Understanding Remedies & Penalties in a Commercial Contract

Understanding Remedies & Penalties in a Commercial Contract By LEE SWEE SENG LLB(Hons) , LLM , MBA LEE SWEE SENG & CO MANAGING PARTNER ADVOCATES & SOLICITORS CERTIFIED MEDIATOR PATENT AGENT NOTARY PUBLIC Copyright www.leesweeseng.com sweeseng@tm.net.my

Understanding Remedies & Penalties in a Commercial Contract • Remedies in the event of breach • Agreed Damages clause • Penalty clause • Exclusion clause • Limiting damages clause • Proving Damages

Remedies available in event of Breach • Damages • Specific performance • Injunction • Liquidated Agreed Damages • Penalty Damages • Forfeiture of Deposit

Breach of Contract • Breach of contract happens where there is an actual failure by a party to the contract to perform his obligations under the contract or an indication of his intention not to do so. • Oxford Dictionary of Law, 4th Edition

Forms of Breach and its effects • Breach of Condition (breach of an important term) – the law permits the Plaintiff to treat himself as being discharged from further obligations and claim damages. • Breach of warranty (breach of a less important term) – the innocent party here may not treat himself as being freed of his obligations under the contract although he may sue and recover damages for non-performance of the subsidiary term. • Ching Yik Development Sdn Bhd v Setapak Heights Development Sdn Bhd [1996] 3 MLJ 675

Forms of Breach and its effects • Breach of innominate terms – this third category of terms depends on the nature and consequences of the breach. • In Ching Yik Development Sdn Bhd v Setapak Heights Development Sdn Bhd [1996] 3 MLJ 675, Gopal Sri Ram JCA highlighted this aspect as follows:

Forms of Breach and its effects • “ If the breach is of such nature that it goes to the root of the contract, then the term broken is fundamental in nature. On the other hand, if the consequences of the breach complained of are not serious in the sense that they do not go to the root of the contract, then the term in question is a subsidiary one entitling the innocent party to recover damages but not to treat the contract as being at an end.”

Forms of Breach and its effects • In other words, if the breach of a particular term goes to the root of the contract , then the remedy of the innocent party lies in repudiation and damages. • However, if the breach produces less consequences, the remedy of the innocent party lies in damages only.

Anticipatory Breach • Anticipatory breach – A refusal to perform a contract before the time for performance is due. • In White & Carter (Councils) Ltd v Mc Gregor [1962] AC 413, when a party commits an anticipatory breach, Plaintiff has a choice: • A) terminate the contract and sue for damages for anticipatory breach • B) continue until the actual breach and then sue for damages

Anticipatory Breach • This dictum in White & Carter was followed in Teh Wan Sang & Sons Sdn Bhd v See Teow Chuan [1984] 1 MLJ 130 where Peh Swee Chin said that: • “A repudiation in advance by one party to a contract, that he will not perform it before the arrival of the time for the performance by the repudiating party, does not, itself, amount to a breach of contract, though it may optionally be, regarded as such breach by the other party in treating it as at the end.”

Statutory provision of breach • Section 40 of the Malaysian Contracts Act 1950 provides that when a party to a contract has refused to perform, disabled himself from performing, the promisee may put an end to the contract or to continue with the contract.

Relief under Contracts Act 1950 • MacIntyre J in Yong Mok Hin v United Malay States Sugar Industries Ltd [1967] 2 MLJ 9 pointed out that the application of section 66 and 75 in cases of rescission under section 40 is not correct. • The appropriate section for right of damages is provided in Section 76 of the Contracts Act 1950. • Section 76 provides that a Plaintiff who rightly rescinds for non-fulfillment of a contract can claim damages sustained.

Damages • The purpose of awarding damages is to compensate the Plaintiff for the loss suffered due to the Defendant’s breach of contract. • Damages is that sum of money which will put the party who has been injured or who has suffered, in the same position as if the contract had been properly performed.

