Divergence and Convergence in the Law of Contractual Penalties and Liquidated Damages Clauses in England, Singapore, and Malaysia

Abstract

Contracts often make provision for the remedies available upon breach, i.e., by providing for a sum or stipulation available to either party upon breach by the other (an ‘agreed damages clause’). A persistent question is whether, and to what extent, such clauses are enforceable. In this paper, we analyse the convergences and divergences between Malaysia, Singapore, and England, in particular following decisions in the apex courts. These clauses are always enforceable under s 75 of the Malaysian Contracts Act 1950, albeit up to the point of ‘reasonable compensation’ only. Whereas, in Singapore and England, if the clause is found to be a ‘penalty’ it is liable to be unenforceable in toto. Malaysian law also differs in that a truncated assessment for ‘reasonable compensation’ is provided for in statute. We argue that the ‘proportionality’ and ‘legitimate interest’ elements in the Cavendish analysis, over the compensatory-centric analysis in Denka Advantech, may be a better fit with the concept of ‘reasonable compensation’ under Malaysian law, and may give content to the statutory interpretation of the phrase in future cases.

Introduction

When parties contract with one another they often make provision for the remedies available to either party upon breach by the other, that is, by providing for a sum or stipulation available to either party upon breach by the other (an ‘agreed damages clause’). A persistent question of law is whether, and to what extent, such clauses are enforceable. In England and Singapore, Lord Dunedin’s tests in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd¹ were the mainstay whereas in Malaysia, agreed damages clauses usually required proof of actual loss to be enforceable. The last 6 years has seen a series of apex court decisions from Malaysia, England, and Singapore that has resulted in a significant reframing of the law in this area. In this paper, we analyse the convergences and divergences between the respective jurisdictions.

With regards to the position in England, we analyse the shift from the traditional position in Dunlop to the modern restatement of the law in Cavendish Square Holding BV v Makdessi and ParkingEye Ltd v Beavis.² In Singapore, we examine the decision in Denka Advantech Pte Ltd v Seraya Energy Pte Ltd³—a resolute defence of Dunlop that rejects the ‘legitimate interest’ test in Cavendish. We proceed with an analysis of the Malaysian position, starting with an historical account of s 75 of the Malaysian Contracts Act 1950 (‘MCA’) and culminating with the Malaysian Federal Court’s decision in Cubic Electronics Sdn Bhd v Mars Telecommunications Sdn Bhd.⁴

We argue that insofar as the question of enforceability of the agreed damages clause is concerned, the Malaysian position differs from that of Singapore and England in that the question of whether an agreed damages clause is a ‘penalty’ (and therefore unenforceable in toto) does not arise in Malaysian law. Agreed damages clauses are always enforceable in Malaysian law, although only up to the extent of ‘reasonable compensation’ whereas they are valid or unenforceable in toto in Singapore and England if they fall foul of the penalty rule. A further difference may be found in the truncated process for assessing ‘reasonable compensation’ as a result of s 75 of the MCA consistent with the statutory provision dispensing with the need for proof. As for where Malaysian law may be headed, we argue that the concept of ‘reasonable compensation’ in s 75 of the MCA is a better fit with the principles set out in Cavendish than those espoused by the Singaporean Court of Appeal in Denka Advantech. Therefore, the Cavendish analysis, which received favourable treatment in Cubic, represents a step in the right direction for Malaysia.

The Penalty Doctrine at Common Law: General Principles

The penalty rule at common law finds its origin in the equitable jurisdiction to relieve a party from defeasible bonds.⁵ With a decline in the use of defeasible bonds, the penalty rule continued to develop at common law in the context of damages clauses.

The boundaries of the doctrine at common law were limited to clauses which sought to award a compensatory remedy to an innocent party upon a breach of contract by the defaulting party (Burrows, 2016: 23(1)–(3)). In this regard, it should be noted that whilst the High Court of Australia in Andrews and others v Australia and New Zealand Banking Group Limited⁶ has extended the scope of the penalty rule to allow for the review of primary obligations between contracting parties, this approach has been rejected in England and Singapore where the courts have maintained that the penalty rule is only engaged when the sum or stipulation in question is imposed as a secondary obligation.⁷ S 75 of the MCA in Malaysia similarly dictates that the court’s ability to review an agreed damages clause is premised on the sum or stipulation being a payment upon breach.

The traditional position, as discussed further below, also presented a dichotomy between clauses that were a genuine pre-estimate of loss (enforceable as a liquidated damages clause), and those which did not represent a genuine pre-estimate of loss and were held in terrorem (unenforceable as a penalty) (Beale, 2017: 26–183). The practical effects of the application of the penalty rule at common law were such that there is no jurisdiction for the court to modify the terms or the quantum of the sum specified in the agreed damages clause. If an agreed damages clause was found to be a valid liquidated damages clause, it would generally be enforced on the terms stipulated in the contract; conversely if the agreed damages clause is found to be a penalty, it would be void and therefore unenforceable in toto.⁸

The burden of proving that an agreed damages clause is a penalty lies with the party who seeks to escape liability under it, not on the party who seeks to enforce it,⁹ and the relevant circumstances in assessing whether an agreed damages clause is a penalty or liquidated damages are those that exist at the time the contract was made (Halson 2018: 52, 2.44). The implications of these aspects are particularly relevant for the Malaysian position with regards to the truncated assessment of damages and the sliding scale of ‘reasonable compensation’ under s 75 of the MCA.

The Position in English Law

Dunlop: The Traditional Statement of the Penalty Rule

The classic statement of the penalty rule at common law is found in Lord Dunedin’s speech in Dunlop, the facts of which are well-known. Briefly, the appellants entered into a contract with the respondents for the supply of motor tyres, covers, and tubes. The terms of the agreement prohibited the respondents from doing several things, including not to sell any of the appellants’ goods to any private customers or to any co-operative society at prices less than the price list issued by the appellants. The agreed damages clause in that case stipulated that New Garage would ‘agree to pay to the Dunlop Pneumatic Tyre Company, Ltd. the sum of £5 for each and every tyre, cover or tube sold or offered in breach of this agreement, as and by way of liquidated damages and not as a penalty’.¹⁰ Dunlop later discovered that New Garage had sold covers and tubes below the price list and brought an action against New Garage, claiming damages as their remedy. Breach of contract was proven; the court directed an inquiry as to damages, where it was held that the stipulated sum of £5 represented liquidated damages and not a penalty. The Court of Appeal reversed that finding¹¹ and awarded nominal damages.¹² On appeal, the law on liquidated damages and the penalty rule fell to be considered by the House of Lords.

