04 mil was forfeitable.

Although the case concerned mainly about a deposit, the Federal Court took the opportunity to revisit the law on LAD and deposit altogether.

  1. On deposit payment

The general principle is that if a deposit is to be a part-payment of a contract, it is recoverable. However, if the deposit serves a dual purpose to guarantee performance and also as part payment, it is not recoverable (Howe v Smith). The primary purpose of what is deposit is that the purchaser means business (Sun properties v Happy Shopping Plaza) and this is a matter of interpretation of the law.

Furthermore, earlier decisions in the UK and India perpetuated the idea that the law of forfeiture of deposit and the law of penalties were mutually exclusive. Once the party could prove that it is a deposit, it can be forfeited without resorting to the law on damages clauses. This too was the default position in Malaysia, until Cubic Electronics.

It was now held that the current approach is to follow the English cash of Cavendish Square Holding BV v Talal El Makdessi. The innocent party forfeiting the amount must show that he has “legitimate commercial interest” to protect and in order to protect that interest, forfeiture is “proportional”. Once these are proven, the burden of proof shifts to the opposite party to show why the forfeiture deposit was excessive. Similarly, the law on penalties can be applied to the law on relief against forfeiture and the Federal Court is inclined to adopt the same approach.

Here, as Cubic Electronics was already in part of the winding-up process, the liquidators had a duty to realise the assets to the best possible price to maximise the amount due to creditors of the company. The failure on the part of the Plaintiff to complete the transaction and resulting the SPA dragged on for four months affected the Defendant financially in terms of increased liquidators fees, depreciation of movable assets and deprived of an opportunity to complete the sale with another party (which offered a higher purchase price). These were all the legitimate interest which the forfeited payments were meant to protect.

The court then assessed whether the amount of deposit was proportional to the damage suffered. Here, the additional RM2 million was not disproportionate as the total value of the Sale and Purchase Agreement is worth RM90 million hence the total deposit forfeited represented only 3.33% of the purchase price. Therefore, the deposit was proportional.

Once this is established, the burden of proof then shifts to the Plaintiff to prove on the balance of probabilities on why the deposit was excessive. The Plaintiff did not adduce any proof on the deposit being exorbitant but only insisted that the Defendant did not prove actual loss and damage. In the absence of evidence to prove the contrary, the sum is still reasonable.

The parties were aware and knew well that the additional deposit payments were to show Mars Telecommunication intention to continue the contract, keep Cubic Electronics abstaining from the sale of the assets and the two were in an equal bargaining position.

On the sum of RM40,000 as interest payment, the court held that since the amount would be forfeited regardless of whether the contract went through, it fell outside the scope of Section 75 hence was not refundable.

2. On Liquidated Agreed Damages (with added points under Macvilla Sdn Bhd v Mervyn Peter Guan Yin Hui and Golden Approach v Lau Seng Leong)

The current law on the assessment of damages in the absence of a LAD clause is that the claiming party must fulfil the Hadley v Baxendale rule which was included into the law of our country under Section 74 Contracts Act.

However, where there is a LAD clause, the clause is prima facie enforceable but Selva Kumar states that party cannot arbitrarily rely on the LAD clause and must prove actual loss or damage or else the court will only award nominal damages. He must prove the actual damage unless his case falls within the limited situation where it is difficult to assess such losses.

Once this is proved, the party is entitled to an amount not exceeding the LAD and the burden shifts to the opposite party to show that the LAD is excessive.

This can be a very heavy burden on the innocent party must prove the elements on which the claim is based. They have an added obligation to prove actual loss and damage despite there being a mutually agreed LAD clause.

Now, Cubic Electronics v Mars Telecommunication changes the law on allocation of the burden of proof. In Para 65, the court held that “there is no necessity for proof of actual loss or damage in every case where the innocent party seeks to enforce a damages clause”. As such, the court has endorsed the concepts of ”legitimate interest” and “proportionality” as above applies to the law on LAD and relevant in deciding what amounts to “reasonable compensation”.

Therefore, the law post-Cubic Electronics is that the burden of proof first lies on the party seeking to rely on the LAD clause. That party has to show that there is a breach of contract and that the contract contains a LAD clause. Once these two are proven on the balance of probabilities, the party is prima facie entitled to a sum not exceeding the LAD sum.

The burden now shifts to the opposite party to show that the clause is unreasonable or to show what ought to be reasonable. Failing to adduce cogent evidence to show the contrary, the court will uphold the LAD clause where the parties in an equal bargaining position (para 71).

“Reasonable compensation” is can be determined by comparing the LAD clause and actual loss that the plaintiff would sustain. However, proof of actual loss is not the sole conclusive determinant although evidence of such is a useful starting point. An unreasonable compensation would be if the amount is extravagant and unconscionable in amount in comparison with the highest conceivable loss which could possibly flow from the breach.

2.1 Macvilla Sdn Bhd v Mervyn Peter Guan Yin Hui & Another

A few months later from the Cubic Electronics v Mars Telecommunication came this case in the Court of Appeal which dealt with the issue of LAD clause under the Housing Development (Control and Licensing) Regulations 1989.

The instant case concerns the LAD clause found in Schedule H of the Housing Development Act on which this action is anchored on. It provides that in the event that the housing developer delays in handing over the property to the purchaser from the statutory deadline, the purchaser is entitled to damages not less than 10% of the purchase price annually, which amounted to RM38,732 here. There was no evidence adduced and yet the Tribunal for Homebuyers allowed the LAD sum of RM32,012.

