16/4/2022 0 Comments
Written by Ms Choong Shaw Mei, Advocate and Solicitor (Malaya) (non-practicing) and part-time lecturer at the Faculty of Law, University of Malaya.
Edited by Ashley Khor.
Reviewed by Ee Jie.
In contract law, liquidated damages clauses are often regarded as effective and important means for contracting parties to negotiate and agree upon compensation payable for the non-performance of contractual obligations. However, Section 75 of the Contract Act 1950 often strikes this clause out. In this article, the author delves into the refined restatement of the law, as laid out by the Federal Court in the case of Tekun Nasional.
There is no denying that commercial reality is an important consideration before courts deliver judgments on the issues of breach and damages in corporate and commercial sectors. In contract law, liquidated damages clauses (‘damages clauses’) are often regarded as an effective and important means for contracting parties to negotiate and agree upon compensation payable for the non-performance of contractual obligations. Such clauses on agreed damages generally aim to reduce the need for costly and time-consuming court proceedings in the event of a breach and to provide certainty for contracting parties with regard to the risks they undertake under the contract. Malaysian law on damages clauses has been far from satisfactory for a number of years due to the interpretation given by the courts that there is no difference between penalty and liquidated damages as understood under English Law in view of Section 75 Contracts Act 1950 (‘CA’), and therefore any ‘submission as to whether a certain clause is a penalty or liquidated damages is an exercise in futility.’
This has led to numerous challenges to well-drafted damages clauses, which had been agreed upon by commercial parties of equal standing, and in turn — judges having to navigate between applying the law as laid down while recognising the commercial importance of such damages clauses. It has also led to the creative drafting of damages clauses in an effort to avoid the implication of Section 75 of the CA, as industry leaders such as the Malaysian Institute of Architects (‘PAM’) sought to make commercial sense of the law inhibiting their use of such an important contractual term. Within the one-year period between May 2017 and April 2018, there were four cases decided by the Court of Appeal that struck down the damages clauses in contracts between the parties pursuant to Section 75 of the CA. In each case, the Court of Appeal (consisting of different quorums) had cited the case of Selva Kumar Murugiah v Thiagarajah Retnasamy (‘Selva Kumar’) in coming to their respective decisions. Tekun Nasional v Plenitude Drive (M) Sdn Bhd and Other Appeals (‘Tekun v Plenitude’) was the last of the four cases to be heard before the Court of Appeal, wherein Tengku Maimun JCA (as Her Ladyship then was) summarised the prevailing law on damages clauses as follows:
While damages clauses continue to feature in many commercial contracts, particularly in the construction industry, judges were often stymied by the Federal Court decision in Selva Kumar. Later affirmed by the Federal Court in Johor Coastal Development Sdn Bhd v Constrajaya Sdn Bhd, this decision interpreted Section 75 of the CA to strike down all damages clauses save in a limited class of cases, i.e. when the court finds it difficult to assess damages for the actual damage or loss. This was the troubling scenario that faced the Federal Court, when the first of the four aforementioned Court of Appeal decisions, Cubic Electronics Sdn Bhd (in liquidation) v Mars Telecommunications Sdn Bhd (‘Cubic’), proceeded to have its appeal heard before the Federal Court. In a detailed and deeply analytical judgment delivered by Richard Malanjum CJSS (as he then was), the Federal Court gave a much-needed restatement of Section 75 of the CA. Cubic is considered by many to have brought about a revised interpretation of the rather convoluted provisions in Section 75 of the CA and clearly established that:
The Cubic decision has generally been well-received by law practitioners, as well as those in the relevant industries, such as the construction industry. The decision has been cited and followed in numerous High Court decisions as well as in the Court of Appeal. There are some views expressed that perhaps the Federal Court had side-stepped the provisions in Section 75 of the CA by wholly embracing the new penalty test set out in Cavendish Square Holdings BV v Talal El Maksessi; ParkingEye Ltd v Beavis, and there certainly have been attempts to apply the Selva Kumar ruling in a number of cases post-Cubic. The question of whether the case of Selva Kumar had been overruled by the Cubic decision was uncertain in the light of the ambivalence shown by the Federal Court in its judgment:
However, Hasnah Mohammed Hashim FCJ, in delivering the judgment of the Federal Court in Tekun v Plenitude, clearly took the view that the decision in Cubic has changed the law on damages clauses:
When we peruse Her Ladyship’s in-depth discussion on the issue of prospective overruling in Tekun v Plenitude — as well as her numerous references to the pre-Cubic position — it is evident that the decision in Cubic was interpreted by the Federal Court in the instant case as an effective overruling of Selva Kumar. The question of whether the Cubic decision has a prospective or retrospective effect would only be pertinent if the decision itself has an overruling implication. While the author does not share Her Ladyship’s approach in applying the principles of overruling a precedent, Hasnah Mohammed Hashim FCJ no doubt based her judgment on the understanding that Cubic had indeed overruled the decision of Selva Kumar when discussing the impact of Cubic on the case before her. With this clear stance taken by the Federal Court in Tekun v Plenitude, it is hoped that efforts to revive the Selva Kumar ruling and revert to the previous problematic legal position with regard to damages clauses, would finally be put to rest.