Lord Dunedin, who delivered the leading speech in Dunlop, summarised that the ‘essence of a penalty is a payment of money stipulated as in terrorem of the offending party’ whereas ‘the essence of liquidated damages is a genuine covenanted pre-estimate of damage’.¹³ This is the so-called ‘liquidated damages/penalty dichotomy’. He formulated four tests to determine whether an agreed damages clause was a penalty or an enforceable liquidated damages clause:

• (i) ‘It will be held to be penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach’;

• (ii) ‘It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid’;

• (iii) ‘There is a presumption (but no more) that it is penalty when a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage’; and

• (iv) ‘It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of the breach are such as to make precise pre-estimation almost an impossibility. On the contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties.’¹⁴

For the vast majority of the twentieth century, Lord Dunedin’s statement of the law on penalties and the ‘Dunedin tests’ formed the locus classicus on the law of agreed damages clauses in England.¹⁵ However, as none of the tests concludes that a clause which is not a genuine pre-estimate of loss is necessarily one which carries a deterrent effect,¹⁶ the application of Lord Dunedin’s tests in Dunlop developed such that the in terrorem requirement became redundant for the penalty rule (Halson 2018: 24). The courts’ exercise for assessing the enforceability of an agreed damages clause was thus primarily determined by whether it represented a genuine pre-estimate of loss at the time of entering into the contract—and not strictly because the clause was intended to coerce or intimidate the other party. This is an unsurprising result given that the idea of a clause representing a genuine pre-estimate of loss between parties does not easily share a rational connection to the idea of a clause having a deterrent effect on a party (and the subjectivity that this may entail).¹⁷

Towards the turn of the twenty-first century, the English courts started introducing a broader ‘commercial justification’ approach that etched away at the tangled dichotomy between a genuine pre-estimate of loss and a penalty clause held in terrorem. In this renewed approach, it was considered that even if an agreed damages clause was not a genuine pre-estimate of loss, it would still be possible to enforce the clause if there was some other (commercial) reason to justify it. The foremost of this is Colman J’s decision in Lordsvale Finance plc v Bank of Zambia.¹⁸Lordsvale was concerned with a provision in a loan agreement for interest to be payable at a higher rate if the borrower fell into default.¹⁹ In arriving at his decision, Colman J sought to recast the penalty rule in modern terms, focusing on whether the agreed damages clause in the contract was commercially justifiable although not necessarily a pre-estimate of loss suffered upon default by the customer. Although previous authorities suggested that such provisions were penal, Colman J found that the clause was enforceable as its predominant purpose was not to deter a breach but represented the commercial risk in the transaction.²⁰

In Murray v Leisureplay plc,²¹ an employee sought to enforce an agreed damages clause stipulating that he was to receive a year’s salary in the event of wrongful termination. His employer argued in response that the clause was unenforceable as a penalty. All three members of the Court of Appeal approved of Colman J’s commercial justification approach in Lordsvale, with Arden LJ fashioning a similar test that would allow for an agreed damages clause to be enforced if there was ‘some other reason which justified’ it even if it did not constitute a genuine pre-estimate of loss under the Dunlop tests.²² On the facts of Murray, Arden LJ found that the clause in question posed commercial advantages for both the employee and the employer and noted that it was not shown that the parties could not reasonably have come to the view that the clause was a genuine pre-estimate of loss or that it was not otherwise justifiable.²³

This approach of justifying the enforceability of an agreed damages clause by reference to broader surrounding commercial reasons was expounded by Lord Atkinson in Dunlop too. Lord Atkinson examined the nature of the appellants’ trade and business and concluded that, in substance, the agreed damages clause was designed to avoid a systemic undercutting of prices by other sellers and to prevent an overall breakdown of Dunlop’s trade and business.²⁴ He reasoned that the sum stipulated in the agreed damages clause was enforceable as it represented a genuine pre-estimate of Dunlop’s interest in securing the due performance of the contract²⁵ and not necessarily because it represented a genuine pre-estimate of their loss. On this analysis, it would follow that an agreed damages clause which was not commensurate with securing the performance interest between parties would be treated as a penalty.

Whilst this commercial justification approach represented an altogether broader and more nuanced position than the predominant focus on the compensatory principles found in Lord Dunedin’s tests, the modern cases did not discard entirely the in terrorem requirement under the traditional statement of the law—an aspect that was clarified in Cavendish.

Cavendish: The Modern Statement of the Penalty Rule—the ‘Legitimate Interest’ Test

In 2015, the UK Supreme Court had occasion to review the penalty rule in English law. The resulting decision, although framed as a reinterpretation of the Dunlop test, has fundamentally departed from the traditional statement of the penalty rule.

There were two separate appeals heard in Cavendish. Cavendish Square Holding BV v Makdessi²⁶ (the ‘Makdessi Appeal’), and ParkingEye Ltd v Beavis²⁷ (the ‘ParkingEye Appeal’). The leading judgment in Cavendish was jointly delivered by Lords Neuberger and Sumption.²⁸ They observed that whilst Lord Dunedin’s four tests had ‘achieved the status of a quasi-statutory code’,²⁹ the tests were being applied too literally and that resulted in artificial categories and distinctions between a genuine pre-estimate of loss and a penalty, and between a genuine pre-estimate of loss and a deterrent.³⁰ Lords Neuberger and Sumption correctly point out that the scope of the penalty rule is to govern agreed damages clauses which are penal in nature and that this is a question that cannot be solely determined by whether the clause is a genuine pre-estimate of loss.³¹ In this regard, Lords Neuberger and Sumption preferred instead Lord Atkinson’s analysis in Dunlop and the modern ‘commercial justification’ cases,³² which they considered to have provided a better insight into the unenforceability of agreed damages clauses in instances where the clause exceeds the party’s performance interests in the contract.³³

Thus, in determining whether an agreed damages clause is unenforceable as a penalty, Lords Neuberger and Sumption reformulated the rule as follows: ‘The true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.’³⁴ Lord Mance³⁵ and Lord Hodge³⁶ (Lord Toulson concurring)³⁷ had each formulated the penalty rule on similar terms.

