A stunning restatement of the law

on Liquidated Agreed Damages

Section 75 of the
Contracts Act 1950
Introduction
Section 75 of the Contracts Act 1950

75. Compensation for breach of contract where penalty stipulated for.

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 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.
Liquidated and Ascertained Damages
(LAD)
• LAD: damages which amount the parties have agreed upon during the
formation of contract for the injured party to collect as compensation
upon a specific breach (e.g. late performance)
• English common law on LAD: if the amount fixed is a genuine pre-
estimate of loss, the amount is recoverable by the injured party in
the event of breach without having to prove actual damage, while if
the amount fixed is held to be a penalty, it is not recoverable but only
the damages actually proved
The Dunlop Pneumatic penalty test
In deciding whether an LAD clause is a genuine pre-estimate of loss or a
penalty, Lord Dunedin set out the following principles:
a) that the provision would be penal if “the sum stipulated for is extravagant
and unconscionable in amount in comparison with the greatest loss that
could conceivably be proved to have followed from the breach”;
b) that the provision would be penal if the breach consisted only in the non-
payment of money and it provided for the payment of a larger sum;
c) that there was “a presumption(but no more)” that it would be penal if it
was payable in a number of events of varying gravity; and
d) that it would not be treated as penal by reason only of the impossibility of
precisely pre-estimating the true loss.
Importance of LAD clauses
Per Mohd Zawawi JCA in Malayan Cement Industries Sdn Bhd v Golden
Island Shipping (L) Bhd:
“At the outset, it must be recognised that there are a number of
advantages to the inclusion of a liquidated damage clause in a contract.
Among significant advantages are: a liquidated damages clause
permits the parties to enter into a contractual relationship with a better
understanding of their respective rights and obligations in the event of
breach and can eliminate the cost and delay of a complex lost-profit
analysis if the relationship breaks down.”
Judicial Interpretation of S.75 Contracts
Act
The issues:
• the law is said to declare all LAD clauses to be penalty
• the question of whether or not actual damage must be proven
• what is meant by “reasonable compensation”
• is there a cap on the amount the courts may award in the event
actual loss is proven
Selva Kumar a/l Murugiah v Thiagarajah a/l Retnasamy
(“Selva Kumar”) [1995] 1 MLJ 817 (FC)
Held, allowing the appeal in part by ordering the respondent to refund the instalment
payments (less the deposit) to the appellant,
1) in Malaysia, there is no distinction between liquidated damages and penalties as
understood under English law, in view of section 75 of the Contracts Act 1950 which
provides that in every case the court must determine what is the reasonable
compensation, ‘whether or not actual damage or loss is proved to have been
caused thereby’ (‘the words in question’).
2) However, the words in question must be given a restricted construction. Hence,
despite the words in question, a plaintiff who is claiming for actual damages in an
action for breach of contract must still prove the actual damages or the reasonable
compensation in accordance with the settled principles in Hadley v Baxendale. Any
failure to prove such damages will result in the refusal of the court to award such
damages.
[cont’d]

3) However, for cases where the court finds it difficult to assess damages for the
actual damages employable, and yet the evidence clearly shows some real loss
inherently which is not too remote, the words in question will apply. The court
ought to award substantial damages as opposed to nominal damages which
are reasonable and fair according to the court’s good sense and fair play. In
any event, the damages awarded must not exceed the sum so named in the
contractual provision.

