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Cubic Electronics v Mars Telecommunications: The Federal Court revisits the law on damages and reverses the burden of proof for liquidated claims
Damages are, at the core of it, the raison d'être for civil litigation. In Cassell v Broome [1972] AC 1027, Lord Hailsham defined damages as follows:
Of all the various remedies available at common law, damages are the remedy of most general application at the present day, and they remain the prime remedy in actions for breach of contract and tort. They have been defined as "the pecuniary compensation obtainable by success in an action for a wrong which is either a tort or a breach of contract." They must normally be expressed in a single sum to take account of all the factors applicable to each cause of action and must of course be expressed in English currency: Mayne and MacGregor on Damages, 12th ed. (1961), para. 1.
Damages have been a thorny topic in Malaysia due to the absolute need to prove damages. This precedent was established by the Federal Court in the decisions of Selva Kumar v Thiagarajah [1995] 2 CLJ 374 and Johor Coastal v Constrajaya [2009] 4 CLJ 569.
Cubic Electronics
Of-late, the Federal Court has revisited the issue of damages. In Cubic Electronics v Mars Telecommunications [2018] MLJU 1935, the Federal Court considered the decisions of Selva Kumar and Johor Coastal and laid down a new precedent pertaining to damages in Malaysia.
The Facts of Cubic Electronics
Cubic Electronics involved an interesting set of facts that must be appreciated prior to any discussion as to its principles. Conveyancers would do well to consider these facts when drafting any sale and purchase agreement.
The land and machinery in Malacca
Cubic Electronics (Cubic) was the owner of a piece of land (together with machinery on said land) in Malacca. Cubic went into liquidation and the liquidators put this land up for sale via tender.
Before the tender could be carried out, Mars Telecommunications (Mars) offered to purchase the land for RM90 million (RM80m for the land, RM10m for the machinery).
Mars issued a letter dated 06.10.2011 to Cubic. Mars also issued a duly-filled tender form and Information Memorandum to Cubic.
The Information Memorandum
The Information Memorandum contained a clause that the land would require a deposit of 2%, whereas the machinery would require a deposit of 10%.
Cubic and Mars agreed that Mars would be allowed to pay a deposit of RM1m first as an earnest deposit. The Information Memorandum further stated that a Sale and Purchase Agreement would have to be executed by 06.11.2011 failing which, the earnest deposit would be forfeited as agreed liquidated damages and not as a penalty.
The S&P is not executed - The 1st Extension
The S&P was not executed by 06.11.2011. Mars sought an extension of time until 23.11.2011. Cubic agreed, provided Mars paid an additional RM500,000.00. Mars made the payment accordingly.
The S&P is not executed - The 2nd Extension
The S&P was again not executed by 23.11.2011. Mars sought a second extension of time until 23.12.2011. Cubic agreed, provided Mars paid an additional RM500,000.00. Mars made the payment accordingly.
The S&P is not executed - The 3rd Extension
The S&P was again not executed by 23.12.2011. Mars sought a third extension of time until 23.01.2012. Cubic agreed, provided Mars paid an additional RM 1m and interest of RM40,000.00. Mars made the payment accordingly.
The S&P is not executed - The 4th Extension is sought but refused
At this stage, Mars had paid Cubic a sum of RM3.04m.
On 25.01.2012, Mars again wrote to seek an extension of time, together with a cheque for RM6m.
Cubic refused the cheque and returned it. Cubic further terminated the sale with the S&P not executed. Cubic further sought to forfeit the sum of RM3.04m that had been paid by Mars.
Cubic then sold the land to a third party via an open tender exercise.
Mars took out a civil suit against Cubic seeking a return of monies paid. Cubic counterclaimed, seeking damages for rental and utility charges as Mars was a tenant of the land at that material time.
The decision in the High Court
The High Court allowed Cubic’s counterclaim but dismissed Mars’s claim for a refund.
The decision in the Court of Appeal
Mars appealed. The Court of Appeal ruled that the forfeiture of the full sum of RM3.04m was impermissible. However, the COA allowed Cubic to retain RM1m, being the initial earnest deposit that had been paid.