Some comments can be made in respect of the penalty rule as reformulated in Cavendish. Firstly, the Cavendish test places no emphasis on the long-standing requirement to show that the agreed damages clause represents an attempt to accurately forecast the loss that an innocent party would suffer on breach. This realignment of the penalty rule in Cavendish by reference to the legitimate interests of the innocent party also elegantly does away with the opaque dichotomy in Dunlop between a genuine pre-estimate of loss and the metaphysical quality of a clause being held in terrorem of the defaulting party.³⁸ But as a compensatory interest is an example of a legitimate interest, there may yet be an understandable retreat to the genuine pre-estimate of loss analysis in cases where the agreed damages clauses are straightforward and where the only legitimate interest involved is that of compensation for breach. This represents a continuing—albeit narrower—role for Lord Dunedin’s four tests to determine the enforceability of an agreed damages clause in England.³⁹

Secondly, whilst Cavendish advanced a normative shift for the underpinnings of the penalty rule, the concept of a ‘legitimate interest’ was left undefined by the Supreme Court. This may not be a concept so easily circumscribed in the context of contractual remedies (Rowan 2019: 149–163). It thus remains to be seen how the courts will treat the reformulated proportionality element and the factors that a court may regard as relevant to the legitimate interest test under the Cavendish penalty rule. These include factors such as: the relevant criteria to identify any purported performance interest in a contract as a ‘legitimate’ one; and how such legitimate interests are valued for purposes of a proportionality analysis against the sum or stipulation in the agreed damages clause.⁴⁰ Without further clarity on such aspects, the Cavendish test may present a concept that is too wide or flexible and is therefore left to be measured at the discretion of judges.

This can be seen on the facts of the ParkingEye Appeal in Cavendish. Lords Neuberger and Sumption held that the £85 charge by ParkingEye had two main objects which they thought to be perfectly reasonable.⁴¹ One was to manage the efficient use of parking space and to deter inconsiderate parking practices.⁴² More controversially, however, was the second purpose which recognised the £85 charge as part of ParkingEye’s revenue and profit-generating scheme from its services provided.⁴³ They held that these were ‘legitimate interests’ and that the sum charged by ParkingEye was not out of proportion to its legitimate interests or that of the landowner.⁴⁴ The £85 charge was thus held to be recoverable from Mr Beavis. As we discuss later in this paper, it is to be doubted whether that second purpose of ‘making a profit’ ought to have been recognised as a legitimate interest on the facts of the case. It remains to be seen whether the interest of making a profit, that presumably applies to the vast majority of commercial transactions, would still be applied in favour of a party enforcing an agreed damages clause in situations where the court has misgivings about the party or the transaction in question.

This wider scope employed by the ‘legitimate interest’ test would also appear to contradict a party’s purpose of inserting an agreed damages clause in the first place, that is, to preserve the availability of a remedy against the defaulting party without entering into potentially protracted and expensive litigation to determine the enforceability of the clause. In contrast, the fact of the in terrorem requirement becoming redundant means that the Dunlop tests have arguably settled into a relatively straightforward and certain set of criteria for parties. An agreed damages clause arrived at based on a comparison against the greatest loss likely to be suffered upon breach is expected to be an easier process for parties to undertake than it would be to, firstly, identify all legitimate interests in the performance of the contract, and secondly, to place an appropriate value that is not disproportionate to the identified interests.

On the other hand, it has also been suggested that the reformulated proportionality element in Cavendish would permit a broad margin of error before a clause will become unenforceable, and it could be a way for courts to more readily uphold bargains and promote a greater certainty amongst commercial parties dealing at arm’s length such as to enforce agreed damages clauses on the terms stipulated (Halson 2018: [2.48]). If at all, that may be the case once the courts have further refined the ambit of the ‘legitimate interest’ test but given the present uncertainty, it is expected that defaulting parties are more likely to contest the summary enforcement of agreed damages clauses.⁴⁵

The Position in Singaporean Law

Unlike India and Malaysia, Singapore has not codified its law of contract through statute. Contract law in Singapore is thus primarily governed by the common law. The Singaporean position on the penalty rule is heavily informed by the traditional statement of the law in Dunlop. In 2015, in the case of Xia Zhengyan v Geng Changqing,⁴⁶ the Singaporean Court of Appeal reaffirmed that the law on penalties in Singapore is embodied within the principles laid down by Lord Dunedin which in turn ‘constitute the backbone of all analysis on this topic’ in Singapore.⁴⁷ Five years later, in the case of Leiman, Ricardo v Noble Resources Ltd,⁴⁸ the Singaporean Court of Appeal reaffirmed that Dunlop remains the leading statement on the penalty rule in Singapore.

In late-2020, in Denka Advantech Pte Ltd v Seraya Energy Pte Ltd,⁴⁹ Andrew Phang Boon Leong JA, delivering the unanimous judgment of the Singaporean Court of Appeal, fundamentally disagreed with the Cavendish test and re-endorsed Lord Dunedin’s statement of the principles in Dunlop.⁵⁰

The purpose underlying the penalty rule as conceived in Denka Advantech was that it seeks to prevent the imposition of a remedy that is disproportionate to the loss suffered as a result of a breach.⁵¹ This conception of the penalty rule is a result of the Court of Appeal recognising that an agreed damages clause is a type of contractual remedy, and is therefore subject to the norm that a contractual remedy must aim to compensate the innocent party and not to punish the defaulting party.⁵² The Court of Appeal reasoned that determining the enforceability of an agreed damages clause by reference to whether it is a genuine pre-estimate of loss is consistent with the defaulting party’s secondary obligation to provide compensatory relief upon breach.⁵³ On this analysis, the Court of Appeal was of the view that an agreed damages clause which stipulates for a sum that is more than a genuine pre-estimate of loss is supra-compensatory and is therefore necessarily penal for purposes of the penalty rule.⁵⁴

