The case of Cubic Electronics: Do actual losses need to be proven for compensation?

In the recent Federal Court case of Cubic Electronics Sdn Bhd (in liquidation) v Mars Telecommunications Sdn Bhd [Appeal No. 02(f)-64-09/2019(W)], the Malaysian apex court had the opportunity to re-evaluate the position of law with regard to Section 75 of the Contracts Act 1950 (the “CA 1950”) which provides as follows:

“When a contract has been broken, if a sum is named in the contract as the amount to be paid in each case of such breach, of 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.”

Prior to this landmark decision, the appellate courts had – such as that in the seminal cases of Selva Kumar Murugiah v Thiagarajah Retnasamy [1995] 1 MLJ 817 and Johor Coastal Development Sdn Bhd v Constrajaya Sdn Bhd [2009] 4 MLJ 445 – consistently held that a Section 75 of the CA 1950 imposes an obligation on the innocent party to prove the actual damage suffered in order to recover damages notwithstanding the provision of a damages clause contained in the contract.

However, the principle of law as stated above must now be treated with caution in view of the judgment delivered by His Lordship Richard Malanjum.

BRIEF FACTS

The Defendant was the owner of a piece of land (the “Land”) together with the plant and machinery (the “Machineries”) located on the said land (hereinafter referred to collectively as the “Properties”). Following the winding up of the Defendant, the Properties were put up for sale by way of an open tender exercise.

Before the tender could be carried out, the Plaintiff made an offer to purchase the Properties for the sum of RM90 million (RM 80 million for the land and RM 10 million for the machineries) in accordance with a Memorandum issued by the Defendant.

It is a term of the Memorandum that all offers for the Land must be accompanied by a sum equivalent to 2% of the Offer Price whereas all offers for the Machineries must be accompanied by a sum equivalent to 10% of the Offer Price. However, the Plaintiff offered an earnest deposit of RM 1 million instead of 2% of the Offer Price for the Land and 10% of the Offer Price for the Machineries.

The Plaintiff paid the sum of RM 1 million, following which the liquidators of the Defendant accepted the Plaintiff’s offer and did not proceed with the tender exercise. The acceptance of the Plaintiff’s offer was, however, subject to the execution of a Sale and Purchase Agreement (the “SPA”) which must be executed within 30 days, failing which the earnest deposit of RM 1 million would be forfeited as agreed liquidated damages and not by way of penalty.

The Plaintiff did not execute the SPA and had, on three occasions, requested for an extension of time to do the same. In return, the Plaintiff paid additional sums towards the earnest deposit amounting to RM2 million plus interest of RM40,000.00 for the balance deposit payable. At the material time, the Defendant informed the Plaintiff that failure to comply with the deadline for executing the SPA would result in the forfeiture of the sums paid by the Plaintiff as agreed liquidated damages and not by way of a penalty.

The Plaintiff sought for a fourth extension and sent a cheque worth RM6 million which was stated to be payable towards the balance deposit. The Plaintiff’s request was refused. The Defendant thereupon terminated the sale without executing the SPA and returned the Plaintiff’s said cheque. The Defendant also wrote to inform the Plaintiff that the sums paid thus far, namely RM3.04 million were forfeited.

The Properties were subsequently sold to a third party. The Plaintiff thereupon filed an action seeking for, amongst others, a declaration that the termination of the sale was wrongful and invalid and further sought the return of the sums paid to the Defendant. The Defendant counterclaimed for rentals and utility charges based on the tenancy of the Properties by the Plaintiff.

PROCEEDINGS IN THE COURT BELOW

The High Court dismissed the Plaintiff’s claim and allowed the Defendant’s counterclaim. On appeal, the Court of Appeal ruled that the forfeiture of the RM3.04 was not permissible but allowed the Defendant to forfeit RM 1 million of the earnest deposit.