The Selva Kumar ruling seriously undermined the importance and effectiveness of
LAD clauses and consequently its role in allowing parties to a contract to allocate
risks in their contractual obligations and to avoid expensive and lengthy litigation
in the event of breach.
Johor Coastal Development Sdn Bhd v Constrajaya Sdn Bhd
(“Johor Coastal”) [2009] 4 MLJ 445
The issues before the Federal Court:
(1) Whether that part of the decision in Selva Kumar which obliges a
party having the benefit of a liquidated damages clause to prove its
losses, notwithstanding the words in S.75 Contracts Act “whether or
not actual damage or loss is proved to have been caused thereby”, is
correct
(2) Whether or not parties entering into a contract are entitled to
contract out of the provisions of S.75 Contracts Act
The Federal Court by a 2:1 majority answered the first question in the
affirmative but did not address the second issue on the facts of the case.
A dissenting voice
Dissenting judgement of Hashim Yusof FCJ in Johor Coastal:
1. The monies was rightly forfeited by the appellant, being an amount that was
reasonable in view of the nature of the project and its abandonment by the
respondent three years after the agreement was signed. Although proof of
loss and damages could be given, it would be a very lengthy process that the
parties agreed on a stipulated sum in the event of breach. It could not be the
case that the innocent party would be the one to have to prove the loss.
2. The parties had expressly agreed and named the sums payable in case of
breach as reasonable compensation to the non-defaulting party. The party
further waived any objection thereafter that those sums would be otherwise
than fair or reasonable compensation. Such stipulation was not contrary to
S.75 Contracts Act.
To avoid the effect of Selva Kumar ruling – contracting out
of S.75 Contracts Acts
• e.g. of an LAD clause drafted in response to the Selva Kumar ruling:
Clause 22.2 of the PAM Contract 2018: “The Liquidated Damages
stated in the Appendix is a genuine pre-estimate of loss and/or
damage which the Employer will suffer in the event the Contractor is
in breach…The parties agree that by entering the Contract, the
Contractor shall pay to the Employer the said amount, if the same
becomes due without the need for the Employer to prove his loss
and/or damage…”
• Obiter by FC in Cubic decision – “parties not at liberty to contract out
of S.75”[para 54]
Recent COA decisions applying Selva Kumar ruling
• Malayan Cement Industries Sdn Bhd v Golden Island Shipping (L) Bhd [2018]
• 1 CLJ 228 - contract to purchase iron ores

• Saycon Construction Sdn Bhd v Rosado Tradeline Sdn Bhd [2018] 4 MLJ 652
- construction contract

• Tekun Nasional v Plentitude Drive (M) Sdn Bhd and 2 Other Appeals [2018] 8 CLJ 693
- big contract to develop the entire core system infrastructure of the defendant which
consisted of upgrading loan repayment facility by introducing the mobile gadget and
standing instruction system

• Mars Telecommunications Sdn Bhd v Cubics Electronics Sdn Bhd (In liquidation)
[2017] 6 MLJ 321
- sale and purchase of land
Cubic Electronics Sdn Bhd (In liquidation) v Mars
Telecommunications Sdn Bhd (“Cubic”) [2018] MLJU 1935
Facts:
The Plaintiff offered to purchase land with plant and machinery thereon from the
Defendant for RM90 million on the terms set out in the Info Memo. Pursuant thereto, the
Plaintiff paid an earnest deposit of RM1 million. Failure to execute the SPA within a month
from the date of the acceptance would result in the forfeiture of the earnest deposit as LAD
and not by way of penalty. Upon the signing of the SPA the Plaintiff would have to pay 10%
of the purchase price as deposit.
On numerous requests by the Plaintiff and upon the payment of further sums by the
Plaintiff toward the earnest deposit, the Defendant had on three occasions granted an
extension of time to the Plaintiff to execute the SPA. By the time the final request was
rejected by the Defendant, the Plaintiff had made a total payment of RM3 million plus the
non-refundable interest of RM40,000.
The Courts’ decisions

• The High Court had dismissed the Plaintiff’s claim for the refund of the
earnest deposits forfeited, and held that that the forfeiture of the
deposits does not contravene S.75 Contracts Act and that the deposits
paid amounting to RM3 million are true deposits whereby the
Defendant need not prove loss or damage.
• The Court of Appeal, delivering its judgement in July 2017, agreed with
the learned High Court Judge that deposits are, generally speaking,
liable to be forfeited without proof of damage but held that the
amount liable to be forfeited by the Defendant was only the RM1
million that was agreed as earnest deposit at the time of entering into
the agreement.
[cont’d]

• On the question of the additional RM2 million forfeited by the

Defendant, the Court of Appeal referred to the decisions of the
Federal Court in Selva Kumar and Johor Coastal and held that:
“…In forfeiting the payments made, the Defendant not only failed to
adduce any evidence to prove that they suffered any damage, but
that they had also failed to prove that the whole sum forfeited was a
reasonable compensation which the Defendant would be entitled to
forfeit, as envisaged by S75 CA.”
Questions before the Federal Court