The appeal to the Federal Court
Cubic then appealed to the Federal Court. The question before the Federal Court were, in pith and substance, as follows:
a. Where terms and the date for the execution of a S&P have been agreed, would any additional payments made (pending an extension of time to execute the S&P) be subject to forfeiture?;
b. Whether a purchaser (Mars) who has paid interest as consideration for an extension of time be entitled to claim a refund of the same in the event of the purchaser’s default in executing the S&P and paying the balance deposit.
The Federal Court’s decision
Mars took the position that the sum of RM3.04m was not a deposit but instead, was a penalty forfeiture that is proscribed by Section 75 of the Contracts Act 1950 (para. 29 of the Judgement).
In contrast, Cubic took the position that the sum of RM3.04m was a deposit that was subject to forfeiture.
The Federal Court considered that “the question is whether section 75 is equally applicable to forfeiture of deposits or once it is found to be a deposit the section has no application?” (para. 30 of the Judgement).
Distinguishing between part-payments and deposits
The Federal Court noted that there is a distinguishing factor between part-payment for a contract price and a deposit. At para. 32:
“The general principle is that 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.”
However, it emphasised that a “deposit paid which is not merely part payment but also as a guarantee of performance is generally not recoverable.“ (Para. 33)
The Federal Court went on to state that to determine “Whether a payment is part-payment of the price or a deposit is a question of interpretation that turns on the facts of the 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.” (Para. 36)
The forfeitability of deposits
The Court then turned to consider several cases from India and the UK, respectively that of Kailash Nath Associates v Delhi Development Authority [2015] 4 SCC 136 and Cavendish Square Holding v Talal El Makdessi [2015] UKSC 67 before stating as follows:
45. As such, the courts in the United Kingdom and India have held that presently the principles of law on damages clause are equally applicable in relation to forfeiture of deposits instead of the mutually exclusive approach. We are therefore inclined to hold that the time has come for our courts to adopt a similar approach. After all section 75 of the Act and section 74 of the Indian Contract Act 1872 are in pari materia.
In-line with this, the Federal Court accepted that if a payment contains the dual-characteristics of a deposit and a part-payment of the contract sum, it is to be treated as a deposit and is to be forfeitable.
Penalties are still unenforceable
Despite the reasoning above, the Federal Court emphasised that the Courts will always stand as bulwark against unreasonable and unsubstantiated damages clauses. At paragraphs 50 until 54 of the Judgement, the Court underscored the position of the Courts vis-à-vis unconscionable and oppressive contracts.
Liquidated damages and proportionality
The Federal Court then went on to consider liquidated damages clauses and whether the same would amount to a penalty. The Federal Court emphasised as follows:
57. Thus, under English law, the current approach is that in determining whether a damages clause in a contract amounts to a penalty, courts must first consider whether any “legitimate commercial interest” in performance extending beyond the prospect of pecuniary compensation flowing from the breach is served or protected by a damages clause and then evaluate whether the provision made for the interest is proportionate to the interest identified. And the overall common denominators that must be further identified by the courts are whether the damages clause:
(i) is a secondary obligation and not a primary obligation which would be enforceable per se;
(ii) which imposes a detriment on the contract-breaker; and
(iii) which is out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.
58. The restatement of the principles of law on damages clause represents a clear shift in judicial attitude where courts are reluctant to interfere with parties’ freedom of contract, especially if the contracting parties have comparable bargaining power and are properly advised. Hence, in a sense, the reformulation in Cavendish (supra) gives more legal certainty to the operation of a damages clause as a permissible risk allocation tool. It also signifies judicial recognition of the notion of broader commercial justifiability. Loss or damage is no longer confined to pecuniary compensation. Applying the new approach or test it is therefore, as alluded to earlier, only in situations when the sum stipulated in a damages clause is unconscionably high and exorbitant by reference to the innocent party’s legitimate interest in the performance of the contract that such a clause is struck down.
The Court has stated that a liquidated damages clause would be, on the face of it, enforceable. However, if it can be shown that the clause is unconscionable or is exorbitant, the same (clause) would be at risk of being struck-down. Essentially, the Courts would play an important balancing role and the doctrine of proportionality and reasonableness would be all-encompassing.