THE APPEAL TO THE FEDERAL COURT

The Defendant was granted leave to appeal to the Federal Court on the following questions of law:

1. Where, in a sale and purchase of property, where terms and conditions of the SPA have been agreed and a date is fixed for the execution of the SPA, whether any additional deposit paid for the extension of time for completion is equally subject to forfeiture; and
2. Whether a purchaser who has agreed and willingly paid an interest in consideration of an extension of time be entitled to claim a refund of the same in the event he defaults in executing the SPA and paying the balance deposit on the due date.

THE FEDERAL COURT DECISION

At the outset, the Federal Court, with reference to the English cases of Dies v British and International Mining and Finance Co [1939] 1 KB 715 and Howe v Smith (1884) 27 Ch D 89, held that any sums paid in advance of performance and as part-payment of the contract price is generally recoverable by the purchaser whereas a deposit paid which was not merely part payment but which also serves as a guarantee of performance is generally not recoverable.

The Federal Court also held that it is a question of interpretation on the facts of each individual case as to whether a payment is part-payment of the price or a deposit. Accordingly, a payment is held to be a deposit – which said deposit is nevertheless subject to Section 75 of the CA 1950 – once it has been determined that the said payment possesses the dual characteristics of an earnest money and part-payment.

Upon analysing the applicable cases pertaining to Section 75 CA 1950, the Federal Court acknowledged that previous authorities on this issue, including the cases of Selva Kumar (supra) and Johor Coastal (supra), held that an innocent party to a contract must prove its actual loss and damage in order to enforce a clause governing the consequences of a breach thereof, except in cases where it is difficult to assess actual damage or loss.

Notwithstanding the same, the Federal Court departed from the abovementioned principle of law wherein it was held that it is not in every case that an innocent party is required to prove its actual loss and damage in order to enforce a damages clause. Pertinently, the Federal Court held that the cases of Selva Kumar (supra) and Johor Coastal (supra) should not be interpreted as “imposing a legal straightjacket 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”.

In so deciding, the Federal Court was guided by the English Supreme Court case of Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67 with regard to the concepts of “legitimate interest” and “proportionality” which was held to be relevant in deciding what amounts to a reasonable compensation in accordance with Section 75 of the CA 1950. It was further held that the fundamental feature of Section 75 of the CA 1950 is the notion of reasonableness.

Accordingly, the Federal Court held that a sum which shall be payable in the event of breach shall amount to an unreasonable compensation if it is “extravagant and unconscionable in amount in comparison with the highest conceivable loss which could possibly flow from the breach”. As such, there should not, in the absence of proper justification, be a “significant difference” between the amount of damages stipulated in the contract and the amount of loss and damage which is likely to be suffered by the innocent party.

As a restatement of law and in departing from previous authorities, His Lordship Richard Malanjum conclusively held that Section 75 of the CA 1950 permits reasonable compensation regardless of whether actual loss or damage is proven by the innocent party. Notwithstanding the above, His Lordship concluded that proof of actual loss is not determinative as to what amounts to a reasonable compensation although evidence of such losses and damage may be a useful starting point.

Proof of actual loss is not determinative as to what amounts to a reasonable compensation

In view thereof, it was held that the party seeking to enforce the damages clause pursuant to Section 75 of the CA 1950 bears the onus of adducing evidence that there was a breach of contract and that the contract contains a clause stipulating the sums to be paid in the event of breach.

The Federal Court further held that an innocent party, upon having established such matters, shall be entitled to receive a sum which does not exceed the contract stipulated sum regardless of whether actual loss of damage is proven. This is, however, nevertheless subject to proof by the defaulting party that the damages clause as well as the sum stipulated therein is unreasonable.

Significantly, His Lordship Richard Malanjum held that in the event that there exists a dispute as to what amounts to a reasonable compensation, the burden lies on the defaulting party to demonstrate that the damages clause, including the sum stated therein, is unreasonable.

In accordance with the principles of law stated above, the Federal Court answered the first leave question in the affirmative and the second leave question in the negative. Consequently, the appeal was allowed with the order of the High Court reinstated, albeit on different grounds.