The Federal Court in this case resolved the issue relating to forfeiture of deposit paid in a sale and purchase agreement in relation to section 75 of the Contracts Act 1950.
Facts of the Case
The appellant (Cubic Electronics Sdn Bhd) was wound up on 25 July 2011 and liquidators was appointed to manage the company’s affairs. The appellant owns a land in Melaka together with plant and machinery (“the properties”). As the appellant was wound up, the said properties were put for sale through an open tender. Before the open tender is carried out, the respondent (Mars Telecommunications Sdn Bhd ) made an offer to purchase the properties for RM90 million with an earnest deposit of RM1 million to be paid. The liquidators accepted the offer subjected to the term that the sale and purchase agreement (“SPA”) must be executed within 30 days failing which the earnest deposit of RM1 million paid by the plaintiff would be forfeited as agreed liquidated damages and not by way of penalty.
The appellant had granted two extensions of time for the respondent to execute the SPA subjected to the condition that a further earnest deposit of RM500,000.00 for each extension had to be paid. On the respondent’s third request for an extension of time, respondent was required to pay a further sum of RM1 million and a non-refundable interest of RM40,000.00 for the delay in the making the payment of the balance of deposit. A fourth extension of time was requested by the respondent but it was refused by the appellant. the appellant through its solicitors terminated the sale and informed the respondent that a total of RM3,040,000.00 was forfeited. The properties were then sold to a third party.
The respondent initiated an action against the appellant to seek for a declaration that the termination of the sale was wrongful and invalid and sought for the return of the deposit money and interest paid. The respondent counterclaim for the rentals and utility charges based on the tenancy of the property by the respondent. The High Court had dismissed the respondent’s claim and the counterclaim is allowed. On appeal, the Court of Appeal only allowed the appellant to forfeit RM1 million of the earnest deposit. The Court of Appeal is of the view that only Rm1 million was agreed as earnest deposit as the SPA was yet to be signed. The appellant also failed to prove it had suffered any damages and that the sum forfeited was reasonable compensation in accordance with section 75 of the Contracts Act 1950 (“CA 1950”). Hence, the present appeal to the Federal Court. Leave was granted to appeal on two questions.
Issue of the Case
Whether any additional deposit paid for c to execute the SPA is forfeitable?
Whether a purchaser who has agreed and willingly paid an interest in consideration of an extension of time can claim for a refund if he defaults in executing the SPA and paying the balance deposit on the due date?
Judgment of the Case
First Issue
Appellant submitted that the additional deposit paid are forfeited as agreed liquidated damages and it is not a penalty. Thus, the appellant is not required to prove its loss before forfeiting the earnest deposit. Appellant referred to a few cases and claims that a 10% deposit was common in a contract for the sale of land. The earnest deposit paid by the respondent in this case is not excessive or unreasonable because it is only 3.33% of the purchase price.
Respondent argued that in accordance with section 75 CA 1950 and Selva Kumar Murugiah v Thiagarajah Retnasamy [1995] 1 MLRA 188 whether it is a penalty or liquidated damages, the appellant must prove the damage suffered unless the sum named is a genuine pre-estimate. The RM2 million paid for extending the time for executing the SPA amounts to a penalty because it was to penalise the respondent for not being able to execute the SPA and pay the deposit sum on time. Respondent claimed that the appellant had not discharge their burden to prove its loss thus could not forfeit the RM2 million additional deposit.
For determining whether the payments made for the extension of time are deposits or penalties, it is necessary for the Court to consider the principles of law relating to the forfeiture of deposits, damages and its relation to section 75 of the CA 1950.
Section 75 of the Contracts Act states:
“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.”
The general principle is that if there is a breach of contract, any money paid in advance of performance and as part payment of the contract price is generally recoverable (see: Dies v. British and International Mining and Finance Co [1939] 1 KB 715). However, deposit paid is generally not recoverable because it is not merely part payment but also act as a guarantee of performance (see: Howe v. Smith (1884) 27 Ch D 89). To determine whether a payment is part-payment of the price or a deposit, we would need to interpret it from the facts of a case, and the usual principles of interpretation apply. Once it has been ascertained that a payment possesses the dual characteristics of earnest money and part payment, it is a deposit.
In Linggi Plantations Ltd v. Jagatheesan [1971] 1 MLRA 747, the Privy Council decided that the law on damages clause did not apply to forfeiture of deposits, but the amount of deposit must be reasonable. This case was affirmed in Workers Trust and Merchant Bank Ltd v. Dojap Investments Ltd [1993] AC 573 where the Privy Council held that when a deposit is not a reasonable amount and there are no special circumstances which could justify such deposit, the provisions for its forfeiture is a plain penalty. The Court then will order for its repayment of the sum less any damage actually proved to have been suffered as a result of the breach of contract.
In Cavendish Square Holding BV v. Talal El Makdessi [2015] UKSC 67, the Supreme Court suggested that both the law on penalties and the law on relief against forfeiture may be applied to the same and a case like Workers Trust and Merchant Bank Ltd may be best rationalised as applying the reformulated law on penalties, that is, looking at legitimate interest and proportionality rather than the law on relief against forfeiture. Thus, in situation when the sum stipulated in a damage clause is unreasonably high in comparison to the innocent party’s legitimate interest in the performance of the contract, then such a clause is struck down.