Selva Kumar and Johor Coastal are restated- Reasonableness and proportionality are to be the bastion of interpretation
The Federal Court went on to consider Selva Kumar and Johor Coastal and stated as follows:
65. With respect and for reasons we shall set out below, we are of the view 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. Selva Kumar (supra) and Johor Coastal (supra) should not be interpreted (as what the subsequent decisions since then have done) as imposing a legal straightjacket in which proof of actual loss is the sole conclusive determinant of reasonable compensation. Reasonable compensation is not confined to actual loss, although evidence of that may be a useful starting point.
66. As for our reasons we begin by saying that in view of the legislative history of section 75 of the Act which need not be elaborated in this Judgment, we are of the considered opinion that there is nothing objectionable in holding that the concepts of “legitimate interest” and “proportionality” as enunciated in Cavendish (supra) are relevant in deciding what amounts to “reasonable compensation” as stipulated in section 75 of the Act. Ultimately, the central feature of both the Cavendish case (supra) and section 75 of the Act is the notion of reasonableness. Indeed, the ParkingEye v Beavis [2015] UKSC 67 judgment is replete with instances where the United Kingdom Supreme Court conflated “proportionality” with reasonableness” (see: ParkingEye (supra) at paragraphs [98], [100], [108], [113] and [193]).
…
68. Consequently, regardless of whether the damage is quantifiable or otherwise, it is incumbent upon the court to adopt a common sense approach by taking into account the legitimate interest which an innocent party may have and the proportionality of a damages clause in determining reasonable compensation. This means that in a straightforward case, reasonable compensation can be deduced by comparing the amount that would be payable on breach with the loss that might be sustained if indeed the breach occurred (emphasis added). Thus, to derive reasonable compensation there must 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
The burden of proof is reversed but the baby is not out with the bathwater
The Federal Court went on, very importantly, to reverse the burden of proof:
70. We turn now to the issue on burden of proof. The initial onus lies on the party seeking to enforce a 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.
71. 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 is unreasonable or to demonstrate from available evidence and under such circumstances what comprises reasonable compensation caused by the breach of contract. Failing to discharge that burden, or in the absence of cogent evidence suggesting exorbitance or unconscionability of the agreed damages clause, the parties who have equality of opportunity for understanding and insisting upon their rights must be taken to have freely, deliberately and mutually consented to the contractual clause seeking to pre-allocate damages and hence the compensation stipulated in the contract ought to be upheld.
As such, the Federal Court has set a new precedent as to how a liquidated damages clause is to be interpreted. Essentially:
i. The innocent party must adduce evidence of a liquidated damages clause;
ii. The clause must have been breached;
iii. The onus then shifts to the defaulting party to show that the liquidated damages clause is unreasonable;
iv. The defaulting party will then be required to adduce evidence as to what comprises reasonable compensation;
v. The defaulting party may also adduce evidence of exorbitance or unconscionability for the liquidated damages clause.
Significance of this decision
Following on from Cubic, all contracts will have to be carefully scrutinised to ensure that the liquidated damages clause is reasonable and proportionate. This would be an excellent manner in which both parties to a contract would have their legitimate interests adequately protected.
The need to prove damages has also been reversed. The party seeking to rely on a LAD clause will be entitled to point to the same and to claim that damages have been sustained (if said party is innocent). In contrast, a party seeking to disprove LAD must show that the amount claimed is unreasonable, disproportionate and/or repugnant to common sense.
The Federal Court provided a useful distillation of its principles at paragraph 74 of its Judgement. Readers would be advised to digest the Judgement in toto.
The decision in Cubic
The Court, having set-out these principles, went on to hold that the sum of RM3.04m bore all the hallmarks of additional payments that would go towards the earnest deposit.
The Court was of the further opinion that “…when the three extensions of time were granted, the primary obligation on the Plaintiff’s part was to ensure that the SPA was completed by the new deadline. Failure by the Plaintiff to perform this primary obligation would then result in it having to fulfil its secondary obligation to forfeit the agreed sums.”
