THE CUBIC PUZZLE & LIQUIDATED DAMAGES III – MORE CONFUSION

This final part of the Cubic Puzzle series highlights further confusion arising from the Cubic case, due to discrepancies between the principles enunciated by the FC and their purported application to the facts.

You can find Cubic Puzzle I here, and Cubic Puzzle II here.

The confusion / discrepancies discussed below relate to the following areas:
(a) the relevance of actual loss & potential loss;
(b) burden of proof; and
(c) at a doctrinal level, whether to interfere with the freedom of contract.


ACTUAL LOSS & POTENTIAL LOSS

Principle

To assess whether the damages clause amount is reasonable compensation, that amount is to be compared to the loss that might be sustained if the breach occurred (see para 68), i.e. potential loss.

Proof of actual loss is not the sole conclusive determinant of reasonable compensation, although evidence of that is a useful starting point (see para 74(vi)).

However, the FC did not elaborate how the proof of actual loss is a “useful starting point”.  Useful starting point towards what end?  Establishing potential loss?  (The situation gets murkier as you will see below, because potential loss seems to be a red herring when it comes to application).

Application

The FC did not ask, nor discuss, whether there was any potential loss.

At para 84, the FC identified the actual losses suffered by Cubic due to delay in completing the sale; they are depreciation in value of moveable assets, liquidator’s fees, and loss of opportunity to sell to another party.  The foregoing were legitimate interests which the forfeited deposits were intended to guard against (see paras 85, 86).

From the FC’s application above, it seems that:
(a) potential loss is irrelevant;
(b) instead, actual loss is relevant; and
(c) actual loss has to be established, in order to show that there exists legitimate interests behind the damages clause.


BURDEN OF PROOF

Principle

The innocent party has to show (i) breach of contract and (ii) contract contains a damages clause (para 70).  Once that is established, defaulting party has to show either (i) damages clause is unreasonable; or (ii) show what is reasonable compensation caused by the breach.  See paras 70, 71.

The concepts of legitimate interest and proportionality are to be taken into account in determining what is “reasonable compensation” (para 74(iv)).  This indicates that legitimate interest and proportionality are factors to be considered as part of the burden of proof on the defaulting party, for it is he who has to address the issue of reasonable compensation.

In summary, the principle is therefore:
(a) innocent party to prove (i) breach of contract and (ii) contract contains a damages clause; and
(b) defaulting party to prove (i) damages clause is unreasonable; or (ii) reasonable compensation caused by the breach; both taking into account legitimate interest and proportionality.

Application

However, the FC deviated from the above principle when it analyzed the facts.  The FC first found that there was actual loss which amounted to legitimate interests (behind the forfeiture clause) and the forfeited amount was proportionate, before shifting the onus to the defaulting party to show that the forfeiture was excessive (paras 85 to 88).  This suggests that the innocent party also bore the burden of proving legitimate interest and proportionality, which contradicts the principle the FC stated earlier.

From the FC’s application above, it seems that:
(a) innocent party has to prove (i) breach of contract; (ii) contract contains a damages clause; (iii) actual loss / legitimate interests; and (iv) proportionality; and
(b) defaulting party has to prove that (i) the damages clause is unreasonable; or (ii) the forfeiture was excessive.

In the upshot, there is confusion as to what the innocent and defaulting parties have to prove respectively.


DOCTRINAL LEVEL INCONSISTENCY – INTERFERE OR NOT?

There is also inconsistency at a doctrinal level.  On the one hand, the courts should be “slow” to not give effect to a damages clause (see para 72).  This expresses an inclination – at most times – to preserve the sanctity of the contract.

On the other hand, section 75 is a curtailment of the absolute freedom to contract, designed to check against potential abuse by a party at another’s expense (see para 53).  In other words, section 75 interferes with the sanctity of the contract.

As section 75 is an Act of Parliament, it applies to all Malaysian contracts, all of the time. Instead of preserving the sanctity of the contract at most times, section 75 mandates the courts to do the opposite every time – i.e. interfere with the freedom to contract when that section is engaged, so that only reasonable compensation is awarded notwithstanding the amount agreed in the contract.


CONCLUSION

There are many issues that require clarification post Cubic.  Unfortunately, it may take some years before another case gives the FC the opportunity to revisit section 75.  In the meantime, the Cubic principles will be a fertile ground of dispute whenever a damages clause is in play.

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.