The characterisation of a supra-compensatory clause as ‘penal’ highlights the normative divergence that now exists between England and Singapore. In Cavendish, the enforceability of an agreed damages clause is judged in relation to the performance interests in the contract (which may include compensatory interests); whereas in Denka Advantech, the enforceability of an agreed damages clause is assessed in relation to a party’s compensatory interests alone. The Court of Appeal was thus committed to the compensatory principles enunciated by Lord Dunedin in Dunlop and on that basis, was compelled to reject the Cavendish approach. They saw the Cavendish test as overstepping the boundaries of contractual remedies and secondary obligations, that went beyond compensating the innocent party.⁵⁵ The Court of Appeal therefore concluded that: ‘the “legitimate interest” (or commercial interest) of the plaintiff, whilst grounded in practical factual circumstances, has no role to play at the level of legal principle—except to the extent that the “legitimate interest” concerned is coterminous with that of compensation’.⁵⁶

In this regard, there is some merit to be had in preserving the certainty that Lord Dunedin’s tests are said to bring for commercial parties, but the overemphasis in Denka Advantech on the compensatory principles within the context of contractual remedies may be problematic in other respects. For instance, not all contractual remedies are payments of money designed to protect compensatory interests. The contractual remedies that a court may award upon breach of contract include specific or injunctive relief, which do not speak to the innocent party’s compensatory interests alone. Therefore, Denka Advantech may have overextended its position insofar as it attacks the ‘legitimate interest’ test as one that goes beyond the orthodoxy of contract law in situations where an agreed damages clause seeks to protect non-compensatory interests. The narrower conception of the penalty rule in Denka Advantech also offers a restricted view of the full scope of remedies that parties may contractually agree to for a breach of contract. It should be noted that agreed damages clauses are particularly relevant for commercial parties in situations where there is undoubtedly some loss suffered upon breach but there is an inherent difficulty in ascertaining or proving the actual loss upon breach—as was the situation in Dunlop.⁵⁷ In such situations, but for the contractually-agreed remedy, the likelihood of receiving only nominal damages upon breach creates a significant disincentive preventing parties from entering into the contract in the first place. It therefore seems counterintuitive to determine the enforceability of a party-assessed remedy based on the rigid rules applicable to a court-assessed remedy, especially when considering that commercial parties dealing at arm’s length are arguably in the best position to identify their potential interests and exposures in a given transaction.⁵⁸

Whilst the Court of Appeal was able to draw a consistent line of argument for its compensatory-centric approach to justify the penalty rule, it elides the so-called dichotomy between a genuine pre-estimate of loss and a clause held in terrorem as found in Lord Dunedin’s statement of the law. From the Court of Appeal’s characterisation of supra-compensatory clauses, it may be reasonably inferred that the Court of Appeal would consider that the ‘penal’ or ‘punitive’ quality of such clauses creates a deterrent against a party from breaching a contract. However, without the Court of Appeal offering further analysis on this juxtaposition of a genuine pre-estimate of loss and the in terrorem requirement under the traditional statement of the penalty rule, the decision in Denka Advantech is better seen as a defence of the genuine pre-estimate of loss tests in particular and not of Lord Dunedin’s statement of the law as a whole.

Further, it should be noted that the Court of Appeal in Denka Advantech also considered that the relevant elements discussed in Cavendish (such as the commercial justification for an agreed damages clause as well as the relative bargaining power between parties) and Lord Atkinson’s approach in Dunlop should be subsumed under the traditional rubric of assessing whether or not the agreed damages clause concerned is a genuine pre-estimate of the likely loss in general based on Lord Dunedin’s tests.⁵⁹ It is, however, unclear how the broader concepts identified in Cavendish would fit within Lord Dunedin’s four tests.

In the final analysis, although the position in both jurisdictions were once closely aligned, there is now a significant divergence between the position in English law as stated in Cavendish and the position in Singaporean law as stated in Denka Advantech. The chief reason for this divergence stems from the respective courts’ starting conception of the ‘penalty rule’ and the underlying norms which are said to define the ‘penal’ quality of an agreed damages clause. The resulting difference in England and Singapore is further emphasised by the Singaporean Court of Appeal’s view that it would have reached a different conclusion to the Supreme Court in the ParkingEye Appeal if it were to decide the matter based on Lord Dunedin’s Dunlop principles.⁶⁰

The Position in Malaysian Law

The law of contract in Malaysia was codified through statute, namely, the Malaysian Contracts Act 1950 (MCA). The law on agreed damages clauses in Malaysia is found in the discussion on s 75 of the MCA.

S 75 of the MCA reads:

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. (emphasis supplied)⁶¹

From the above, it may be appreciated that the elements underlining the application of s 75, MCA are as follows: (i) it is contingent upon a breach of contract (i.e. relates to secondary and not primary obligations); (ii) it applies either where there is a sum or other stipulation payable or performable upon breach of contract in favour of the innocent party; (iii) the sum or stipulation is enforceable in the absence of proof of actual damage or loss; and (iv) however, the sum or stipulation may not always be enforced in full and is subject to reduction commensurate with the level of ‘reasonable compensation’.

The history of the section begins in Maniam v State of Perak.⁶² In Maniam, the Malaysian courts began on the correct footing, acknowledging, as the Privy Council did in Bhai Panna Singh v Bhai Arjun Singh⁶³ that ‘[s 75 of the MCA] cuts through the most troublesome knot in the common law doctrine of damages.’⁶⁴ The comments made by the Privy Council in Bhai Panna Singh relate to s 74 of the Indian Contract Act, 1872 (ICA) which is ipsissima verba s 75 of the MCA.⁶⁵ Curiously, however, the court in Maniam, while finding that s 75 of the MCA was of no application, went on to opine that ‘in our law in every case if a sum is named in a contract as the amount to be paid in case of breach it is to be treated as a penalty.’⁶⁶ In doing so, the court seemingly resorted to the need to treat an agreed damages clause as a penalty to justify any intervention to grant relief amounting to ‘reasonable compensation’.

