Dichotomy of Contracts Reinforced

A case commentary on Johor Coastal Development Sdn Bhd v. Constrajaya Sdn Bhd by Claudia Cheah

 

 

In the recent case of Johor Coastal Development Sdn Bhd v. Constrajaya Sdn Bhd [2009] 4 CLJ 569, the Federal Court was asked to review its earlier decision in the case of Selva Kumar a/l Murugiah v. Thiagarajah a/l Retnasamy [1995] 2 CLJ 374 which held that a party must still prove its losses even though there is an agreed liquidated damages clause and notwithstanding the words in section 75 of the Contracts Act, 1950 (‘Act”) ‘whether or not actual damage or loss is prove to have been caused thereby’.

 

 

Section 75 of the Act 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, 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 added)

 

 

Brief Facts

The parties entered into two sale and purchase agreements, containing identical terms, wherein the Respondent purchased land from the Appellant with an obligation to construct and complete a mixed development project thereon within three years from the date of the agreements (‘Project’).

 

The purchase price for the land was to be paid by way of instalments. The Respondent paid an initial payment of 12% and subsequent payments amounting to about 50% of the purchase price. The Respondent failed to pay the balance of the purchase price and further abandoned the Project three years after the date of the agreements. Thus, the Appellant terminated the agreements and forfeited all monies paid by the Respondent.

 

The Respondent commenced an action at the High Court to recover the amount forfeited by the Appellant on the ground that the same was a penalty and unenforceable by virtue of section 75 of the Act. The Appellant maintained that the forfeiture was in line with specific terms of the agreements, where the parties specified the sums payable by the defaulting party as fair and reasonable compensation in the event of termination and expressly waived their rights to challenge those sums as otherwise than fair and reasonable compensation. The Appellant also argued that the parties had by their mutual agreement contracted out of section 75 of the Act.

 

The relevant provisions in the agreements read as follows:

 

8.2 Consequences of termination of Agreement


Upon the termination of this Agreement … :-

(b) All instalments previously paid by the Purchaser to the Vendor …. shall be forfeited to the Vendor absolutely, except where the termination occurs within four (4) months from the date of this Agreement, in which event an amount equal to ten per centum (10%) of the Purchase Price shall be forfeited to the Vendor absolutely, and all instalments previously paid by the Purchaser to the Vendor …shall be returned to the Purchaser, without interest;.

 


16.2 Reasonable Compensation

Both parties hereby unconditionally and irrevocably acknowledge that the sums stipulated in this Agreement to be payable by the defaulting party would constitute reasonable compensation to the non-defaulting party and each party hereto hereby waives any objection it may now or hereafter have that those sums would be otherwise than fair and reasonable compensation.

 


Decision of the High Court

The High Court held that the forfeiture was unlawful and ordered a full refund of the monies paid by the Respondent. The High Court found that the sums forfeited were part payments of the purchase price and thus could not be forfeited unless the Court was satisfied that it was a reasonable sum under section 75 of the Act, upon proof of actual loss by the Appellant. As the Appellant failed to furnish such proof, the court could not determine the reasonable compensation envisaged by section 75 of the Act.

The Appellant appealed to the Court of Appeal.

 

 

Decision of the Court of Appeal

The Court of Appeal allowed the Appellant’s appeal in part. It held that the Appellant was entitled to forfeit the initial payment of 12% of the purchase price as a “true deposit” paid under the agreements. However, the balance monies must be refunded to the Respondent as the Appellant failed to strictly prove damage under section 75 of the Act.

 


Leave to Appeal To The Federal Court

The Appellant obtained leave to appeal to the Federal Court on the following two questions :-

 

(1) Whether that part of the decision in Selva Kumar a/l Murugiah v. Thiagarajah a/l Retnasamy [1995] 1 MLJ 817 which obliges a party having the benefit of a liquidated damages clause to prove its losses, notwithstanding the words in Section 75 of the Contracts Act 1950 ‘whether or not actual damage or loss is proved to have been caused thereby’, is correct?

(2) Whether or not parties entering into a contract are entitled to contract out of the provisions of Section 75 of the Contracts Act 1950?