1. Where, in a sale and purchase of property, where terms and

conditions of the SPA have been agreed and a date fixed for the
execution of the SPA, whether any additional deposit paid for the
extension of time for completion is equally subject to forfeiture; and
2. Whether a purchaser who has agreed and willingly paid an interest
in consideration of an extension of time be entitled to claim a
refund of the same in the event he defaults in executing the SPA
and paying the balance deposit on the due date. [1]
Federal Court’s decision

Richard Malanjum CJ, in delivering the judgement of the FC,

summarised the legal principles now applicable to liquidated damages
clauses in Malaysia as follows:
i. If there is a breach of contract, any money paid in advance of
performance and as part-payment of the contract price is generally
recoverable by the payer. But a deposit paid which is not merely
part-payment but also as a guarantee of performance is generally
not recoverable.
[cont’d]

ii. Whether a payment is part-payment of the price or a deposit is a

question of interpretation that turns on the facts of a case, and the
usual principles of interpretation apply. Once it has been
ascertained that a payment possesses the dual characteristics of
earnest money and part-payment, it is a deposit.
iii. A deposit is subject to section 75 of the Act.
iv. In determining what amounts to “reasonable compensation” under
section 75 of the Act, the concepts of “legitimate interest” and
“proportionality” as enunciated in Cavendish (supra) are relevant.
[cont’d]

v. A sum payable on breach of contract will be held to be unreasonable

compensation if it is extravagant and unconscionable in amount in
comparison with the highest conceivable loss which could possibly flow
from the breach. 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 which is likely to be
suffered by the innocent party.
vi. Section 75 of the Act 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.
[cont’d]

vii. The initial onus lies on the party seeking to enforce a damages clause
under section 75 of the Act to adduce evidence that firstly, there was
a breach of contract and that secondly, the contract contains a clause
specifying a sum to be paid upon breach. Once these two elements
have been established, the innocent party is entitled to receive a sum
not exceeding the amount stipulated in the contract irrespective of
whether actual damage or loss is proven subject always to the
defaulting party proving the unreasonableness of the damages clause
including the sum stated therein, if any.
viii. If 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.
The law relating to deposits
The learned CJ referred to the decision in Cavendish v Square Holdings BV v Talal El
Maksessi [2015] UKSC 67 where the UK Supreme Court had made the observation that:
(i) both the law on penalties and the law against forfeiture may be applied to the same
clause (on forfeiture of deposit) albeit the relationship between the two is “not entirely
easy” and
(ii) the previously ambiguous position purporting to support the mutually exclusive approach
may be best rationalised by applying the reformulated law on penalties, that is, looking at
legitimate interest and proportionality rather than the law of relief against forfeiture.

In agreement with the UK developments, the learned CJ held that a deposit is subject to S.75
Contracts Act – departing from previous ruling in Linggi Plantations Ltd v Jagatheesan [1972]
1 MLJ 89 (PC)
Cavendish Square Holdings BV v Talal El Maksessi
(“Cavendish”)
• Facts: By an agreement, Mr Makdessi agreed to sell to Cavendish a controlling stake
in the holding company of the largest advertising and marketing communications
group in the Middle East. The contract provided that if he was in breach of certain
restrictive covenants against competing activities, Mr Makdessi would not be
entitled to receive the final two instalments of the price paid by Cavendish (clause
5.1) and could be required to sell his remaining shares to Cavendish, at a price
excluding the value of the goodwill of the business (clause 5.6). Mr Makdessi
subsequently breached these covenants. He argued that clauses 5.1 and 5.6 were
unenforceable penalty clauses. The Court of Appeal, overturning the High Court’s
decision, held that the clauses were unenforceable penalties under the penalty rule
as traditionally understood.
• Held: that neither clause 5.1 nor clause 5.6 are unenforceable penalty clauses, and
accordingly allowed the appeal
The Legal Principles
• The penalty rule, being of long standing, should not be abolished but
neither should it be extended [36-40].
• The fundamental principle is that the penalty rule regulates only the
contractual remedy for the breach of primary contractual
obligations, and not the fairness of those primary obligations
themselves. The relevant contractual remedy typically stipulates
payment of money, but it equally applies to obligations to transfer
assets or clause where one party forfeits a deposit following its own
breach of contract [13-18].
[cont’d]

