3 April. 2019
In this article, David Cheong Zhao Yee discusses the federal court’s interpretation of section 75 of the contracts act 1950.
Introduction
The Federal Court’s recent decision in Cubic Electronics Sdn Bhd v Mars Telecommunications Sdn Bhd[1] pertaining to the interpretation of section 75 of the Contracts Act 1950 (“Section 75”) appears to have effectively changed the law on the recoverability of liquidated and ascertained damages (“LAD”) which is a subject matter of critical importance and of much dispute in the construction industry.
Definition and nature of LAD
In the construction setting, LAD is a sum of money pre-determined and agreed between an employer and a contractor in a construction contract, usually calculated by way of a stipulated sum per day of the contractor’s delay from the completion date specified in the contract until the works are completed.
This sum is a genuine pre-estimate of loss which the employer is likely to incur due to the contractor’s breach of his obligation to complete the works under the contract. It is stipulated in the contract and its recovery is triggered by the crystallisation of the contractor’s breach which is his failure to complete the works within the completion date specified in the contract[2].
The nature of an LAD clause is such that, after the crystallisation of the contractor’s breach, there is no requirement for the employer to prove his actual loss and he can recover the stipulated LAD sum “simpliciter” from the contractor[3].
Previous law on the recoverability of LAD
The employer’s entitlement to LAD is encapsulated in the wording of Section 75 which reads as follows:
“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 … 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 … ”
Pre-Cubic Electronics, the Federal Court’s interpretation of Section 75 in Selva Kumar Murugiah v Thiagarajah Retnasamy[4] was that where a contract has been breached, the innocent party cannot recover “simpliciter” the sum fixed in a damages clause and he must prove the actual damage suffered.
The wording of Section 75 will only apply if his case falls within limited situations where it is difficult to assess damages as there is no known measure of damages. The actual damage or reasonable compensation must also be proved in accordance with the principles in Hadley v Baxendale[5],[6]. This approach has been followed and applied by the courts.
Recoverability of LAD in Malaysia post-Cubic Electronics
In a departure from Selva Kumar, the Federal Court in Cubic Electronicsheld, amongst others, that:
- Section 75 allows reasonable compensation to be awarded by the court regardless of whether actual loss or damage is proven. Reasonable compensation is not confined to actual loss, although evidence of that may be a useful starting point.
- The initial burden lies on the party seeking to enforce a damages clause under Section 75 to show that there was a breach of contract and that the contract contains a clause stipulating a sum to be compensated upon breach. Once these two elements are established, the innocent party is entitled to receive a sum capped to the amount specified in the contract regardless of whether actual damage or loss is proven.
- The defaulting party, of course, is entitled to dispute the reasonable compensation by discharging the burden of proving the unreasonableness of the damages clause including the sum stipulated therein.
In essence, the courts should be slow to refuse to give effect to a damages clause for contracts negotiated at arm’s length between parties who have been properly advised. To require that the innocent party proves that a damages clause is not excessive would undermine the damages clause in a contract, which is intended to promote business efficacy and reduce litigation between the parties.
Conclusion
The crux of the decision in Cubic Electronics is the shift of the burden of proof pertaining to a damages clause from the innocent party to the defaulting party.
In the construction context, this means the contractor, and not the employer, will have to prove that the LAD clause and the sums stated therein are unreasonable.
That said, the employer continues to bear the burden of proving the contractor’s breach of his completion obligations and the applicability of the LAD clause.
For further information, please contact:
David Cheong Zhao Yee, Shearn Delamore & Co
davidcheong@shearndelamore.com
[1] [2018] MLJU 1935
[2] Datuk Sundra Rajoo & Ir Harbans Singh KS, Construction Law in Malaysia, (2012), Sweet & Maxwell Asia, p 384.
[3] Ibid, p 385
[4] [1995] 1 MLJ 817
[5] (1854) 9 Exch 341
[6] Johor Coastal Development Sdn Bhd v Constrajaya Sdn Bhd [2009] 4 MLJ 445.