Types of Damages • Nominal Damages • Pecuniary and Non-pecuniary damages • Liquidated and Unliquidated damages

Nominal Damages • Definition of nominal damages according to Chitty on Contracts:- “Whenever a party is liable for breach of contract, either express or implied, the Plaintiff is generally entitled to nominal damages although no actual damage is proved; the violation of a right at common law will usually entitle the plaintiff to nominal damages without proof of special damage.”

Nominal Damages • Situations where nominal damages are normally awarded: • A) where the Plaintiff has suffered no pecuniary loss; • B) where the damage is shown but its amount is not sufficiently proved; • C) although the plaintiff has sustained damage, the damage arises from the conduct of the Plaintiff himself; • D) Plaintiff simply brings his action with a view to establishing his right.

Nominal Damages • In Industrial & Agricultural Distribution Sdn Bhd v Golden Sands Construction Sdn Bhd [1993] 3 MLJ 433, the Court further illustrated the importance of proving damages and stated that : • “damages are not meant to be punitive in nature but rather compensatory…It is therefore important for the plaintiff to establish his loss and not, so much as what the defendant had gained from the breach.”

Pecuniary damages • Pecuniary damages are losses that can be qualified in monetary terms. • They may consist of: • A) expectation losses eg. Loss of profits/earnings • B) reliance losses eg. wasted expenses

Principles of claiming damages - Causation • In order to recover damages, the Plaintiff must show that his losses were caused by the Defendant’s breach. (show causation) • He has to prove that the loss was due to the act or default of the Defendant and there is no break in the chain of causation between the Defendant’s breach and the Plaintiff’s losses.

Remoteness of Damages • Apart from causation, the Plaintiff must also show that the losses he has suffered are not remote in order to recover them. • In English law, the test of remoteness of damages was laid down in Hadley v Baxendale (1854) 9 Ex 341.

Hadley v Baxendale (1854) 9 Ex 341 • A shaft in the plaintiffs’ mill broke down and the plaintiffs hired the defendant to transport the shaft for repairs. • The Defendant delayed in returning the shaft and the Defendant did not know that the plaintiffs did not have a spare shaft. • The Plaintiffs sued for loss of profits as damages. • The Court held that the losses which are too remote are not recoverable.

Hadley v Baxendale (1854) 9 Ex 341 • Losses are not too remote if they are: • A) ordinary losses which arise naturally in the usual course of things; or • B) extraordinary losses which arise within the reasonable contemplation of the parties at the time they entered into the contract. • Here, the loss of profits did not fall under the 1st limb as normally mills would have spare shaft.

Hadley v Baxendale (1854) 9 Ex 341 • Since the Defendant did not know that the Plaintiffs did not have spare shaft, the losses did not fall under 2nd limb. • Hence, the losses are not recoverable.

Victoria Laundry (Windsor) Ltd v Newman Industries Ltd [1949] 2 KB 528 • The Court further explained the test of Hadley v Baxendale in that: • A) the Plaintiff can always recover foreseeable losses or damages which arises naturally • B) what is reasonable foreseability depends on the knowledge the parties had • C) knowledge is actual or imputed knowledge

Remoteness of damages in Malaysia • In Malaysia, Section 74 Contracts Act 1950 sets out the consequences of a breach of contract: • (1) when a contract has been broken, the party who suffers by the breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things

Remoteness of damages in Malaysia • from the breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it. • (2) Such compensation to be given for any remote and indirect loss or damage sustained by reason of the breach.

Remoteness of damages in Malaysia • Section 74 of the Contracts Act 1950 provides for the test for remoteness of damages which is nearly similar to the test in Hadley v Baxendale : Toeh Kee Keong v Tambun Mining Co Ltd [1969] 1 MLJ 171. • Therefore, once it is shown that the losses could fall under the 1st or 2nd limb, the Defendant is liable to the full extent of it so long as the extent of damages has been shown on the balance of probabilities.