Nearly a decade later, the Malaysian appellate court in Wearne Brothers (M) Ltd v Jackson⁶⁷ alluded to the concept of a genuine pre-estimate of loss as justifying the full recovery of the sum stipulated in the contract to be payable on breach. Relying also on Bhai Panna Singh, the court held that ‘the effect of [s 75 of the MCA] is to disentitle the plaintiff to recover simpliciter the sum fixed in the contract whether as penalty or liquidated damages’⁶⁸ and that damages suffered must be proved ‘unless the sum named is a genuine pre-estimate.’⁶⁹ With respect to the judge in Wearne Brothers, the requirement that the plaintiff must ‘prove the damages’, appears to be in tension with the express proviso ‘whether or not actual damage or loss is proved to have been caused thereby’ in s 75 of the MCA, and is uncomfortably close to the resurrection of the penalty-liquidated damages divide which ‘ceased to be of great legal importance’.⁷⁰

When it came to deciding the case on the facts of the case in Wearne Brothers, however, the judge expressed the ratio of the case in terms which suggest that the court upheld the agreed damages clause on the basis that it was not ‘unreasonable’, noting that it appeared to represent a ‘genuine pre-estimate of damages for depreciation contemplated by the parties at the time when they entered into an agreement’ and ‘[does] not appear to be unreasonable, disproportionate to the nature and extent of depreciation.’⁷¹ Expressed in different terms, Wearne Brothers may be understood to stand for the proposition that where an agreed damages clause is shown to be a genuine pre-estimate of damages, that would be sufficient to establish that the award of the stipulated sum would be ‘reasonable compensation’ in the circumstances of the case.

The burden placed upon the plaintiff to ‘prove damages’ in order to obtain reasonable compensation, however, appeared to take a life of its own in the following decades. Chief of these was in the case of Selva Kumar a/l Murugiah v Thiagarajah a/l Retnasamy⁷² where the Malaysian Federal Court, which is the highest court of Malaysia, relying on Bhai Panna Singh,⁷³ and the Indian Supreme Court cases of Fateh Chand v Balkishen Das⁷⁴ and Maula Bux v Union of India,⁷⁵ extended and entrenched the position in law holding that proof or evidence of actual damage or loss is required in order to justify the award of such reasonable compensation.⁷⁶

A distinction was drawn in Selva Kumar between contracts where reasonable compensation would be difficult to assess on the one hand and contracts where reasonable compensation could be readily assessed in accordance with ‘settled rules’⁷⁷—such settled rules being a reference to the principles laid down in the case of Hadley v Baxendale⁷⁸ and which are as enumerated in s 74 of the MCA.⁷⁹Selva Kumar also restricted the applicability of the phrase ‘whether or not actual damage was proved to have been caused thereby’ to those cases where the court would find it difficult to assess actual damage or loss.⁸⁰ A plaintiff would have to prove actual damage or loss in the usual way in all other cases. A failure to adduce evidence of actual loss or damage would result in the award of nothing more than nominal damages, in spite of the statutory provision which indicated the contrary.⁸¹ This position was further entrenched by the Malaysian Federal Court in Johor Coastal Development Sdn Bhd v Constrajaya Sdn Bhd.⁸²

This requirement of proof of actual damage or loss before such a clause could be enforced, whether in full or in part, was seen to be difficult to reconcile with the express wording of s 75 of the MCA. In that regard, it is noteworthy that a number of first instance decisions doubted the correctness of the proposition on the need to prove ‘actual loss or damage’ arising out of Selva Kumar. Among these were the High Court cases of Lebbey Sdn Bhd v Tan Keng Hong⁸³ and Yap Yew Cheong v Dirga Niaga (Selangor) Sdn Bhd.⁸⁴ In Lebbey, the High Court disregarded the ratio in Selva Kumar viz. that there was an overall requirement for proof of actual loss or damage before a claim for compensation could be made, and that the requirement of proof of the same was dispensed with only in circumstances where the court would find it difficult to assess actual damage or loss. Instead, the High Court employed a literal interpretation to s 75 of the MCA, namely that:

…[where] the parties have agreed to liquidated damage[s] if one party breaches the [contract], whether or not actual damage or loss is proved to have been caused [t]hereby, the complaining party will be entitled to reasonable damages not exceeding the amount agreed to by the parties as liquidated damages.⁸⁵

Distinguishing Selva Kumar, the High Court in Lebbey interpreted the Selva Kumar decision as dealing with a liquidated damages clause which was ‘unreasonable’.⁸⁶

The literal interpretation of s 75 of the MCA was also applied in the case of Yap Yew Cheong.⁸⁷ There, the High Court observed that the purpose of such a stipulation is to ‘smoothen the evidential path of the injured party’ in the light of the exacting exercise for the injured party to prove his monetary damages against a contract-breaker incentivised to resist and challenge every iota of evidence advanced.⁸⁸ The High Court had also noted that the effect of the Selva Kumar decision is such that an injured party ‘will be deprived of benefitting under [a] liquidated damages clause, namely recovery of actual loss without proof’ and that in ‘construing an Act of Parliament, by reference to some authorities from other jurisdictions, there was a need to give effect to the will of Parliament no matter what the consequences would be.’⁸⁹

Also in issue is the continued reference to the measure of damages obtainable under Hadley v Baxendale principles as the basis for adjudging the reasonableness or otherwise of any compensation claimed pursuant to a stipulation within the contract. For present purposes it is observed that there is a dissonance between the approach under Hadley v Baxendale principles, as contained in s 74 of the MCA, where loss is to be assessed at the time of breach, and the usual operation of an agreed damages clause, the enforceability of which (and, the extent to which enforceable) ought to be ascertainable from the moment the contract containing such a clause is entered into.⁹⁰

In 2018, the Malaysian Federal Court sought to correct the course from the state of the law enshrined in Selva Kumar and Johor Coastal, in the case of Cubic Electronics Sdn Bhd v Mars Telecommunications Sdn Bhd.⁹¹ In essence, Cubic was critical of and significantly departed from the position in Selva Kumar and Johor Coastal and clarified that there was ‘no necessity for proof of actual loss or damage in every case where the innocent party seeks to enforce a damages clause.’⁹²

