The panel, comprised of Koh Swee Yen, SC (Partner, WongPartnership LLP), Matt Gearing, QC (Leading Counsel and Arbitrator, Fountain Court Chambers), Andrew Pullen (Barrister, Fountain Court Chambers), and Lok Vi Ming, SC (Managing Director, LVM Chambers) and moderated by Kent Phillips (Partner, Hogan Lovells), discussed the divergence of approaches in relation to liquidated damages across the leading common law jurisdictions, as well as the pitfalls for parties contracting for or seeking to enforce liquidated damages clauses.
This article summarizes the lively and thought-provoking panel discussion as well as the key takeaways.
As a general principle, a contractual clause that is designed to deter a breach rather than provide genuine compensation will be considered a penalty. The consequence of a clause being categorized as a penalty is that it will be deemed unenforceable.
Position under English law
The traditional test in Dunlop Pneumatic Tyre Co Ltd v. New Garage & Motor Co provided that the test as to whether a contractual clause is a penalty is whether the clause is a genuine pre-estimate of loss.
In 2015, the issue of penalty clauses was brought before the UK Supreme Court in Cavendish Square Holding BV v. Talal El Makdessi and ParkingEye Ltd v. Beavis. While the UK Supreme Court considered that the penalty rule was an “ancient, haphazardly constructed edifice which has not weathered well,” it rejected calls to abolish or substantially extend the rule against penalty clauses. Instead, the rule was reformulated – the requirement that the clause has to be a genuine pre-estimate of loss was abandoned – instead, the UK Supreme Court held that the true test is whether the clause is a “secondary obligation that 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.”
Position under Australian law
The penalty rule was considered in Australia in Andrews v. Australia & New Zealand Banking Group Ltd a few years prior to the UK Supreme Court Cavendish decision. Andrews arose out of representative proceedings commenced by Mr. Andrews on behalf of approximately 38,000 group members against ANZ in relation to certain fees charged by ANZ on its customers. The High Court of Australia made it clear that the penalty rule is not restricted to secondary obligations and could apply even in situations where there is no contractual breach. While there was no single test laid down, the High Court of Australia appeared to take into account a broad assessment of commercial interests and how one might protect them, recognizing that there is very good reason to leave judgment of protection of commercial interests to the contracting parties themselves.
It should be noted that the UK Supreme Court in Cavendish considered the Andrews decision but declined to follow the position in Australia, taking the view that it would “represent the expansion of the courts’ supervisory jurisdiction into a new territory of uncertain boundaries, which has hitherto been treated as wholly governed by mutual agreement.” In other words, the UK Supreme Court’s concern with the Australian position was that it might lead to undue interference by the courts of parties’ own allocation of contractual obligations and risk.
Post-Andrews there have been several decisions taken at the appellate level. In these decisions, the courts have chosen to take a hands-off approach to scrutinizing contractual obligations despite the enlargement of the equitable jurisdiction to supervise the operation of commercial clauses that the Andrews decision represented.
In the New South Wales Court of Appeal case of Australia Capital Financial Management Pty Ltd v. Linfield Developments Pty Ltd which concerned a call option in a development agreement, the court held that the call option was not penal in its operation because it was not out of all proportion to the protection of the developer’s legitimate interests in relation to the proposed development. In a separate New South Wales Court of Appeal case of Arab Bank Australia Ltd v. Sayde Developments Pty Ltd, the court held that the default interest payable under a commercial loan facility was not a penalty, highlighting the importance of assessing the likely consequences of default at the time the contract was made and not at the time of breach.
Position under Singapore law
The Singapore Court of Appeal had the opportunity to consider the development of the penalty rule in the UK, the divergence of approach in Australia, and clarify the Singapore position in Denka Advantech Pte Ltd v. Seraya Energy Pte Ltd. Similar to the UK Supreme Court, the Singapore Court of Appeal rejected the position in Andrews taking the view that extending the application of the penalty rule to primary obligations would impinge on parties’ freedom of contract. That being said, the Singapore Court of Appeal declined to abolish the penalty rule altogether, opting to retain the power where there is a breach of contract to decide the appropriate remedy for the innocent party.
The Singapore Court of Appeal also took the opportunity to analyze the Cavendish decision. Instead of following the legitimate interest approach in Cavendish the court reiterated its endorsement of the Dunlop test and held that the test of whether the contractual provision concerned provided a genuine pre-estimate of the likely loss was wholly consistent with the fact that the focus was on the secondary obligation on the part of the party in breach to pay damages by way of compensation.
Application of a liquidated damages clause
The panel also discussed the comparative approaches under English law and Singapore law on liquidated damages following the UK Supreme Court case of Triple Point Technology Inc v. PTT Public Company Ltd.
Triple Point concerned a dispute between Triple Point and PTT under a staged milestone payment contract. The contract subsequently ran into delay, and Triple Point stopped work on the grounds of non-payment. PTT then terminated the contract on the basis that Triple Point had wrongfully suspended work under the contract.
The two key issues that were discussed in the case were (i) whether liquidated damages accrued up to the date of termination even when termination had occurred before PTT had accepted the delayed work and (ii) whether or not there was a cap on liquidated damages.
Position under English law
On the first issue, the Supreme Court in Triple Point restored the orthodox position that where a contract is terminated, liquidated damages would accrue up until termination (even if the delayed works had not been accepted), and that general damages could be claimed thereafter.
In respect of the second issue, there was a limitation of liability clause in the contract which provided:
“This limitation of liability shall not apply to contractor’s liability resulting from fraud, negligence, gross negligence or wilful misconduct of contractor or any of its officers, employees or agents.”
In considering this clause the Supreme Court held that the word “negligence” had the effect of excluding breaches of contractual negligence, and to restrict negligence to tortious negligence would give the word a meaning other than its natural and ordinary meaning.
Position under Singapore law
The position under Singapore law as to the first issue appears to be aligned with the Supreme Court’s position in Triple Point. In the Singapore High court case of LW Infrastructure Pte Ltd v. Lim Chin San Contractors Pte Ltd the High Court held that the termination of a contract does not affect the right to liquidated damages which would have accrued before termination. This decision was criticized by the Court of Appeal in Triple Point, but the Supreme Court in overturning the Court of Appeal’s decision appeared to agree with the judgment in LW Infrastructure.
On the second issue, like the position taken in the UK, the Singapore courts maintain the conceptual difference between contractual and tortious negligence, although both liabilities do generally overlap. Whether or not a contractual clause would have the effect of covering both contractual negligence and tortious negligence would likely come down to the way the clause is drafted and the natural and ordinary meaning of the words, like in the Triple Point Supreme Court case.
Over the years, both similarities and divergences in the various common law jurisdictions’ approaches to liquidated damages have developed. Where the approaches have diverged – such as in relation to the penalty rule – it remains to be seen whether the different approaches yield different results.
Authored by Shi Jin Chia.