In Malaysia, section 75 of the CA 1950 was introduced as a limit to the absolute freedom of contract as prevention of potential abuse by a party at another expense. The leading case on this issue has always been the case of Selva Kumar Murugiah v Thiagarajah Retnasamy [1995] 1 MLRA 188 which held that an innocent party in a contract that has been breached, cannot simply recover the sum fixed in a damages clause whether as penalty or liquidated damages. He must prove the actual damage he has suffered unless his case falls under the limited situation where it is difficult to assess actual damage or loss.
The Federal Court in this case are of the view that section 75 of the CA 1950 allows reasonable compensation to be awarded by the court irrespective of whether actual loss or damage is proven. Proof of actual loss is not the sole conclusive determinant of reasonable compensation although evidence of that may be a useful starting point. The initial onus lies on the party seeking to enforce a damages clause under section 75 of the CA 1950 to adduce evidence that firstly, there was a breach of contract and that secondly, the contract contains a clause specifying a sum to be paid upon breach. Once these two elements have been established, the innocent party is entitled to receive a sum not exceeding the amount stipulated in the contract irrespective of whether actual damage or loss is proven subject always to the defaulting party proving the unreasonableness of the damages clause including the sum stated therein, if any. If there is a dispute as to what constitutes reasonable compensation, the burden of proof falls on the defaulting party to show that the damages clause including the sum stated therein is unreasonable.
The facts of this current case shows that the additional sums of RM2.04 million was paid to the appellant in exchange for them to extend the time to execute the SPA. They also consistently indicated that the money paid would constitute part payment of the earnest deposit which include a guarantee of performance in executing the SPA. The parties were also aware that if there is default in executing the SPA, it would be forfeited as agreed liquidated damages. When an extension of time was granted, the appellant had repeatedly warned the respondent that it would be forfeited if they failed to execute the SPA. Both of the parties had the benefit of legal representation and respondent had made no objection to the conditions imposed by the appellant. Hence, it is clear that the respondent agreed that the additional payments would form part of the deposit.
As the respondent had gone into liquidation, the liquidator has a duty to sell the company’s asset at the best possible price and at a timely manner to pay its creditors, thus it is reasonable to required some form of guarantee from potential buyer. The Court are of the view that the total deposit was not disproportionate to the purchase price. It is merely 3.33% of the purchase price of RM90 million. Therefore, the respondent had the burden of proof to show that the additional deposit amount was excessive. The respondent had only insisted that it should be entitled to a refund because the appellant had not proved actual loss or damage. Since the respondent did not discharge its burden of proof, the Court held that the additional RM2 million amounts to reasonable compensation.
Second Issue
Appellants also submitted that the Court of Appeal erred in deciding that the sum of RM40,000.00 as interest must be refunded because it was not paid as deposit but as consideration for a further extension of time to execute the SPA. Respondent claimed that there is no clause in the SPA which allow the appellant to imposes any interest on the balance deposit sum and it amounts to unjust enrichment.
The appellant explained that the amount was attained by calculating the interest of 8% per annum on the balance deposit of RM6 million. It was not to constitute part payment of the purchase price and was agreed by the parties as payment for the delay in receipt of the balance deposit. It was also agreed by them to be non-refundable regardless of whether there is any breach to execute the SPA, thus it fell outside the scope of section 75 of the CA 1950. For these reasons, the Court held that the amount is not refundable to the respondent.
In conclusion, this appeal was allowed by the Court with cost.
Principle of the Case
If there is a breach of contract, any money paid in advance of performance and as part-payment of the contract price is generally recoverable by the payer. But a deposit paid which is not merely part payment but also as a guarantee of performance is generally not recoverable. A deposit is subject to section 75 of the CA 1950 and it allows reasonable compensation to be awarded by the Court irrespective of whether actual loss or damage is proven.
The initial onus lies on the party seeking to enforce a damages clause under section 75 of the CA 1950 to adduce evidence that firstly, there was a breach of contract and that secondly, the contract contains a clause specifying a sum to be paid upon breach. If there is a dispute as to what constitutes reasonable compensation, the burden of proof falls on the defaulting party to show that the damages clause including the sum stated therein is unreasonable.
Additional Notes
When the appeal of Tekun Nasional v Plenitude Drive (M) Sdn Bhd and another appeal [2021] 10 CLJ 20; [2021] 6 MLRA 677, The Federal Court had decided on this issue in Cubic Electronics Sdn Bhd v. Mars Telecommunications Sdn Bhd. Cubic. The Court held that the case of Cubic Electronics Sdn Bhd should not be applicable retrospectively to cases where full trial had been completed and decided by the court of first instance. The Court of Appeal had decided based on the law applicable at that material time. In this case, the retrospectivity of Cubic Electronics Sdn Bhd would cause manifest injustice to Tekun Nasional. Therefore, it stood to reason that Cubic Electronics Sdn Bhd would only apply prospectively, that was, to cases where trials had not been completed.