Member Article

The Federal Court in Johor Coastal Development Sdn Bhd v Constrajaya Sdn Bhd[1] (“Johor Coastal”) was invited to consider if the legal principles enunciated and the application of section 75 of the Contracts Act 1950 (“CA”) in Selva Kumar a/l Murugiah v Thiagarajah a/l Retnasamy[2] (“Selva Kumar”) remains good law.

Section 75 of CA reads:

“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,orif the contract contains any otherstipulation by way of penalty, the party complaining of the breach is entitled,whether or not actual damage or loss is provedto have been caused thereby, to receive from the party who has broken the contractreasonable compensation not exceeding the amount so namedor, as the case may be, the penalty stipulated for.” [Emphasis added] 

Brief Facts

Johor Coastal concerned two sale and purchase agreements of two lots of land for payment consideration of RM4,590,000 and RM10,830,000 respectively, to be paid in six instalments (“the Agreements”). The respondent/purchaser (“Johor Coastal Development”) made an initial payment of 12% and three instalments were subsequently made to the appellant/vendor (“Constrajaya”). Johor Coastal Development failed to pay the balance purchase price.

Constrajaya terminated the Agreements and forfeited all monies paid by Johor Coastal Development. Johor Coastal Development then instituted an action against Constrajaya seeking recovery of payments made. Constrajaya contended that it was entitled to retain the whole of the forfeited sum without proof of damage based on a plain reading of Clauses 8.2 and 16.2 of the Agreements.

Clause 8.2 reads:

“8.2 Consequences of termination of Agreement : Upon the termination of this Agreement… (b) All instalments previously paid by the Purchaser to the Vendor including the First Payment and any interest thereon paid as at the date of termination shall be forfeited to the Vendor absolutely…”

Clause 16.2 further provides:

“16.2 Reasonable Compensation : Both parties hereby unconditionally and irrevocably acknowledge thatthe sums stipulatedin this Agreement to be payable by the defaulting partywould constitute reasonable compensationto the non-defaulting partyand each party hereto hereby waives any objectionit may now or hereafter have that those sums would be otherwise thanfair and reasonable compensation.” [Emphasis added] 

Federal Court decision

Johor Coastal was deliberated right up to the Federal Court. The Federal Court by a majority of two to one upheld the Court of Appeal decision; the Court of Appeal held that, save for the initial payment of 12%, Constrajaya was not entitled to forfeit the remaining sums. The initial payment of 12% was considered a “true deposit” with the purpose to secure future performance of the contract.

The 12% was also considered not to be extortionate or unusual in light of the nature of the contract and the development project envisaged by the parties. The remaining sums were ordered to be refunded on the basis that sums sought to be recovered as as loss or damage required proof of actual loss.

Law

The Federal Court, having regard to the Indian cases and Selva Kumar, pronounced that the principles and application of section 75 in Selva Kumar remain good law and affirmed that:

1. Non-defaulting parties may forfeit earnest deposits stipulated in the contract. Section 75 of the CA has no application to earnest deposits.
2. Section 75 of the CA has done away with the distinction between liquidated damages and penalties. Where additional compensation is claimed, irrespective of the existence of a liquidated and ascertained damages (“LAD”) clause in the contract, proof of loss is required.
3. Section 75 of the CA confers the requisite jurisdiction on the Court to determine the quantum of reasonable compensation “whether or not actual damage or loss is proved to have been caused thereby” (“the Phrase”).
4. For contracts where reasonable compensation is not assessable or difficult to assess by reason of there being no employable measure/method to assess actual damage or loss, the need to prove actual damages will be dispensed with. Where reasonable compensation is assessable with settled rules, such compensation must be proved.

A recent attempt to revisit this principle of awarding damages was seen in the cases of MARS Telecommunications Sdn Bhd v Cubic Electroncis Sdn Bhd (In Liquidation)[3]and Malayan Cement Industries Sdn Bhd v Golden Island Shipping (L) Bhd[4]. Attempts to distinguish Johor Coastal failed and the principles relating to the need to prove actual loss were reaffirmed by the Court of Appeal.

Option to contracting out of section 75 In the above referenced cases, the question was raised as to whether parties are permitted tocontract out of the application of section 75 by an express stipulation in their contract. There was no conclusive answer to this question and this remained untested until the recent High Court case ofKejuruteraan Bintai Kindenko Sdn Bhd v Serdang Baru Properties Sdn Bhd[5]which considered this issue.

Facts

The plaintiff (“Bintai Kindenko”) was appointed as a turnkey contractor by the defendant(“Serdang Baru Properties”) pursuant to a Letter of Acceptance. A formal contract based on the JKR Conditions of Contract for Design and Build and Turnkey Projects 1999 edition subject to certain modifications was executed between the parties.

Serdang Baru Properties terminated the employment of Bintai Kindenko for breach of contract, that is,failure to carry out works regularly and diligently in accordance with the contract and claimed for a sum of RM33,555,000.00 as the total amount of LAD computed based on Clauses 5.8 and 5.10.

The Arbitrator allowed Serdang Baru Properties’s claim and decided that there was no need to prove loss. However, the LAD was reduced to RM32,235,000.00 taking into account Bintai Kindenko’s entitlement to some extension of time. Subsequently, Bintai Kindenko applied to the High Court to vary the Arbitration Award pursuant to section 42 of The Arbitration Act 2005.

Questions of Law

Essentially, Bintai Kindenko referred the following questions of law in respect of section 75 to the Court:

1. Whether there must be an express provision to state that parties are contracting out of section 75 of CA;
2. Whether as a matter of law, parties can agree to contract out of the CA;
3. Whether upon reading the LAD clause, parties had in fact contracted out section 75 of CA.

High Court Decision

Clause 5.8 provides:

“The liquidated and ascertained damages (LAD) shall be at the rate of RM40,000.00 per day. TheLAD is deemed to be as actual loss which the Employer will suffer and the contractor shall be liable to pay the samewithout the need for the Employer to prove the actual damages or loss.”[Emphasis added]

Despite the clear statement in Clause 5.8 of the Letter of Acceptance that actual damages are acknowledged to have been suffered, the High Court required proof of loss and held that the Arbitrator should read Clause 5.8 in the same way as Clause 16.2 in Selva Kumar.

Clause 5.8 does not exclude the application of section 75. The High Court took the view that the Arbitrator ought to have applied the principles in Selva Kumar when assessing damages. The High Court held it is settled law that, even though parties are entitled to contract out of the CA, parties cannot do so if it is inconsistent with the CA[6].

The case of Ooi Boon Leong v Citibank NA[7]where parties sough to contract out of sections 86, 92 and 94 of CA was distinguished on the basis that the provisionssought to be excludeddid not deal with general principles of law. Instead they dealt with the contractual relationship between the parties. Section 75 deals with the general principles of contract. Contracting out of section 75 is not permissible as it willfall foul of the CA and common law principles.

The High Court held in favour of the Bintai Kindenko and varied the Arbitration Award accordingly.

Conclusion

It appears that contracting parties have to be prepared to prove their losses and cannot seek to circumvent the need to prove actual losses/reasonable compensation by an insertion of a clause seeking to contract out of section 75 or to deem the damages as having been incurred.