Mitigation of Damages • The duty to mitigate only comes about when there is a breach of contract. • The explanation in Section 74 CA 1950 provides that in estimating the loss or damage arising from a breach of contract, the means taken to remedy the inconvenience caused by the non-performance of the contract must be taken into account.

Principles of mitigating • The Plaintiff must take reasonable steps to mitigate his loss and must not incur unreasonable expenses. • If the Plaintiff fails to mitigate his loss, he could only recover that part of the loss which is caused by his failure to mitigate. • If the Plaintiff mitigates his loss and does not incur any loss, then the loss cannot be recovered. • If the Plaintiff mitigates his loss and still incur losses, then these losses can be recovered.

Timing of Assessment of Damages • As a general rule, damages should be assessed as at the date of breach. • In Malaysia, the Court in Elkobina (M) Sdn Bhd v Mensa Mercantile (Far East) Pte Ltd [1994] 1 MLJ 553 held that: • A) the normal measure for damages is the difference between the market price of the goods or property as at the date of breach and the contract price. • B) in appropriate cases, losses can be assessed as at the date of trial.

Liquidated Agreed Damages (LAD) and Penalty Clause - UK position • Liquidated Damages - genuine pre-estimate of the loss that will be caused to one party if the contract is broken. • Penalty Clause - payment of money stipulated as in terrorem of the offending party to force him to perform the contract • Penalty clause is not enforceable under the English law. • Dunlop Pnuematic Tyre Co. Ltd v New Garage and Motor Co Ltd [1915] AC 79

Dunlop Pnuematic Tyre Co. Ltd v New Garage and Motor Co Ltd [1915] AC 79 • The Court must determine whether the payment stipulated is a penalty or liquidated damages. • Various test has been advanced to determine whether the sum is a penalty clause and not liquidated damages. • It will be a penalty if:- • a) the sum stipulated is extravagant and unconscionable in amount when

Dunlop Pnuematic Tyre Co. Ltd v New Garage and Motor Co Ltd [1915] AC 79 • compared with the loss which can be proved. • b) the breach consists only of not paying a sum of money and the sum is the sum greater than the sum which ought to have been paid. • c) when a single lump sum is made payable by way of compensation, on occurrence of one or more or all of several events.

Effects of penalty clause to contracts • It fixes in advance the damages payable in the event of default. • It will also limit a defaulting party’s liability • It can provide a means of pressure on the defaulter so as to coerce him into performing the contract.

The Malaysian position of Liquidated Agreed Damages and Penalty clause • The Malaysian position is governed by Section 75 of the Contracts Act 1950. • Section 75 provides that: 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,

The Malaysian position of Liquidated Agreed Damages and Penalty clause • 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.

Principles under the Malaysian law • In Malaysia, it appears that there is no distinction between penalty and liquidated damages : SS Maniam v The State of Perak [1957] MLJ 75 • This distinction has ceased to be of great importance as the position in UK because the result of either case is that the court must determine reasonable compensation. : Wearne Brothers (M) Ltd v Jackson [1966] 2 MLJ 155

Principles under the Malaysian law • In Maniam SS v The State of Perak [1957] MLJ 75, the Courts have stated that every fixed amount will be treated as a penalty and as long as the sum is reasonable it is allowed. • It is the duty of the court to determine the quantum of what is the reasonable compensation to be handed out.