The Court held that Mars’s failure to complete the S&P within the pre-requisite time period was detrimental to Cubic. On the facts, Cubic had rejected a proposal from a separate party, on the basis that it had finalised the S&P with Mars.
The Court held that “the Defendant’s [Cubic’s] deprivation of a 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. In short, the Defendant had a legitimate interest in ensuring that the bargain between itself and the Plaintiff came into fruition in a timely manner.”
The Court then allowed the appeal with costs and set-aside the order of the Court of Appeal.
Critique
The cheque for RM6m was not considered
The facts in Cubic appear to be self-explanatory. However, one vital issue that the Judges failed to consider would be that Mars did indeed put-forth a genuine attempt to pay for the full sum of the deposit. The cheque of RM6m that Mars extended when seeking the 4th extension of time was completely disregarded by the Federal Court and it is regrettable that the same was not considered in-depth.
On the face of it, it does appear as if Mars had a legitimate interest in the lands and if the sums in the cheque were totalled together with the sums already paid, this would be in-excess of the 2% (RM1.6m for the lands) and 10% (RM1m for the machinery) that were sought as a deposit.
The fact that the Federal Court failed to consider this payment in the grand-scheme of things (without allowing for equitable principles to govern the conduct of the parties) is regrettable.
The failure to consider Cavendish Square in-depth
A further critique that may be levelled would be that the Federal Court adopted a superficial application of Cavendish (heard together with ParkingEye) [2016] 2 All ER 519, without delving into its merits or considering the background to the decision.
It is arguable that the Federal Court cherry-picked Cavendish. It is important to note that the Supreme Court in Cavendish also considered notions applicable in European law; this is completely inapplicable to the jurisprudence in Malaysia.
In Paciocco v Australia and New Zealand [2016] HCA 28, the Australian High Court (the equivalent of Malaysia’s Federal Court) considered Cavendish and noted that the jurisprudential leanings in Australia had diverged from that in the UK:
[120] The Supreme Court of the United Kingdom subsequently held in Cavendish Square Holding BV v Makdessi that only a detriment imposed on breach of contract can amount to a penalty. The common law of the United Kingdom has to that extent now taken a different path from the common law of Australia. This is not the occasion to critique the relative merits of the divergent contemporary approaches or to debate the competing perspectives on our common legal history which contributed to that divergence.
The High Court in Paciocco noted that:
[10] Differences have emerged from time to time between the common law of Australia and that of the United Kingdom in a number of areas. Those differences have not heralded the coming of winters of mutual exceptionalism. All of the common law jurisdictions are rich sources of comparative law whose traditions are worthy of the highest respect, particularly those of the United Kingdom as the first source. No doubt in a global economy convergence, particularly in commercial law, is preferable to divergence even if harmonisation is beyond reach. The common law process will not always be the best way of achieving convergence between common law jurisdictions. The penalty rule in the United Kingdom, a product of that process, was described by Lord Neuberger and Lord Sumption in their joint judgment in Cavendish as “an ancient, haphazardly constructed edifice which has not weathered well”. More than one account of its construction and more than one view of whether it should be abrogated or extended or subsumed by legislative reform is reasonably open. There has been much activity in this area within national jurisdictions and in the development of internationally applicable model rules and principles which were discussed in Cavendish in the judgments of Lord Mance and Lord Hodge. It may be that in this country statutory law reform offers more promise than debates about the true reading of English legal history.
It is regrettable that our Federal Court did not underscore the fact that our jurisprudential leanings are unique, having had the benefit of 62 years of independence. Nettle J provided a cogent dissenting judgment in Paciocco that ought to be read in full.
Conclusion
In conclusion, the law on liquidated damages in Malaysia has been broadly restated. Parties must be careful in their contractual drafting and where a liquidated damages claim is concerned, one must be wary that the same will be prima facie enforceable.
This starting-point can be displaced but only if evidence to the contrary is adduced.
Practitioners must also take note that with this the decision in Cubic, disputes pertaining to LAD will be made manifold easier for some; in the same vein and given the zero-sum game that litigation invariably is, it will become inherently difficult for others.
GAVIN JAYAPAL
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