The author is, however, of the view that the application of the principles of overruling by the Federal Court with regard to the Cubic decision in the instant case is incorrect. Firstly, the Federal Court did not invoke the doctrine of prospective overruling when delivering its judgment in Cubic. In general, it has been held that ‘a decision of this court — or indeed of any court — is retrospective in effect unless a specific direction of prospectivity is expressed’.Secondly, it was clarified by the Federal Court that ‘the law as declared by this court and made subject to the doctrine of prospective overruling applies to all pending cases and all those cases still under appeals within our court system’. The position would be that even a decision declared to have prospective overruling effect would apply to all cases which have yet to attain its finality, including cases pending appeal. It is therefore uncertain on what basis the learned Federal Court judge concluded in Tekun v Nasional that:
Notably, it is somewhat problematic that the new principle, in this case, reversed the party having the burden of proof at trial. Nonetheless, this issue may not have been as significant in the instant case, as will be explained later.
It would therefore not be incorrect to surmise that there was no reason not to apply the decision of Cubic to allow the Plenitude’s claim under the damages clause in the case of Tekun v Plenitude — unless Tekun Nasional, the defaulting party, can successfully prove that it is a penalty based on the concepts of ‘legitimate interest’ and ‘proportionality’. In the light of the restatement of the law, the Federal Court in the instant case could have sent the case back to the High Court to determine if the damages Clause 11.2 was indeed a penalty. However, from the Federal Court’s discussion of the facts, this appeared to be an issue the parties had raised on submission at the trial and was duly considered by the High Court judge — notwithstanding that the law then was to generally strike down damages clauses by virtue of the Selva Kumar ruling. In any event, the Federal Court judgment did in fact refer to the penalty test and concluded that:
Having done so, the Federal Court went on to hold that Plenitude, being the claimant, had also failed to prove the actual damage suffered as a result of the breach now that they were not able to rely on Clause 11.2.
III. PROOF OF ACTUAL LOSS
The author would now proceed to analyse why Plenitude, as the plaintiff, was held to have failed in their attempt to prove actual loss. The Federal Court regarded this as fatal, whereby only nominal damages were awarded to them. It would appear that the trial at the High Court had focused on the calculation of the amount claimed under Clause 11.2, and the nature of the damages claimed in the sum of RM 29,829,132.40. Upon conclusion of the trial, the sum claimed was held to be special damages, which must be specifically pleaded and strictly proven. The High Court judge further held that the plaintiff was not entitled to claim the specific contract sum in light of Section 75 of the CA but nevertheless made an order — in the exercise of his residual discretion — that the plaintiff was entitled to general damages which were to be assessed. The approach above is consistent with the view that the trial had primarily focused on the plaintiff proving the factual and legal basis of the defendant’s breach, as well as the computation of the plaintiff’s claim for agreed damages based on the formula prescribed within the damages clause. The learned judge went on to establish that the plaintiff did not have the opportunity to prove their claim on general damages ‘since the defendant had not specifically challenged the specific amount claimed by the plaintiff until the submission stage’. In the premises, His Lordship felt compelled to ‘exercise his residual discretion to order damages to be assessed, as a matter of procedural fairness and justice’.
