The Law on Penalties in Singapore – Lessons from a Landmark UK Supreme Court Decision
Introduction
Contracting parties in commercial transactions often make express provision for the payment of a monetary sum upon breach of contract. As a matter of contractual certainty, they have the salutary effect of forewarning parties of the consequences of breach. However, such clauses will not be automatically upheld by the Courts. If they are found to amount to a liquidated damages clause, they will be enforced; if they are instead penalty clauses, they will be rendered unenforceable.
The traditional test for distinguishing between a liquidated damages clause and a penalty clause was laid down in the seminal House of Lords decision in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd (“Dunlop”). A clause will be regarded as a penalty, and therefore unenforceable, if it is not a “genuine covenanted pre-estimate of damages”.1 In Singapore, Dunlop remains good law, despite being more than a century old. It was most recently applied by the Court of Appeal in Xia Zhengyan v Geng Changqian (“Xia Zhengyan”).2
In 2015 however, the UK Supreme Court (“UKSC”) upended a century of case law and reformulated the applicable test for penalties. In Cavendish Square Holdings v El-Makdessi (“Cavendish”), the UKSC explained that the true test for a penalty is whether the detriment imposed on the contract-breaker is “out of all proportion” to any legitimate interest of the innocent party in having the contract performed.3
Given that Cavendish was decided only a few months after Xia Zhengyan, Singapore Courts have yet to rule on the applicability of Cavendish to local jurisprudence. In analysing the key facts and holdings in Cavendish, as well as past Singapore case law, this commentary will consider the possible impact Cavendish may have on Singapore law.
Cavendish and the Law on Penalties in the UK
Dunlop and Cavendish – the UKSC’s Views on the Applicable Test
In Cavendish, the UKSC traced the roots of the penalty rule to the equitable jurisdiction to relieve from defeasible bonds.4 While the common law enforced the bonds according to their letter, equity regarded the real intention of the parties as being that the bond should stand as security only, and restrained its enforcement on terms that the debtor paid damages, interest, and costs.5 Eventually, this equitable rule was adopted and further developed by the common law,6 which proceeded on the basis that while parties generally meant what they said, it was against public policy to enforce a penalty.7 Hence, the contract-breaker would be relieved from the consequences of breach if the sum of money payable was out of all proportion to any damages liable to be suffered.8 However, at the end of the day, the Court does not review the fairness of men’s bargains, either at law or in equity.9
As noted by the UKSC, it was in Dunlop where the modern test for penalties was first formulated. In Lord Dunedin’s leading speech in Dunlop, he suggested that:
1. A clause would be penal if the sum payable is extravagant and unconscionable in comparison with the greatest loss that could have arisen from the breach;
2. A clause would be penal if the breach consists only in the non-payment of money and it provides for the payment of a larger sum;
3. There is a presumption that a clause is penal if a single lump sum is payable on the occurrence of one or more events; and
4. Nonetheless, a clause would not be treated as penal simply because it was impossible to precisely pre-estimate the true loss suffered.10
Unfortunately, subsequent cases went wrong in treating these guidelines in Dunlop as a “quasi-statutory code” by strictly applying them without a deeper consideration of the entire factual matrix.11 This was despite the fact that none of the other three Law Lords in Dunlop expressly agreed with Lord Dunedin’s reasoning, and Lord Atkinson had actually decided the case on the broader basis that there was a wider interest in enforcing a damages clause than just pecuniary compensation.12
In fact, the impugned clause in Dunlop failed all but the last of Lord Dunedin’s tests: it imposed a single lump sum payable on breach (five pounds for every tyre-cover or tube sold in breach of that contract), and was not an accurate estimation of what the appellant stood to lose when the respondent breached the contract (as Lord Atkinson observed, “in the sense of direct and immediate loss the appellants lose nothing by such a sale.”)13 It was only because the appellant had an interest in the protection of its brand, reputation and goodwill, that the Court held that the impugned clause was commensurate with that interest and hence not a penalty.14
Therefore, simply because a clause is not a pre-estimate of loss does not necessarily mean that it is penal in nature. Similarly, there is nothing inherently penal or contrary to policy to attempt to influence the conduct of a potential contract-breaker, so classifying a clause as a deterrent is unhelpful in construing its true nature.15 The proper test, as stated in the leading speech by Lord Neuberger, is whether the impugned clause is a secondary obligation which imposes a detriment on the contract-breaker that is out of all proportion to any legitimate interest of the innocent party.16 There is also the Cavendish presumption which sets forth that “in a negotiated contract between properly advised parties of comparable bargaining power … the parties themselves are the best judges of what is legitimate in a provision dealing with the consequences of the breach”.
Does Cavendish Represent a Sea-change in the Law?
