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Construction Law Miniseries Episode 3: Cubic Electronics changed the Law on Liquidated Ascertained Damages

By

Harneshpal Karamjit Singh, Legal Associate (Class Action, Commercial & Construction Department)


Hakem Arabi & Associates

Today, I would like to share my humble and respectful views on Construction Law touching Liquidated Ascertained Damages (“LAD”).

  1. In the Columbia Law Review Article titled Liquidated Damages, it has been stated that:

    “Where the parties to an agreement stipulate in advance that, if a breach occurs, the one who committed the breach shall pay to the other a fixed sum of money, the amount so agreed upon is called liquidated damages if it is the intention of the parties that it shall represent the loss sustained and it does actually approximately represent such loss” 1.

  2. In light of the above definition, the focus is on the Federal Court decision of Cubic Electronics Sdn Bhd (In Liquidation) v Mars Telecommunications Sdn Bhd (“Cubic Electronics”) which was a Landmark decision which Messrs Hakem Arabi & Associates were the solicitors for Mars Telecommunication.

  3. Cubic Electronics is an important Federal Court decision, despite not being a Construction Law matter, that concerned the position of law on LAD.

  4. The Federal Court was concerned with the issue of whether where terms and conditions of the Sales and Purchase Agreement (“S&P”) had been agreed to and a date was fixed for the execution of the S&P, can any additional deposit paid for the extension of time for completion be equally subject to forfeiture.

  5. Short Facts of Cubic Electronics



  6. n this case, the Respondent had agreed to purchase a piece of land for RM90,000,000.00 from the Appellant by accepting the Appellant’s information memorandum dated 15 September 2011. The Respondent made the first earnest deposit on 3 October 2011 amounting RM1,000,000.00. The acceptance was subject to a term in the information memorandum that stated that the S&P should be executed within 30 days of 7 October 2011, failing which, the earnest deposit would be forfeited as agreed liquidated damages.

  7. Three further extensions were granted and three further deposits were made amounting to RM2,040,000.00 including RM40,000.00 interest. The Respondent was cautioned that the deposits made would be forfeited as agreed liquidated damages if the S&P was not executed as per the granted extensions. It was when the Respondent requested for a fourth extension, the Appellant refused the request and terminate the sale. The Appellant informed that all deposit payments made were forfeited accordingly.

  8. Findings of the Federal Court



  9. The Federal Court noted that the focus of the issue mentioned in paragraph 4 above is on the treatment of deposits vis-à-vis Section 75 of the Contracts Act 1950 (“Section 75”). Section 75 states:

    “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.”

  10. Relying heavily on the literature of English and Indian case laws, the Federal Court held that it was time for Malaysia to adopt the principles of law on a damages clause are equally applicable in relation to forfeiture of deposits instead of the mutually exclusive approach.

  11. The Federal Court noted that contract law has three important factors as follows:
    1. It enables parties to create legally binding obligations with each other;
    2. It provides a means as to the enforcement of these obligations;
    3. Freedom of contract achieved by providing for rules when obligations undertaken by contracting parties are ignored, or when the law imposes certain obligations on the contracting parties.

  12. Section 75 operates as a vital curtailment of absolute freedom of contract, designed to check against potential abuse by a party at another’s expense. As such, parties are not liberty to contract out Section 75.

  13. As long as a payment has the dual characteristics of earnest money and part payment, it will be deemed as a deposit and subject to Section 75. In determining what is “reasonable compensation” under Section 75, the Courts must apply the principles of “legitimate interest” and “proportionality”. Only if the amount of compensation is extravagant and unconscionable, it will be considered unreasonable compensation. Otherwise, the damages provided for in the contract should mirror the loss/damage likely suffered by the innocent party.

  14. Section 75 allows reasonable compensation regardless whether actual loss or damage is proven. Actual loss should not be the sole consideration of reasonable compensation but evidence of that may be a useful starting point.

  15. The burden of proof is divided:
    1. Primary burden of proof: Innocent party seeking to enforce damages clause under Section 75 needs to prove breach of contract; and the contract provides for a clause specifying a sum to be paid upon breach.
    2. At this stage: If established, innocent party entitled for a sum not exceeding the amount stipulated in the contract irrespective of whether actual damage or loss is proven.
    3. Secondary burden of proof: Defaulting party entitled to prove that the sum stated in the damages clause is unreasonable including if there is a dispute as to what constitutes reasonable compensation.

  16. The Federal Court held that the parties were well aware of the fact that earnest deposit payments would be forfeited as “agreed liquidated damages”. The deposits were subject to the same test of “legitimate interest” and proportionality” of the damages clause under Section 75.

  17. Amongst others, the depravation of chances for the Appellant to enter into negotiations with third parties, goal of securing the execution of the S&P and avoiding delay in its completion were all “legitimate interest”. The total deposit amounted to 3.33% of the purchase price which was deemed proportionate under the principle of “proportionality”. In turn, the Respondent could not prove that such amount was unreasonable or exorbitant. The deposits were reasonable compensation under Section 75.

  18. Impact on the Construction Industry


  19. LAD clauses are the norm in the Construction Industry whether it covers contracts between employers (developers) and contractors; contractors and sub-contractors; or even developers and homebuyers for the completion of works and delivery of vacant possession within a specified time period.

  20. The position is such, following the decision of Cubic Electronics, that if the defaulting party has failed to complete the works and deliver vacant possession within the specified time period, the innocent party will be able to recover the sum in the LAD clause without the need to prove actual loss/damage as cocooned in Section 75.

  21. The innocent party (for example the employer/developer) will only need to prove that there has been a breach of the contract (for example late/failure of delivery of vacant possession) and that the contract has a LAD clause. The innocent party need not prove actual loss/damage. The innocent party will be entitled to the sum as contained in the LAD clause. It is for the defaulting party (the contractor) the sum stated in the damages clause is unreasonable.

Citation
1 Alvin Brightman, “Liquidated Damages” (1925) 25(3) Columbia Law Review 277 2 [2019] 2 CLJ 723