The Court of Appeal in Tekun v Plenitude agreed with the learned judge that the plaintiff is clearly entitled to compensation for any loss or damage, including that of earnings and profits, if any, even if they cannot rely on Clause 11.2. However, it would appear that the Court of Appeal was of the view that the parties in the trial before the High Court focused on the wrong approach. In an attempt to prove the loss suffered, the parties had referenced Clause 11.2, which was based on the loss of opportunity. The Court of Appeal appeared to have taken the view that such a method of calculation would be an inaccurate representation of the actual loss suffered. For that reason, the appellate court decided that based on the precedent set by SPM Membrane Switch Sdn Bhd v Kerajaan Negeri Selangor, the matter should be remitted to the High Court for the assessment of damages to be made on the correct basis — in relation to the contract price rather than the loss of opportunity. Having agreed with the High Court judge in not allowing liquidated damages in the sum of RM 29,829,132.40, Tengku Maimun JCA (as Her Ladyship then was) went on to establish:
It is therefore evident that the further order for assessment of damages by the Court of Appeal was made on the basis that the trial had focused on the wrong consideration on quantum, which was the loss of opportunity rather than the actual loss of profit suffered by the plaintiff. As Hasnah Mohammed Hashim FCJ has pointed out in the Federal Court judgment, ‘the evidence of damages as adduced by Plenitude at the trial was purely mathematical with no supporting evidence such as its operating expenses’. This would seem to lend support to the further order for the assessment of damages made by both the Court of Appeal and the High Court, albeit on somewhat different bases. Such an order, necessitated by the failed opportunity during trial to address the proper basis on the quantum of damages, would contradict what the Federal Court had termed as ‘a second bite of the cherry’ for the plaintiff. Both the High Court judge and the Court of Appeal were equally concerned with the fact that the plaintiff should be properly compensated for their obvious loss suffered as a result of the breach by the defendant. While different approaches were taken by the High Court and the Court of Appeal, it was without a doubt decided on the understanding that the plaintiff should be allowed to prove their loss by way of assessing damages for the actual loss suffered upon the damages clause held to be void. It was therefore rather unexpected for the Federal Court to decide that the plaintiff should only be awarded nominal damages when the failure to prove actual loss was likely attributable to the limited focus of the trial or the wrong basis of assessment of damages taken by the parties at the trial.
IV. TWO DIFFERENT BURDENS OF PROOF
The Federal Court decision in Tekun v Plenitude has elucidated the importance of viewing the burden of proof in establishing whether the clause is a penalty separately from the burden of proof in establishing actual loss. The law before Cubic was that all damages clauses were strictly not allowed by Section 75 of the CA, and therefore, plaintiffs will have to prove actual loss in order to recover damages. Nevertheless, even before the Cubic decision, the plaintiff at a trial would often attempt to establish that the damages clause in the contract was in fact reasonable. Simultaneously, effort would also be made to prove actual loss in the event the damages clause would be indeed struck down under Section 75 of the CA — leading to some confusion as to what has actually been proven. The new development in the law as decided by Cubic is clearly stated by Hasnah Hashim FCJ in the instant case that:
For further clarification, it may be important to point out the steps to be taken under the restated legal principles:
Therefore, under this new development in the law in relation to Section 75 of the CA, one of the main issues to be determined at trial in the first instance is whether a damages clause is enforceable when the breach is established. The burden of proof according to Cubic falls on the defaulting party to prove that the damages clause is unreasonable based on the concepts of ‘legitimate interest’ and ‘proportionality’. This issue is then likely to be the focus of the trial at first instance. Since the burden of proof is on the defendant to prove that the damages clause is unreasonable, the plaintiff, in all likelihood, would not be submitting evidence to prove actual loss until the court has ruled on the validity of the damages clause. While it is possible the plaintiff as claimant would nevertheless make some attempts to establish that the amount stated in the damages clause is reasonable, it is crucial to point out such effort by the plaintiff is by no means a discharge of the burden of proving actual loss caused by the breach.