• (referencing the reasoning in Dunlop Pneumatic Tyre Company Ltd)

What makes a contract provision penal? … The validity of a clause
providing for consequences of a breach of contract depends on
whether the innocent party can be said to have a legitimate interest
in the enforcement of the clause. There is a legitimate interest in the
recovery of a sum constituting a reasonable pre-estimate of
damages, but the innocent party may have a legitimate interest in
performance which extends beyond the recovery of pecuniary
compensation. The law will not generally uphold a contractual
remedy where the impact of that remedy significantly exceeds the
innocent party’s legitimate interest [18-30].
[cont’d]
The new penalty test

• The concept of “deterrence” and “genuine pre-estimate of loss” are

unhelpful. 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 [32].
• Per Lord Mance: “…The first test is to consider whether any (and if so
what) legitimate interest is served and protected by the clause, and
secondly, whether the provision made for that interest is extravagant,
exorbitant or unconscionable.”
Application of the legal principles to facts
in Cavendish
• Clause 5.1 is a price adjustment clause. It is not a secondary provision but a
primary obligation. The Sellers earn consideration for their shares by
(amongst other things) observing the restrictive covenants. Whilst clause 5.1
has no relationship with the measure of loss attributable to the breach,
Cavendish also had a legitimate interest in the observance of the restrictive
covenants, in order to protect the goodwill of the Group generally. The
goodwill of the business was critical to Cavendish and the loyalty of Mr
Makdessi was critical to the goodwill. The court cannot assess the precise
value of that obligation or determine how much less Cavendish would have
paid for the business without the benefit of the restrictive covenants. The
parties were the best judges of how it should be reflected in their
agreement.
[cont’d]

• A very similar analysis applies to clause 5.6. It is also a primary

obligation, and it could not be treated as invalid without rewriting
the contract [83-88]. It was said to be penal because the formula
excluded goodwill from the calculation of the payment price. It did
not represent the estimated loss attributable to the breach. But it
reflected the reduced consideration which Cavendish would have
been prepared to pay for the acquisition of the business on the
hypothesis that they could not count the loyalty of Mr Makdessi [79-
83].
ParkingEye Limited v Beavis (“ParkingEye”)

• Facts: ParkingEye Ltd agreed with owners of the Riverside Retail Park to
manage the car park at the site. ParkingEye displayed numerous notices
throughout the car park, saying that a failure to comply with a two hour time
limit would “result in a Parking Charge of 85 pound sterling”. On April 15
2013, Mr Beavis parked in the car park, but overstayed the two hour limit by
almost an hour. ParkingEye demanded payment of 85 pounds sterling. Mr
Beavis argued that the Parking Charge was unenforceable at common law as
a penalty, and/or that it was unfair and unenforceable by virtue of the Unfair
Terms in Consumer Contracts Regulations 1999. The Court of Appeal upheld
the first instance decision rejecting those arguments.
• Held: that the charge does not contravene the penalty rule, or the UTCCR
1999 (dismissed the appeal by a majority of six to one)
Application of new penalty test to
ParkingEye v Beavis
• Mr Beavis has a contractual licence to park in the car on the terms of
the notice posed at the entrance, including the two hour limit. The
charge was for contravening the terms of the contractual licence. This
is a common scheme, subject to indirect regulation by statute and the
British Parking Association’s Code of Practice. The charge had two
main objects: (i) the management of the efficient use of parking space
in the interest of the retail outlets and their users by deterring long-
stay or commuter traffic, and (ii) the generation of income to run the
scheme [94-98].
 [cont’d]

• Unlike in Cavendish, the penalty rule was engaged. However, the charge
is not a penalty. Both ParkingEye and the landowners had a legitimate
interest in charging overstaying motorists, which extended beyond the
recovery of any loss. The interest of the landowners was the provision
and efficient management of customer parking for the retail outlets. The
interest of ParkingEye was in income from the charge, which met the
running costs of a legitimate scheme plus a profit margin [99]. Further
the charge was neither extravagant or unconscionable, having regard to
practice around the UK, and taking into account the use of this particular
car park and the clear wording of the notices [100-101].
• note: not relevant to discuss the UTCCR 1999
Applying the new penalty test to Cubic

