Liquidated damages (LDs) or penalty regimes are where parties often come unstuck. While privity of contract enables parties to agree a specified amount payable upon breach (or, in some jurisdictions, upon the occurrence of a stipulated event), such clauses are not beyond the scrutiny of courts or arbitral tribunals. Legal systems across the globe differ in their approaches to liquidated damages provisions and case law in common law jurisdictions is continually evolving.
In applying the old English law test from the seminal case of Dunlop Pneumatic Tyre[1] (Dunlop), the recent decision of the Singapore Court of Appeal in Denka Advantech Pte Ltd v Seraya Energy Pte Ltd[2] highlights the need for global projects participants to pay particular attention to the liquidated damages regime applicable to their contracts and to consider whether their liquidated damages provisions comply with the relevant test.
Factual Background
Seraya Energy Pte Ltd (Seraya), an electricity retailer, entered into electricity retail agreements (ERAs) with Denka Advantech Pte Ltd and Denka Singapore Pte Ltd (Denka), whereby Seraya supplied electricity to Denka’s premises. Each ERA contained a liquidated damages clause, which provided for a payment of 40% of the remaining contract value as determined by the average monthly payment around the time of termination. A dispute arose between the parties when Denka indicated that it no longer wished to purchase electricity under the ERAs in August 2014, while the ERAs were due to expire on 31 January 2021. Subsequently, Seraya terminated the ERAs and commenced proceedings against Denka, claiming that Denka was in repudiatory breach of the ERAs. Seraya claimed damages under the liquidated damages clause contained in each of the ERAs.
The High Court Decision
The High Court considered the different tests for a liquidated damages clause versus an unenforceable penalty clause as laid down in the English decisions of Dunlop and Cavendish[3]. In Dunlop, the House of Lords held that the correct test was whether the clause was a genuine pre-estimate of loss likely to be suffered by the innocent party as a result of breach of contract. In Cavendish, by contrast, the UK Supreme Court found that the true test is that a LD clause is a penalty only if it was out of proportion to the aggrieved party’s “legitimate interests” in the enforcement of the primary obligation under the contract, which could extend beyond compensation to broader commercial considerations.
The High Court found that it was bound to apply the Dunlop test. This is because it was bound by the Singapore Court of Appeal’s prior decision in Xia Zhengyan v Geng Changqing[4], which was handed down prior to Cavendish. Applying the Dunlop test, the High Court rejected Seraya’s claims under the liquidated damages clauses, opining that they were unenforceable penalty clauses because their primary intention was to deter any breach by Denka. Seraya appealed to the Singapore Court of Appeal.
The Court of Appeal Decision
The Court of Appeal dealt with two questions:
1. Should the scope of the rule against penalties in Singapore be extended (as it had been in Australia) to apply not only to sums payable upon breach of contract, but also to sums payable upon the occurrence of stipulated events?
2. What is the applicable test for distinguishing between a liquidated damages clause and a penalty clause?
As to (1), the Court declined to follow the approach adopted by the High Court of Australia in Andrews v Australia and New Zealand Banking Group Limited[5] and, instead, confirmed that the rule against penalties only applies to sums payable upon contractual breach. The Court opined that extension of the penalties rules could lead to a situation in which the court is required to review the substance of a bargain, which in turn would interfere with the parties’ freedom of contract.
As to (2), the Court confirmed that the appropriate legal test for a penalty under Singapore law is the Dunlop test, rejecting the Cavendish approach as being too far from the intended purpose of LD clauses to provide an appropriate compensation scheme.
On the merits of the case before it, the Court held that the liquidated damages clause was not “extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach”.[6] Therefore, the Court upheld the clause and awarded damages to Seraya amounting to $30.8m.
What does this mean for you?
Denka v Seraya has clarified the applicable test for liquidated damages versus penalty provisions, which will come as a relief to project participants choosing Singapore law as the substantive law applicable to their contract. However, there is a more general warning to heed, given that the Singapore Court of Appeal was willing to depart from the English court’s prevailing view of LD regimes under Cavendish: it is essential that parties understand the LD regimes within which they are contracting and are clear on the likely approach that a relevant court or arbitral tribunal would take.
The discussion above has highlighted some of the key differences amongst English, Singapore and Australian common law regimes in the scope and test to be applied. Approaches differ significantly again once civil law jurisdictions are considered. There, parties must first understand the meaning of the words “liquidated damages” or “penalty” and then must grapple with the effect of their clause constituting one or the other. To give a few examples:
- Under French law, the Civil Code recognises delay penalties as valid. Article 1152 of the French Civil Code further regulates liquidated damages, pursuant to which the party who has breached the contract must pay to the other party damages in the amount agreed in the contract. Liquidated damages under French law must be commensurate with the loss suffered. Otherwise, article 1152 of the French Civil Code provides that a judge can, at the request of a party or not, either lower or increase the contractually stipulated damages if held obviously excessive.
- Under UAE law, the terms liquidated damages and penalty are used interchangeably to refer to pre-determined compensation amounts. Pursuant to Article 390 of UAE Civil Code, the courts can increase or decrease the damages awarded to ensure that the compensation is equal to the harm caused.
- Swiss law distinguishes between penalties and liquidated damages. Penalty clauses are regulated by the Swiss Code of Obligations, while liquidated damages are not. However, liquidated damages clauses are acceptable and subject to the same judicial review as contractual penalties as per article 163(3) of the Code of Obligations.
To protect yourself against the risk of a liquidated damages clause being rendered unenforceable or the amount awarded being reduced by a court or tribunal, planning ahead is key. Some important considerations are:
- Trigger event: does your clause apply upon contractual breach, or upon the occurrence of some other event?
- Governing law: what is the test for liquidated damages or penalty provisions under the substantive law governing your contract, and what is its scope?
- Language used: what are the contractual interpretation principles applicable to your clause, and how might the language you use affect its interpretation?
- Aides in contractual interpretation: does the substantive law governing your contract allow for the admissibility of pre-contractual documentation to demonstrate how the pre-agreed sum was derived?
- The pre-agreed sum: how is this derived, and does it satisfy the applicable test that will be applied under the governing law of your contract?
For further detailed discussion on liquidated damages in the construction context, please see Chapter 10 “Employer Claims” authored by our colleagues Boris Kasolowsky and Samantha Lord Hill in Rosenberg, K., Miller Rankin, E. and Dayton, B., Dealing with Delay and Disruption in Constructions Projects, Sweet & Maxwell (2020), (Freshfields summary is available at https://www.freshfields.com/en-gb/our-thinking/publications/dealing-with-delay-and-disruption-on-construction-projects/
[1] Dunlop Company, Ltd v New Garage and Motor Company, Limited [1915] AC 79.
[2] Denka Advantech Private Limited & another v Seraya Energy Pte Ltd & another [2020] SGCA 119.
[3] Cavendish Square Holding BV v Makdessi [2016] AC 1172.
[4] Xia Zhengyan v GengChangqing [2015] 3 SLR 732.
[5] Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205.
[6] Denka Advantech Private Limited & another v Seraya Energy Pte Ltd & another [2020] SGCA, para 66.