In the event that the court rules that the amount named in a contract is proven to be exorbitant and unreasonable, the damages clause would be treated as a penalty and therefore, void under Section 75 of the CA. Consequently, the plaintiff would not be able to rely on the damages clause and would then have to prove actual loss according to Section 74 of the Contracts Act 1950. Should the said damages clause be ruled to be a penalty after the conclusion of the trial, the plaintiff should not be held to have failed in proving actual loss without being afforded a further opportunity to do so. In such a case, it may certainly be necessary for the judge conducting the trial to make an order for the assessment of damages — as was done by the High Court judge in the case of Tekun v Plenitude. This is because of the likelihood that the parties during the trial would be engaged primarily with the issue of proving whether the damages clause would pass the penalty test. As the burden of proof now lies with defendant, any effort put in by the plaintiff (although not required) to show the court that the damages clause is reasonable, would not be the same as that required to prove actual loss in the event the said clause is held to be a penalty.
The unfortunate conflation of the two different burdens of proof may well be the basis of much confusion and can lead to an unfortunate outcome similar to that of the Tekun v Plenitude case, whereby only nominal damages would be awarded due to the perceived failure of the plaintiff to prove actual loss. This would be unfair because at the stage of the trial, the plaintiff may not yet have the opportunity to establish its case for proving actual loss while the parties are focused on determining if the damages clause is a penalty. While this may not have been the exact situation in the Tekun v Plenitudecase, this scenario is likely to arise with the application of the restated legal position on Section 75 of the CA on damages clauses as decided by Cubic. Therefore, a trial involving damages clause may have to be bifurcated for the validity of the damages clause to be decided first. Here, the burden is on the defendant to prove that the same is unreasonable and imposed without legitimate interest. Only when the damages clause is ruled as a penalty, would the plaintiff be then required to prove actual loss.
It is hoped that the legal principles on this important aspect of commercial law are now well-settled, and that contracting parties are able to proceed with a clear understanding of their positions under the law. Such parties should be able to confidently rely on a properly negotiated and well-drafted damages clause to govern their obligations under the contract in the event of a breach of contract. A contracting party using such clauses to oppress other parties with weaker bargaining power should expect the intervention of the court by virtue of the penalty rule. This is deemed a necessary intervention by the courts although it encroaches on the freedom of the parties to contract. As such, it was aptly stated by the learned former Chief Justice in Cubic that ‘… in our case, the legislative mechanism introduced by s 75 of the Act must be considered a necessary curtailment of absolute freedom of contract, designed to check against potential abuse by a party at another’s expense.’ However, His Lordship went on to opine that:
The above dicta clearly demonstrate the twin concerns of the court in applying the law to uphold the notion of the freedom of contract, as well as to regulate the freedom of contract. The restatement of the law by the apex court bringing about the new interpretation of Section 75 of the CA was certainly timely, and much needed to give more legal certainty to the operation of a damages clause as a permissible risk allocation tool. The respected High Court judge, Lim Chong Fong J, in discussing the decision in Cubic, wrote:
While it may be said that the Contracts Act 1950 needs to be amended and updated and Section 75 of the CA itself may be somewhat convoluted and ambiguous, it is certainly within the purview of the court in the meantime to make such interpretation and ruling as may be necessary in keeping with commercial reality and the demands of modern contract law.
Disclaimer: The opinions expressed in this article are those of the author and do not necessarily reflect the views of the University of Malaya Law Review, and the institution it is affiliated with.
 Maple Amalgamated Sdn Bhd v Bank Pertanian Malaysia Bhd  6 MLJ 348, ; Triple Point Technology Inc v PTT Public Company Ltd  UKSC 29, .
 Selva Kumar Murugiah v Thiagarajah Retnasamy  1 MLJ 817, 823 (Peh Swee Chin FCJ).
