The Federal Court revisited section 75 of the Contracts Act 1950 in a recent case. This may have an impact on the liquidated damages clauses in construction contracts.
Section 75 is convoluted. It reads as follows:
“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 other 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.”
Section 75 is relevant whenever liquidated damages (“LD”) clauses in construction contracts are sought to be enforced or challenged. Those clauses provide for a sum to be paid when there is a breach of the contract (i.e. contractor fails to complete his works by the completion date).
As such, those clauses fall within the coverage of section 75. Consequently, the employer is only entitled to receive “reasonable compensation” not exceeding the LD amount.
In Cubic Electronics Sdn Bhd v Mars Telecommunications Sdn Bhd  1 AMR 737, the Federal Court (“FC”) had occasion to revisit the principles relating to section 75. It must be noted at the outset that Cubic concerned a property sale transaction and not a construction dispute.
I shall set out the facts and the FC’s summary of the section 75 principles in this post. The uncertainties & confusion arising from the case will be touched on in my next post.
Cubic is a company in liquidation. Cubic put up its land and machineries (collectively “the properties”) for sale. Mars offered to buy the properties for RM90 million. On submitting the offer, Mars paid an earnest deposit of RM1 million to Cubic.
Cubic accepted Mars’ offer, subject to certain conditions. One condition was that the formal sale and purchase agreement (“SPA”) for the properties has to be signed in 30 days. On signing the SPA, Mars has to pay in full a deposit amount to 10% of the purchase price.
Mars requested for 4 extensions of time to sign the SPA. Cubic granted the first 3 requested extensions, on condition that Mars pays additional earnest deposits. The additional earnest deposits paid by Mars in relation to those 3 extensions add up to a total of RM2 million. The additional earnest deposits were paid on condition that they would be forfeited “as agreed liquidated damages and not by way of penalty” if Mars failed to sign the SPA by the extended deadlines.
Cubic refused to grant the 4th extension of time requested by Mars. Subsequently, Cubic terminated the intended sale to Mars, and forfeited the additional earnest deposits of RM2 million.
Mars initiated a court action against Cubic. Mars claimed for inter alia a refund of the forfeited additional earnest deposits of RM2 million.
The High Court dismissed Mars’ claim. Mars won on appeal to the Court of Appeal, who allowed the claim. Cubic appealed to the FC, and succeeded. As a result, Mars’ claim for refund was unsuccessful in the end.
The crucial questions dealt with by the FC were (a) whether section 75 applied to the forfeiture of the additional earnest deposits; and (b) if it did apply, whether section 75 affected Cubic’s right to forfeit.
In coming to its decision, the FC laid out certain principles relating to section 75.
Summary of Section 75 Principles by the Federal Court
The FC helpfully summarized the relevant principles, at para 74. Those relating to section 75 include:
(a) In deciding what is “reasonable compensation” under section 75, the concepts of “legitimate interest” and “proportionality” in the English House of Lords case of Cavendish Square Holding BV v Makdessi  AC 1172 are relevant.
(b) The sum payable on breach is unreasonable compensation if it is extravagant and unconscionable in amount, when compared with the highest conceivable loss that could possibly flow from the breach. In the absence of proper justification, there should not be a significant difference between the damages spelt out in the contract and the loss likely to be suffered.
(c) Reasonable compensation can be awarded irrespective of whether actual loss is proven. Proof of actual loss is not the sole determinant of reasonable compensation, although evidence of that may be a useful starting point.
(d) To enforce a damages clause, the innocent party has to establish that (a) there was a breach of contract; and (b) that contract contains a clause specifying a sum to be paid on breach. Once both elements are established, the innocent party is entitled to receive a sum not exceeding the specified sum, irrespective whether or not actual loss is proven, subject to the defaulting party proving the unreasonableness of the damages clause.
(e) If there is a dispute as to what is reasonable compensation, the burden of proof falls in the defaulting party to show that the damages clause, including the sums stated therein, is unreasonable.
However, the above summary by the FC must be treated with caution. This is because they conflict with other parts of the decision, as I will highlight in my subsequent posts which can be found here (part II) and here (part III).
The contents of this article are published for the purpose of general information only; they are not to be regarded, used or relied on as legal advice for any matter. Please contact us if you require legal advice specific to your case.