Principles under the Malaysian law • Whether the sum agreed as liquidated damages or otherwise is reasonable would depend on the extent of the damages suffered and the circumstances of each case : Hsu Seng v Chai Soi Fua [1990] 1 MLJ 300 • Upon satisfaction by the court that the said sum is a genuine pre-estimate and it represents a reasonable sum for the loss suffered, it may order the said sum to be paid as damages. • Dato’ Seri Visu Sinnadurai, Law of Contract, 3rd edition

Proving Damages • As a general rule, when a plaintiff claims damages from a defendant, he has to show that the loss in respect of which he claims damages was caused by the defendant’s breach, the actual amount of damages that he suffered and there were no mitigating factors. • Under S2 of the Evidence Act 1950, ‘prove’ means to provide some form of evidence • Santhana Dass, General Principles of Malaysian Contract Law

Proving Damages • sufficient to convince the Judge to the point that he believes it to exist or considers its existence so probable that a prudent man ought under the circumstances of the particular case, to act on supposition that it exists. • The burden of proving the damages lies on the person seeking damages. • Santhana Dass, General Principles of Malaysian Contract Law

Does the plaintiff require to prove damages in cases under Section 75? • The words in Section 75 referred to: ‘whether or not actual damage or loss is proved to have caused thereby’ • Does it mean that the plaintiff does not have to prove any damages suffered?

Selva Kumar Murugiah v Thiagarajah Retnasamy [1995] 2 CLJ 374 • The respondent filed an originating summons seeking a declaration that the agreement was terminated and that he was entitled to forfeit the RM96,000 being payment for the sale of medical practice. • The Federal Court clearly established the principle that requires the plaintiff to prove the actual damages in accordance with the settled principles in Hadley v Baxendale despite of the words in question.

Selva Kumar Murugiah v Thiagarajah Retnasamy [1995] 2 CLJ 374 • The words in Section 75 of the CA did not dispense with the rule that a party claiming damages must prove his loss. • Any failure to prove any damages will result in the refusal of the court to award such damages. • The Federal Court having reviewed, the relevant Indian Supreme Court decisions, recognised that the words in question were intended to cover 2 kinds of contracts.

Selva Kumar Murugiah v Thiagarajah Retnasamy [1995] 2 CLJ 374 • In the first class of cases, the Court finds it difficult to assess such reasonable compensation. • In the second class of cases, the Court could assess such reasonable compensation with settled rules. • The learned judges held that the words in question are limited to cases where the court finds it difficult to assess damages.

Selva Kumar Murugiah v Thiagarajah Retnasamy [1995] 2 CLJ 374 • Therefore, where there is inherently any actual loss or damage from the evidence and damage is not too remote and could be assessed by settled rules, any failure to prove damages will result in the refusal of the court to award damages. • In this case, the respondent did not prove damages. • Thus, the sum of RM96,000 would have to be refunded.

Sakinas Sdn Bhd v Siew Yik Hau [2002] 3 CLJ 275 • Here, the respondents agreed to purchase a condominium unit from the appellant who was the developer. • The agreement was in accordance with Schedule H of the Housing Developers (Control and Licensing) Regulations 1989. • There was failure on the part of the appellants to hand over vacant possession in time.

Sakinas Sdn Bhd v Siew Yik Hau [2002] 3 CLJ 275 • The Federal Court further summarised the judgement in Selva Kumar. • The Federal Court in Selva Kumar did not decide that in every case falling under Section 75 CA there must be proof of actual loss. • Proof of loss will be required under the second class of cases where compensation could be assessed by settled rules.

Sakinas Sdn Bhd v Siew Yik Hau [2002] 3 CLJ 275 • For this reason, a case of delay in completion such as the present case should be treated as belonging to the first class of cases which does not require proof of actual loss because there is no known measure of damages employable. • What the court needs to determine is what is reasonable compensation applying good sense and fair play.

Sakinas Sdn Bhd v Siew Yik Hau [2002] 3 CLJ 275 • Here, the method of calculating the liquidated damages for failure to hand over vacant possession in time is prescribed in the regulations made by the minister. • But in determining reasonable compensation under S75, the court ought not to disregard the fact that the minister in his wisdom balancing the interest of house-buyers and developers and the method in cl.22 is fair method and should be determined by a simple standard method.

Understanding Remedies & Penalties in a Commercial Contract