That there is a difference between the Cavendish test and the Dunlop approach is undeniable. This is best illustrated by the facts of Beavis v ParkingEye Ltd (“Beavis”), which was the second appeal that was jointly heard (and decided) in Cavendish.
Beavis concerned a dispute between a motorist and the managers of a car park regarding an 85-pound charge for overstaying, which the motorist contended was an unenforceable penalty.17 It was conceded by the car park that this 85-pound charge was not a genuine pre-estimate of damages.18 Under the strict Dunlop approach, it would have been thought that this admission alone should have led to a finding in the motorist’s favour.
Applying the Cavendish test however, the UKSC held that the car park had a legitimate interest in charging overstaying motorists beyond the recovery of any loss: its job scope was to manage the efficient use of the parking space, which could only be done by deterring motorists from occupying spaces for long periods.19 Weighed against this interest, the 85-pound charge was proportionate and not penal in nature, although the UKSC commented that this did not mean that the car park could “charge overstayers whatever it liked”.20 In conducting this weighing exercise, the Court considered the fact that 85 pounds was within the level of charges imposed by local authorities for overstaying in car parks on public land, as well as guidelines from the British Motoring Association.21
What Beavis shows is that under the Cavendish test, the Court must look at the entirety of the factual matrix in assessing whether a clause is an enforceable liquidated damages clause or an unenforceable penalty clause. Unlike what post-Dunlop cases may have (wrongly) suggested, the test for penalties is not a simple mechanical comparison of the monetary quantum in the impugned clause against the actual value of the loss.
However, that is not to say that Lord Dunedin’s four tests have been completely rejected. As the UKSC noted in Cavendish, if the impugned clause is a “straightforward damages clause”, then the legitimate interest will rarely extend beyond compensation for breach, and the Dunlop approach is sufficient to determine whether the clause is penal or not. But in other more complex situations, the Court has to consider all the facts and circumstances.
In fact, it may be argued that even under the old Dunlop approach, there already was room for some sort of proportionality analysis that Cavendish brought to the fore.
In Jeancharm Limited T/A Beaver International v Barnet Football Club Limited, the UK Court of Appeal found a late payment clause to be penal because it charged a 260 per cent interest rate per annum for late payments as compensation for administrative costs incurred in processing late payment.22 Similarly, in Ariston SRL v Charly Records Ltd, a late delivery clause was held to be extravagant: in that case, the plaintiff, a record pressing company, had to pay the defendant 600 pounds a day if any manufacturing part of the records was delivered late.23 The Court pointed out that since the same sum was payable even if the plaintiffs failed to return even some of the comparatively unimportant items, it was “out of proportion to any loss suffered” and, therefore, a penalty.
While neither of these cases expressly articulated the weighing approach suggested by Cavendish, there was nonetheless a consideration of the purpose behind the impugned clauses there. It may, therefore, be said that Cavendish only represents an evolution, rather than wholesale revolution, of the rule against penalties.
Singapore and Cavendish – the Way Forward?
Whither Singapore, in the light of the new developments brought about by Cavendish? A cursory examination of past Singapore cases would seem to suggest that Singapore follows the strict Dunlop approach.
The 1999 case of Beihai Zingong Property Development Co v Ng Choon Meng (“Beihai Zingong”) provides one such example of how the Dunlop test was strictly applied by the Singapore Courts. At issue was an “agreed damages” clause that required the respondent to pay S$400,000 for breach of a sale and purchase agreement.24 In coming to its decision to uphold this “agreed damages” as a liquidated damages clause, the Court compared this amount payable against the entire value of the contract. Finding that S$400,000 only represented 4.6 per cent of the entire value of the contract, the Court upheld the clause on the basis that “there was no evidence to show that the amount of damages was extravagant or that the amount was not within the range of profits in transactions of this nature or size”.25
Similarly, in the 2015 case of Xie Zhengyan, the Court also applied Lord Dunedin’s four tests to render unenforceable a provision in a share sale and purchase agreement. Under one of the terms of that agreement, if the respondent failed to transfer the relevant shares to the appellant, the respondent had to return all monies paid by the appellant as well as an additional sum of S$100,000 as a “penalty”. The Court explained that this clause was penal because it was a sum of money that was payable whatever the circumstances, even though a failure to transfer shares could have occurred in a variety of ways (in other words, the impugned clause had failed the second and third of Lord Dunedin’s tests).26 Interestingly enough, the Court went on to describe that the S$100,000 was made “in terrorem” of the offending party, a stark contrast with Cavendish’s disdain for that phrase.
However, a closer examination of both cases reveals that there were other factors that led the Court in both cases to decide in the manner that they did. In Beihai Zingong, the Court explained:
