Following the Cubic Puzzle I, this post highlights the confusion over what is the test to decide if the agreed amount payable on breach (“damages clause amount”) is “reasonable compensation” under section 75, Contracts Act 1950.
But first, a preliminary observation:
Whether the Cubic Principles Apply to Liquidated Damages in Construction Contracts
At the outset, it appears uncertain whether the principles laid out in Cubic apply to liquidated damages clauses in construction contracts.
On the one hand, the section 75 principles seem to be general in nature so that they may extend to such clauses.
On the other hand, the FC emphasized that the Cubic case did not involve a damages clause. Instead, their primary focus was on the treatment of deposits vis-à-vis section 75. See paras 27 and 28f.
The Proportionality Confusion – Compare Damages Clause Amount against (1) Potential Loss, or (2) Transaction Value?
To determine 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, i.e. potential loss. This is the principle declared by the FC at para 68.
The principle appears to be linked to the concepts of legitimate interest and proportionality, which are also to be taken into account (see para 66). Those concepts – enunciated by the English Supreme Court in Cavendish Square Holding BV v Makdessi  AC 1172 – require the courts to (a) first, identify the legitimate interests that a damages clause seeks to protect; and (b) then, assess whether the damages clause amount is proportionate to those interests (see para 57).
Unfortunately, the FC did not apply the above principle when analyzing the facts of the case. Instead, the FC compared the amount payable on breach (RM2 million forfeited deposit) against the transaction value (total purchase price RM90 million); see para 87. The FC did not compare it against potential loss.
Ironically, the FC has already 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 (see para 84). The loss of opportunity and avoiding delay in completing the sale are legitimate interests which the forfeited deposit were intended to guard against (see para 86).
Having identified the actual loss and legitimate interests, the FC should have compared them against the forfeited amount (RM2 million), to decide if the latter is proportionate to the former. The question the FC should have asked is – is RM2 million proportionate to the value of the following factors added together:
(a) depreciation in value of movable assets;
(b) continuing liquidator’s fees; and
(c) loss of opportunity to sell to another party.
The above approach was taken by the English Supreme Court in Cavendish. One of the cases there involved a parking charge of £85.00 imposed on Mr Beavis for overstaying the initial 2 hours of free parking. The Supreme Court identified the legitimate interests behind that charge and then examined whether the amount charged is proportionate to those interests (see Cavendish, paras 98 to 100, 286 to 287).
The above inconsistency between principle and its application by the FC is perhaps the most serious confusion to arise out of the Cubic case.
There are other inconsistencies, which would be the subject of my next post found here.
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.