In addition, the crucial features of the decision in Cubic were: (i) the acceptance by the Federal Court that concepts such as that of ‘legitimate interest’ and ‘proportionality’ which featured in the Cavendish decision were relevant considerations in the determination of the measure of reasonable compensation for the purposes of s 75 of the MCA⁹³; (ii) that proportionality and legitimate interest be adjudged by a common sense approach, and that a comparison of the amount payable on breach with the loss that might be sustained by reason of the breach ought not to be significantly different⁹⁴; and (iii) that upon the innocent party’s proof of a breach of contract by the counterparty and that the agreed damages clause applied to such a breach, the burden of proving the unreasonableness of the stipulated sum would shift to the party in breach.⁹⁵ The Federal Court in Cubic also emphasised that these features, in particular the placement of the burden of proof on the party in breach was in line with the commercial or policy purpose of the agreed damages clause and the free consent of parties in entering a contract containing such a stipulation.⁹⁶

However, Cubic did not go so far as to rule that proof of actual loss was irrelevant to the determination of a s 75 claim. It also did not clearly demarcate between the analytical approach to be taken under a Hadley v Baxendale⁹⁷ assessment for loss or damage at the time of breach as opposed to the reasonableness of the compensation sought as adjudged at the time of entry into the contract (that is, to be consistent with the settled position at common law).

That said, even in recent times, when the Malaysian Federal Court in Tekun Nasional v Plenitude Drive (M) Sdn Bhd⁹⁸ was asked to deal with the pre-Cubic⁹⁹ position in Malaysian law, it had described it as ‘settled law that if a sum is (sic) named in a contract is exorbitant and unreasonable for it to be paid in the case of breach, it must be treated as a penalty and therefore void under s 75 [of the MCA].’¹⁰⁰ The Federal Court went on to hold that the method of calculation employed was an ‘inaccurate representation of the actual loss of profit’¹⁰¹ and ‘since [the innocent party] had failed to prove damages, [the Federal Court allowed] nominal damages’.¹⁰² Thus, the persistence of the problem of interpretation of s 75 of the MCA, both in relation to the classification of an agreed damages clause as a ‘penalty’ or otherwise and in the need to prove damages or actual loss, remained.

Some comments may be made in respect of the Malaysian legal position, viz. s 75 of the MCA. The first point is that while the abolition of the penalty-liquidated damages dichotomy has been repeatedly emphasised by the Malaysian courts, the consequence of finding that a clause is a penalty or not a genuine pre-estimate of loss, i.e. that the clause is unenforceable in toto, continues to be applied, as though the Malaysian position is similar to the position in English law. This is perhaps attributable in some part to the use of the terminology of ‘stipulation by way of penalty’ in s 75 of the MCA, the language of which is traceable to the 1899 amendments to the ICA.¹⁰³ Illustration (f) of s 75 of the MCA, in particular, significantly muddies the waters by stating: ‘A undertakes to repay B a loan of RM1,000 by five equal monthly instalments, with a stipulation that, in default of any instalment, the whole shall become due. This stipulation is not by way of penalty, and the contract may be enforced according to its terms.’¹⁰⁴

It is likely that the insertion of illustration (f) in such terms was, if anything, mere approval of the outcome, and arguably the ratio, in Wallingford v Mutual Society¹⁰⁵ and in Protector Endowment Loan & Annuity Co v Grice¹⁰⁶ both of which held that a clause in a contract which stipulated that the balance of a loan payable by way of instalments was payable upon default in the payment of a single instalment (viz. an acceleration clause). At the very least, these would have been within the contemplation of the drafters of the 1899 amendments to the ICA.¹⁰⁷ Instead, the reference to a ‘stipulation by way of penalty’ in illustration (f) is anomalous when compared with the entirety of the provision as it emphasises the need to determine whether a clause is a penalty or otherwise, and makes no reference to ‘reasonable compensation’ at the heart of the provision. As such, the expansion, or clarification, of the ambit of s 74 of the ICA involved the unintended transplantation of the need, found in English law, to immunise a provision from being a ‘penalty’ clause so as to justify its enforceability.

It would not have been necessary to frame the acceleration clause in illustration (f) as a ‘stipulation…not by way of a penalty’ in order to achieve the intended result, namely the ability to enforce payment of the full balance sum in favour of the plaintiff. This is so because in the vast majority of cases it would be unsurprising for any court to find that reasonable compensation for the plaintiff would, at the very minimum, be ‘the amount so named’ or the ‘penalty stipulated for’ where money or money’s worth were advanced by the plaintiff, the value of which was now sought to be recovered by the plaintiff, provided that the stipulated amount corresponds with the value of the initial loan or debt.¹⁰⁸

Alternatively, all that is achieved by the phraseology of ‘stipulation by way of penalty’ is to clarify that s 75 of the MCA only bites in the case of secondary, and not primary, obligations. This interpretation is justified on the basis that the phrase ‘stipulation by way of penalty’ is parallel to the phrase ‘amount to be paid in the case of such breach’, consonant with the legislative intention in seeking to extend the applicability of s 75 to cases not involving in solido sums only (Swaminathan 2018: 16–19), rather than the importation of the concept of enforceability of the provision for being penal in nature as understood under the English common law.

A second point to be noted is the court’s reliance upon the principles of determining ‘reasonable compensation’ with reference to the criteria in Hadley v Baxendale, contained in s 74, MCA. As noted above, Cubic has not necessarily resolved this outstanding issue by leaving proof of actual loss as an option, though no longer requiring it. By retaining, albeit in a residual fashion, the relevancy of proof of actual loss suffered by the innocent party on breach, a key object of such stipulations would fail to be achieved—namely the relative determinacy of the parties’ liabilities in the light of the clause containing the stipulation or stipulated sum and the truncation of the process of determining quantum envisaged by its inclusion and enforceability. Further, it is questionable whether a comparison between the value of the stipulation or the stipulated sum and the damages that would, in a counterfactual scenario where no clause containing the stipulation existed, be obtainable by way of s 74, MCA is appropriate.