 Some cases distinguished Selva Kumar (Brisdale Resources Sdn Bhd v Law Kim  6 MLJ 76) or sought to bring the fact situation within the limited class of cases which did not require proof of actual loss (Sakinas Sdn Bhd v Siew Yik Yau & Anor  5 MLJ 497) while others did not refer to Selva Kumar at all (Larut Matang Supermarket Sdn Bhd v Liew Fook Yung  1 MLJ 375) or clearly disagreed with the ruling (Yap Yew Cheong & Anor v Dirga niaga (Selangor) Sdn Bhd  7 MLJ 660).
 Malaysian Institute of Architects. (2018). PAM Contract 2018 (With Quantities). Kuala Lumpur, Malaysia: Malaysian Institute of Architects, Clause 22.2: ‘The Liquidated Damages stated in the Appendix is a genuine pre-estimate of the loss and/or damage which the Employer will suffer in the event the Contractor is in breach…The parties agree that by entering into the Contract, the Contractor shall pay to the Employer the said amount, if the same becomes due without the need for the Employer to prove his loss and/or damage…’
 Selva Kumar Murugiah v Thiagarajah Retnasamy  1 MLJ 817 (Federal Court).
 Tekun Nasional v Plenitude Drive (M) Sdn Bhd and Other Appeals  4 MLJ 567.
 See footnote 6 above, .
 Johor Coastal Development Sdn Bhd v Constrajaya Sdn Bhd  4 MLJ 445.
 See footnote 2 above, 828-829.
 Cubic Electronics Sdn Bhd (in liquidation) v Mars Telecommunications Sdn Bhd  6 MLJ 15 (Federal Court).
 See footnote 10 above, [74(f)] – [74(g)].
 VTS Capital Sdn Bhd v Capitol Avenue Development Sdn Bhd (Sabah Electricity Sdn Bhd, third party)  MLJU 167; MS Elevators Engineering Sdn Bhd v Jasmurni Construction Sdn Bhd and another appeal  5 MLJ 209 (Court of Appeal); Bumimetro Construction Sdn Bhd v Sun-Jaya M&E Sdn Bhd  MLJU 136; Capitol Avenue Development Sdn Bhd v HKT Realty Sdn Bhd & Ors  MJLU 1263; GPR Construction Sdn Bhd v Sri Ternak Properties Sdn Bhd  MLJU 1838.
 Cavendish Square Holdings BV v Talal El Maksessi; ParkingEye Ltd v Beavis  UKSC 67.
 MacVilla Sdn Bhd v Mervyn Peter Guan Yin Hui & Anor  MLJU 693 (Court of Appeal).
 See footnote 10 above, .
 Tekun Nasional v Plenitude Drive (M) Sdn Bhd and another appeal  6 MLJ 619, .
 PP v Mohd Radzi Abu Bakar  1 CLJ 457,  (Federal Court).
 Ling Peek Hoe & Anor v Ding Siew Ching and another appeal  5 MLJ 385,  (Federal Court).
 See footnote 16 at para .
 See footnote 10 above, [74 (d)]. The concepts of ‘legitimate interest’ and ‘proportionality’ were held to be relevant in determining what amounts to ‘reasonable compensation’ under Section 75 of the CA.
 See footnote 16 above, .
 See footnote 16 above at para .
 See footnote 6 at para .
 See footnote 6 above, .
 See footnote 6 above, .
 See footnote 16 at para .
 SPM Membrane Switch Sdn Bhd v Kerajaan Negeri Selangor  1 CLJ 177.
 See footnote 6 above at para .
 See footnote 16 above at para .
 See footnote 16 above at para .
 See footnote 16 above, -.
 See footnote 20 above. The application of these concepts was clearly demonstrated in the case of ParkingEye Limited v BeavisUKSC  67 (which appeal was heard together with the Cavendish case) as well as the case of Cubic itself at  and .
 The trial was held before the Cubic decision.
 See footnote 10 above,  and .
 See footnote 10 above, .
 See footnote 10 above, .
 Lim Chong Fong. (2019). Enforcement of Liquidated Damages – A Legal Conundrum Resolved? The Journal of Malaysian Judiciary July 2019, 72, .