Applying the legal principles set out by the UK Supreme Court in

the decision of Cavendish, the Federal Court held that:
1. the Defendant’s deprivation of the chance to enter into
negotiations with a third party in addition to its goal of
securing the execution of the SPA and avoiding delay in
completion, are all legitimate interests which the forfeited
payments were intended to guard against [86].
[cont’d]

2. in considering whether the payments forfeited was

disproportionate, the additional RM2 million paid is not too large a
figure when compared against the total purchase price of the
properties, that is RM90 million. Combined with the initial deposit of
RM1 million (which the Plaintiff is not contesting), the additional
sum of RM2 million represents only 3.33% of the purchase price of
the properties [87].
3. the onus lies on the Plaintiff to show the forfeiture of the additional
RM2 million payments was excessive. The Plaintiff had failed to
adduce any proof showing that the forfeited payments were
exorbitant or unreasonable and consequently, the forfeiture of the
additional RM2 million amounts to reasonable compensation [88].
Impact of Cubic decision on Selva Kumar
ruling
• Most significant part of the FC decision in Cubic is where the learned CJ held that
S.75 Contracts Act allows reasonable compensation as agreed by the parties in
the LAD clause to be awarded by the courts irrespective of whether or not
actual loss or damage is proven
• In line with the basic common law principle relating to LAD clauses that as long
as the clause under consideration is not a “penalty” or “unreasonable”, the
innocent party can enforce the said clause to claim the sum agreed therein
without having to prove actual loss
• Directly contradicts the ruling in Selva Kumar (which was affirmed by Johor
Coastal) that a party having the benefit of a LAD clause is obliged to prove its
losses, notwithstanding the words “whether or not actual damage or loss is
proved to have been caused thereby” in S.75 of the Contracts Act
Meaning of reasonable compensation
• It was held in Cubic that in determining what amounts to “reasonable
compensation” under S.75 of the Contracts Act, the concepts of
“legitimate interest” and “proportionality” as enunciated in Cavendish
are relevant.
• Reasonable compensation in S.75 Contracts Act is therefore that which is
not extravagant, exorbitant or unconscionable.
• Reasonable compensation: a measure, not an amount
• In order to succeed, the party seeking to enforce an LAD clause has only
to establish that he has a legitimate interest to be protected in the event
of breach subject to the compensation imposed being not extravagant,
exorbitant or unconscionable.
Burden of proof to show that the LAD
clause is unreasonable
• FC held that “if there is a dispute as to what constitute reasonable
compensation, the burden of proof falls on the defaulting party to show
that the damages clause is unreasonable.”
• Putting the burden of proof on the defaulting party to show that the LAD
clause is not unreasonable presupposes that any LAD clause is not a penalty
• Problematic in view of wording in S.75 Contracts Act which is said to be
declaratory that any stipulated sum is a penalty
• More consistent with the wording in S.75 Contracts Act to put the burden of
proof on the party seeking to enforce the LAD clause, although, by using the
new penalty test to establish that it is not out of proportion to his legitimate
interest to enforce the clause
Some practical considerations
• When drafting the LAD clause, take note that in order to rely on the
clause, the client would need to be able to establish that what is
prescribed therein is not out of proportion to his legitimate interest
i.e. what is his legitimate interest being protected and how the
amount or remedy prescribed is not unreasonable
• Whether the LAD clause is an attempt to contract out of S.75
Contracts Act- clause can be held to be void
• Who has to prove that it is reasonable compensation – party seeking
to enforce the LAD clause should be prepared to prove the LAD is
reasonable compensation although the law now says otherwise
Conclusion
• Cubic decision reinstates viability and important role of LAD clauses
• Selva Kumar ruling severely limited if not virtually overruled
• Clear and emphatic restatement of the law on LAD is much needed
and widely welcomed by commercial sector especially those in the
construction industry
• A commercially sensible approach
• A modern and liberal approach

Prepared by SM Choong/UMLaw/210519