It is suggested that unlike the position in Singapore as expressed in Denka Advantech¹⁰⁹ the wording of s 75, MCA does not require that the questions of principle are confined to that of compensation only, or in other words that the award of the sum by a court ought to be made on strictly compensatory principles only. While contrary to the decision in Selva Kumar,¹¹⁰ it is submitted that there is little in s 75 which mandates a strict application of the compensatory principle. The compensatory principle, applicable in s 74 of the MCA, is encapsulated not in the use of the word ‘compensation’ but in the remainder of s 74 which provides that it be ‘for any loss or damage cause to him thereby, which naturally arose in the usual course of things from the breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it’ and in the exclusion of ‘any remote and indirect loss or damage sustained by reason of the breach.’¹¹¹

Accordingly, when ‘compensation’ is referred to in s 75 of the MCA, it is not meant to be shorthand for s 74 of the same but refers instead to a broader term denoting the payment of a sum of money or, arguably, the performance of some other stipulation for money’s worth, flowing from the defaulting party to the innocent party as a legal consequence of the former’s breach of contract. Fidelity to the legislative intent, as understood by the express wording of the statute, would be best served by denying the contention that the analysis in s 75, and the ambit of its enforceability, must be bounded within the realm of the compensatory principle alone, without reference to other relevant legitimate interests (including the performance interest in the contract) that may have informed the parties’ decision to enter into a contract containing an agreed damages clause.¹¹²

Towards Convergence: the Way Forward?

It remains to be discussed what insights or observations may be drawn from the discussion of the jurisprudence in Malaysia, Singapore, and England above, and how this may be useful in charting the way forward, particularly in the context of Malaysian law.

The first observation is that the factors which are relevant to the ‘legitimate interests’ and proportionality tests for the enforceability of such a stipulation in England would be relevant to the assessment of whether the compensation sought pursuant to s 75 of the MCA and through the enforcement of an agreed damages clause is reasonable, or what the level of reasonable compensation should be. That there is ‘nothing objectionable in holding that the concepts of “legitimate interest” and “proportionality” are relevant’ to the assessment of reasonable compensation under s 75 of the MCA has been accepted in Cubic.¹¹³ Given that the broader meaning to the phrase “compensation” in s 75 of the MCA seemed to find favour with the Federal Court in Cubic,¹¹⁴ our view is that the principles underlying the broader legitimate interest test in Cavendish is a better fit for the Malaysian position on agreed damages clauses, rather than the compensatory-centric principles advanced in Denka Advantech.

In determining whether the stipulation or sum in an agreed damages clause represents reasonable compensation, or the level of reasonable compensation to be awarded by a court, it is also suggested that the factors to be taken into account in adjudging reasonableness ought to be confined to those facts that were known (or reasonably known) or knowable by the parties at the time of entering into the agreement. In this regard, insofar as the ParkingEye Appeal was concerned, the majority decision of the United Kingdom Supreme Court in Cavendish must be treated with some circumspection.

As mentioned earlier, in the ParkingEye Appeal heard in Cavendish, the Supreme Court found that there were two reasonable objectives to the scheme operated by ParkingEye, namely: (i) to manage the efficient use of parking space in the interests of the retail outlets, and of the users of those outlets who wish to find spaces in which to park their cars; and (ii) to provide an income stream to enable ParkingEye to meet the costs of operating the scheme and make a profit from its services.¹¹⁵ These objectives underpinned the legitimate interests that were later described by the Supreme Court.

In that regard, whilst it would be readily appreciable on the part of a motorist that the operation of a scheme which permitted two hours of parking without charge that there existed a legitimate interest in ensuring that the scarce resource of available parking spaces needed to be properly managed so as to ensure their availability from time to time for the patrons of the retail outlets which it serviced, it is unlikely that the same could be said for the finding of a legitimate interest in levying a charge for overstaying to enable the operator to obtain a profit which was founded upon the particular operation of the scheme that was in all likelihood neither known nor knowable to the motorist.¹¹⁶ It would be equally plausible for the motorist to assume that ParkingEye’s business model was one where the landowner paid a fee to ParkingEye for its operation of the carpark, where the fee was passed on to the tenants in some proportion. This would particularly be so where the parties to the contract are not two business entities who have come together to enter into an agreement, but instead where an agreement was entered into by the conduct of the consumer motorist. The possibility that different schemes might have been employed by ParkingEye would at the very least make it difficult for a consumer, who enters into the contract by conduct, to determine precisely which legitimate interests would or could be relied upon by ParkingEye.¹¹⁷

This is in contrast to the objectives and legitimate interests of the scheme in Dunlop which were known to, or at the very least readily knowable by, the party in breach of the agreement, being a reseller or distributor of Dunlop’s goods. After all, on the facts of Dunlop, the party in breach of the agreement was the one who had applied to Dunlop to supply Dunlop’s goods and could also have been taken to have had sufficient information to appreciate that the maintenance of a uniform price to the public, without which the distribution structure, of which the party in breach was a part, could not be sustained. This principle was stated in Cavendish albeit inappositely applied with respect to the latter of the ‘legitimate interests’ found by the Supreme Court therein.¹¹⁸

The question then turns to what considerations are relevant for the determination of ‘reasonable compensation’. As it stands, the statute provides little guidance on what constitutes ‘reasonable compensation’ and it is observed that the illustrations emphasise that a plaintiff is entitled to reasonable compensation but does not go on to illustrate how or at what point of time that reasonableness is to be determined.

It is envisaged that, in the light of the fact that the determination of the level of reasonable compensation may be a summary or truncated process,¹¹⁹ the assessment of reasonableness will tend towards a qualitative assessment of the propriety and justifiability of the assumptions underpinning any formula or derivation coupled with some evidence of the veracity of the baseline figures, rather than a quantitatively-driven assessment of what the reasonable quantum ought to be. Consideration of the legitimate interests (including performance interests, compensatory interests, and broader commercial justifications) of the innocent party, as known or reasonably knowable by the party in breach, would undergird any assessment of the suitability of the formula for deriving the appropriate level of reasonable compensation. If the stipulated sum is found to not be reasonable, then the court is legislatively empowered to make an adjustment to the unreasonable part(s) of the formula or derivation to arrive at an overall sum for reasonable compensation.

Further, while the wording of s 75 of the MCA does not necessarily preclude the assessment of reasonableness at the time of the breach of contract, it would be peculiar if it were treated otherwise in the light of the purpose of including such a stipulation since the parties ‘should be able to know with a reasonable degree of certainty the extent of their liability and the risks which they run as a result of entering into the contract’.¹²⁰ The approach taken by Wearne Brothers in focusing the analysis to the question of what was ‘contemplated by the parties at the time when they entered into [the] agreement’ and whether the sum fixed did not appear to be ‘unreasonable or disproportionate to the nature and extent’ of the interest in question (in Wearne Brothers, the depreciation of a vehicle), is preferable and aligned with the policy considerations underpinning such stipulations.

While Cubic substantially alleviated the difficulties inherent in Selva Kumar and Johor Coastal, the Malaysian Federal Court fell short in not eliminating the need for proof of actual loss or damage under s 75 of the MCA. Instead, noting that the cases of Selva Kumar and Johor Coastal had imposed a requirement for proof of actual loss or damage as a prerequisite for a claim for reasonable compensation under s 75, Cubic posited that:

‘there is no necessity for proof of actual loss or damage in every case where the innocent party seeks to enforce a damages clause. Selva Kumar and Johor Coastal should not be interpreted (as what the subsequent decisions since then have done) as imposing a legal straitjacket in which proof of actual loss is the sole conclusive determinant of reasonable compensation. Reasonable compensation is not confined to actual loss, although evidence of that may be a useful starting point.’¹²¹

However, it may be that leaving the door open for the evidence of actual loss or damage to be adduced might undermine the purpose of including such an agreed damages clause in the first place, at least practically if also not in principle. If it remains a relevant consideration for the purposes of determining reasonableness, the tendency of a party to litigation, or their legal counsel, would be to put ever increasing amounts of material for the court that would be ‘relevant’ to the question of reasonableness. It also sits uneasily with the principle inherent in the utility of the determinacy of liability prior to any dispute occurring to base the assessment on matters that could only be conceived of post-breach, inviting an unhelpful degree of ex post facto rationalisation.

S 75 of the MCA, unlike the binary, all-or-nothing approach to penalty clauses and liquidated damages in England and Singapore, allows for an adjustment of the level of compensation to be awarded by the court. In that regard, it is submitted that what is envisaged is a relatively simple and truncated process, by reference to the dispensation with the need to prove actual loss or damage. Leaving proof of actual loss as a relevant option disincentivises the use of a summary process for determining the award of reasonable compensation and would, in effect, add a further layer of issues to be determined.

It has been extra-judicially observed that, following Cubic, there is still ‘uncertainty on the resultant consequences if the court finds the stipulated provision unreasonable’, and the question arises whether proof of actual loss is then required in those circumstances, or whether the court may determine ‘reasonable compensation by adjustment of the stipulated provision’ (Lim 2019: [44]). It is observed here that unlike in England and Singapore, where the invocation of the penalty rule is a basis of the court’s jurisdiction to intervene in the otherwise commercial affairs of parties in order to grant relief by refusing to enforce the penalty clause, the juridical basis for intervention in the MCA arguably arises from the power granted to the court to make an adjustment, and that any adjustment is at least prima facie justified provided that it falls within the scope of reasonableness legislated within s 75.

Further, the dispensation of the need to invoke the penalty rule to make an adjustment, by way of a relatively truncated process, is justifiable as a matter of principle. It must be borne in mind that unlike the position in Singapore and England, the naming of a sum or a stipulation in a contract governed by s 75 of the MCA sets a strict cap on the amount of compensation obtainable by a plaintiff. There is no fallback scenario where the clause is found to be invalid or unenforceable in toto and the usual measure of actual loss or damage under Hadley v Baxendale principles is then assessed¹²² since in every case of an agreed damages clause in Malaysia the clause will be enforceable albeit only up to a certain point (i.e. up to the point of ‘reasonable compensation’).

In the light of that, where A and B enter into a contract where the stipulation upon breach favours A; (i) A and B must be deemed to have contracted on the basis of the underlying statutory rule which consists in s 75 of the MCA. That would be the law’s understanding of the parties’ intentions in the light of s 75, MCA¹²³; (ii) in this bargain, A obtains the opportunity to have a valid and enforceable stipulation (up to a point of reasonable compensation) on a summary basis, but A irrevocably gives up any claim above that amount; and (iii) B, on the other hand, accedes to the validity and enforceability of the stipulation (up to the point of reasonable compensation) and an assessment on a summary or truncated basis of determining reasonable compensation but obtains a fixed cap on the maximum liability that it may incur.

In this conception of the operation of s 75 in respect of the parties’ objective intentions in the light of the default statutory rule, the determination of the level of reasonable compensation by the court through a summary process would cohere with apparent Parliamentary intention as well as the widely-held purpose of the adoption of such stipulations in the first place. The ability for the court to determine reasonableness and make any adjustment that is necessary would have been part of the design of the statutory scheme under s 75 which is, in effect, opted into when the parties to a contract name a sum or other stipulation to be the consequence of a breach of contract. The fact that compensatory interests are not the chief end of s 75, but an award (or an adjustment of the award) to align with notions of reasonableness, would be consistent with the conception of the approach above.

Conclusion

The ripples that began with Cavendish have landed up on South-East Asian shores, albeit with differing effects. Leaving that aside, it cannot be denied that the ensuing debate has brought to the fore the differences in the policies and norms that underpin the treatment of agreed damages clauses. In that regard, Lord Neuberger’s exhortation that the common law jurisdictions ‘learn from each other’¹²⁴ remains a timely one. Whether Cavendish and Cubic will ultimately prove (practically and doctrinally) sustainable across a wider range of cases, or whether the relative certainty of Dunlop and Denka Advantech will prove commercially preferable in the long run, remains to be seen. The success or otherwise of either position will depend for the most part on what refinements to those legitimate interests (including performance interests) which can be taken into account in determining whether a clause is penal or whether the stipulated sum is reasonable, respectively, are made in the near future, in the knowledge that any maladjustment in respect of the former may serve to buttress the orthodoxy espoused in Denka Advantech.