 

The Appellant relied heavily on an Indian Supreme Court case of Oil & Natural Gas Corp Ltd v Saw Piples Ltd AIR [2003] SC 2629 where the compensation named in the contract was awarded to the innocent party as genuine pre-estimate of the loss suffered without any proof of actual loss.

 

 

Decision of the Federal Court

The Federal Court dismissed the appeal by a majority of 2-1.

 

Decision of the Majority

 

The majority reaffirmed the principles set out by the Federal Court in Selva Kumar (supra), namely :-

 

1. The words in section 75 of the Act 'whether or not actual damage or loss is proved to have been caused thereby’ must be given a restricted construction. Thus, a party who is claiming for damages in an action for breach of contract must still produce evidence to prove the actual loss or the reasonable compensation. Any failure to prove such loss will result in the refusal of the court to award such damages.

 

2. However, for cases where the court finds it difficult to assess damages for the actual damage as there is no known measure of damages employable, and yet the evidence clearly shows some real loss inherently which is not too remote, the stipulated sum may be recoverable. The court ought to award substantial damages as opposed to nominal damages which are reasonable and fair according to the court's good sense and fair play. In any event, the damages awarded must not exceed the sum so named in the contractual provision.

 

3. The Indian Supreme Court case of Oil & Natural Gas (supra) involved a long term supply contract and not a sale of property for a fixed sum. Thus, it belonged to a line of cases where the loss suffered is incapable of assessment and the amount stipulated is recoverable as genuine pre-estimate of damages.

 

Based on the foregoing, the majority answered the first question in the affirmative. The majority did not answer the second question as they opined that there was no clear provision in the agreements which excluded the application of section 75 of the Act.

 

 

Dissenting Decision of the Minority

The minority held as follows :-

 

1)  The monies were rightly forfeited by the Appellant, being an amount that was reasonable in view of the nature of the project and its abandonment by the Respondent three years after the agreements were signed.  Although proof of loss and damages could be given, it would be a very lengthy process. It was to avoid this lengthy process that the parties agreed on a stipulated sum in the event of a breach. It could not be the case that the innocent party would be the one to have to prove the loss.

 

2)  The parties had expressly agreed and named the sums payable in case of breach as reasonable compensation to the non-defaulting party. The parties further waived any objection thereafter that those sums would be otherwise than fair or reasonable compensation. Such stipulation was not contrary to section 75 of the Act.

 

As such, the Appellant was entitled to receive from the Respondent reasonable compensation not exceeding the sum so named in the agreements, whether or not actual damage or loss is proved to have been caused thereby. Thus, the minority answered the first question in the negative and the second question, positive.

 

 

Observations

 

1. The Federal Court in Johor Coastal has reinforced the dichotomy of contract view expounded in the Selva Kumar case. For contracts where the loss is “difficult to assess” as there is “no known measure of damages employable” (‘1st category’), the innocent party may recover the sum stated in the liquidated damages clause or reasonable compensation which does not exceed the sum so named without proof of actual loss. For all other contracts (‘2nd category’), the liquidated damages clause is redundant and the innocent party must strictly prove the actual loss suffered.

 

2. The dichotomy of contract view creates difficulties especially for construction contracts where proof of loss is inevitably difficult, costly and time-consuming. In fact, subsequent to the Selva Kumar case, the construction industry has included in the PAM 2004 Standard Form of Building Contract, a specific clause to contract out of the need to prove actual loss and exclude the intervention of court in determining a reasonable compensation under section 75 of the Act.

 

3. In view of the Johor Coastal decision, any provision to circumvent the need to prove actual loss will be redundant. The court will apply the dichotomy of contract test to determine whether or not proof of actual loss is required.

 

4. It remains to be seen what type of contract would qualify under the 1st category. However, it is clear that contracts involving sale of property for a fixed sum is not under the 1st category.

 

5. Lastly, it must be emphasized that the innocent party still has the right to retain the deposit. In both Selva Kumar and Johor Coastal, the innocent party was allowed to forfeit 10% and 12% of the purchase price respectively. The issue of proof of actual loss only comes into play if there is a claim for additional compensation.

 

 

CLAUDIA CHEAH ( This e-mail address is being protected from spambots. You need JavaScript enabled to view it )

 
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