The appeal by the housing developer was restricted to the question of whether Section 75 Contracts Act applies to a statutory contract under the Housing Development Regulations 1989. There are case laws going both ways with Sakinas v Siew Yik Hau and Outlet Rank v MBB which followed Selva Kumar which held that the statutory contract is incapable of overriding Section 75 whereas Hariram v Sentul Raya and Brisdale Resources v Law Kim held otherwise.

If the statutory contract is subject to Section 75 CA, this means it would also now be under the scrutiny of Cavendish’s “legitimate expectation” and “proportionality” tests as laid down in Cubic Electronics v Mars Telecommunication despite itself carrying the force of law.

However, the Court of Appeal did not follow Cubic Electronics v Mars Telecommunication’s methodology since it opined that the case relates to applying Section 75 to deposit payment under a contract and hence is of no relevance to the instant case. Instead, the court held the approach to interpreting a LAD clause under Section 75 is as follows:

  1. Where a LAD clause is in dispute, section 75 presumes that a LAD clause is a penalty clause unless the innocent party proves otherwise (different from English position).
  2. If the innocent party fails to prove his claim, the court is obliged to give a reasonable compensation (as contrasted to a nominal compensation in Selva Kumar) not exceeding the stipulated sum (different burden of proof as compared to Cubic Electronics).
  3. If the innocent party is able to prove his claim, the law does not permit him to recover more than the stipulated sum. (different from English position).
  4. In deciding what is reasonable, the court will take into consideration various factors such as in para 52, where 10 per cent of the total value is reasonable or according to market practice and where the contract is governed by an act or reputable institutions of the industry, the courts will give due weight unless compelling reasons not to do so.
  5. As a matter of policy, the court should not put the innocent party to strict proof at the expense of the public pursuant to benefit the defaulting party.

The appeal was dismissed as 10% was reasonable and in absence of the purchasers proving damages, the LAD in statutory contracts should be sustained as reasonable compensation, not only because the parties have agreed to be bound by the statutory contract but also because in the courts view it reflects a sum to be awarded as reasonable compensation.

2.2 Golden Approach v Lau Seng Leong

The Federal Court held that the cause of action to sue for LAD under the LAD clause under the Housing Development (Control and Licensing) Regulations 1989 is the date of expected delivery and not actual delivery.

Previous case law had supported the notion that there is no cause of action on the part of the purchaser to claim for LAD until and unless vacant possession is delivered. This case, however, now holds that the cause of action arises on the date of expected delivery and the time under the Limitation Act 1953 runs from then.

Conclusion

Recent cases have shown a shift in judicial trend and reluctance of the court to interfere with the parties who enter into a contract freely and well-informed. This is a much-celebrated movement the law as it upholds the sanctity of contract and preserves the doctrine of Laissez Faire. Not only in this area but also in the area of laws regarding indemnity, parties need not prove actual damage and losses before it could claim compensation.

Although Selva Kumar and Johor Coastal are said to not apply in Cubic Electronics v Mars Telecommunications, the court did not explicitly state that the cases are now overruled and irrelevant to current laws but stated that it ought not to be interpreted as a straightjacket that proof of actual loss is the sole conclusive determinant of reasonable compensation.

However, the case has also alluded to some idea of penalty clauses despite the holding that the laws on penalty clauses do not apply to the laws of this country (Linggi Plantations). Since LAD are still subject to the rules of “reasonable compensation” using the Cavendish test, has the Court re-introduced the law of penalties back into our jurisprudence?

With regards to Macvilla Sdn Bhd v Mervyn Peter Guan Yin Hui, my concern is that it had reverted the law to pre-Cubic Electronics era as now the burden of proof lies back unto the plaintiff to prove that it is not a penalty clause albeit Macvilla gives the Plaintiff some benefit of the doubt. It is my humble opinion that I prefer the approach under Cubic Electronics as I do not think Section 75 is necessitates a presumption a “penalty clause” as understood under Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd but rather a different use of terminology of the word “compensation” since the title reads “Compensation for breach of contract where penalty stipulated for”. The section also includes “if a sum is named in the contract as the amount to be paid in case of such breach” in addition to “penalty”. Therefore if the court reads “penalty” as “penalty” understood under English law, the burden of proof should still not apply to the innocent party to disprove as it can be “a sum… to be paid in case of such breach”. The differences between the two are almost indistinguishable unless ultimately proven by evidence hence it would be fairer to allocate the burden of proof according to the methodology in Cubic Electronics.

With regards to Golden Approach v Lau Seng Leong, I have mixed feelings for the outcome of the case. Whilst I welcome the decision of the court, my opinion is that there should be statutory intervention to stipulate when does cause of action arise since case law has been going both ways, it negatively affects housing purchasers who will be receiving incorrect advice and would not be able to claim for damages, especially if the action is time-barred.

To give more context, the LAD under the HDA reads “If the Vendor fails to deliver vacant possession … within the time stipulated … the Vendor shall be liable to pay … the rate of ten per centum (10%) per annum of the purchase price … until the date the Purchaser takes vacant possession of the said Parcel.” The clause provides that the purchaser is entitled to 10% per annum of the purchase price until vacant possession is delivered but is ambiguous as to when the purchaser can bring an action for the compensation. Is it when vacant possession is delivered or without waiting for vacant possession?

In a different case in the United Kingdom in Triple Point Technology, Inc v PTT Public Company Ltd, where LAD was sought against the contractor “per day of delay from the due date for delivery up to the date [the employer] accepts such work”. The court found that LAD was dependent on the completion of works and hence unless work was completed, the LAD clause is unenforceable. This was the status of the law pre-Golden Approach.

The perplex situation of law on Liquidated Agreed Damages has yet to be fully resolved despite decisions by the apex court and the Court of appeal as both has seemingly different views on the application of Section 75 towards deposits, LAD and prepayment. It would be interesting to observe future developments of the cases in this area of law.

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