What you need to know about liquidated damages - part five

How are Liquidated Damages approached in other jurisdictions around the world?

While England has wrestled with the issues around the proper formulation and assessment of liquidated damages for a long time that is not to say that nowhere else in the world has struggled with the same issues. In some countries, many of the principles will seem familiar, though often the detail is different. Whereas in others, the underlying principles themselves are quite different.

The differences in approach arise, to a large extent, from whether the system of law governing a particular country is based on case law, such as England, often referred to as a common law jurisdiction or whether it is based on a more developed code of law, such as France, often referred to as a civil law jurisdiction. Set out below are some examples of civil and common law jurisdictions and their essential approach to liquidated damages, highlighting the differences with the English approach set out so far.

Common law jurisdictions outside the UK

Singapore

The penalty rule in Singapore law is well established2. Cavendish Square has not been followed by the Singapore courts, but was referred to in a recent decision3. The High Court cited Cavendish Square not simply for the proposition that the penalty rule applied only to the consequences which arose for breaches to primary obligations and not to the primary obligations themselves, but also for the proposition that “in a negotiated contract between properly advised parties of comparable bargaining power, the strong initial presumption must be that the parties themselves are the best judges of what is legitimate in a provision dealing with the consequences of breach”.

In any event, notwithstanding its reliance on Dunlop, the Singapore position appears closer to the current English position than might be thought to be the case. Singapore case law already drew a distinction between primary obligations and secondary obligations in the applicability of the penalty rule. The Singapore courts have also recognised that a clause providing for a transfer of property upon a breach can constitute a penalty and that the penalty rule could apply to the forfeiture of a deposit.

One potential key difference between the Singapore and English position is that under Singapore law, it does not appear that “commercial justification” will save a clause if it is deemed to be a penalty. The Singapore High Court4 refused to adopt the English test of “commercial justification”. The learned judge noted that the innocent party had simply conceded that the clause was an unenforceable penalty clause “without offering any genuine or compelling reason for the court to prefer the alternative “commercial justification” test”, and that if it were to apply the proposed “commercial justification” test, the innocent party in that case was unable to show why the clauses were not a penalty.

However, it should be noted that an earlier Singapore Court of Appeal decision5 had approvingly cited Lordsvale Finance plc v Bank of Zambia [1996] QB 752 and its use of “commercial justification” to uphold a clause.

Australia

The law on penalties in Australia has been developing differently to English law, but in relation to liquidated damages clauses the differences are minimal. In 2012 the High Court6 held that it was not necessary for the offending provision to operate on the breach of a primary provision in the contract for it to be a penalty. Rather a pre-stipulated sum which was payable upon the happening of an event could also amount to a penalty if the purpose of this sum was to secure performance. The High Court re-confirmed the application of the traditional test in Dunlop to determining if the pre-stipulated sum was a penalty, ie if the amount is extravagant or unconscionable in comparison to the maximum conceivable loss.

In July 2016 the High Court7 gave judgment as to whether the actual fees in question (bank charges for the late payment of credit card bills) were penalties. In deciding that the bank charges were not penalties, the High Court held that in assessing whether a clause is a penalty the court is to look at whether the payment/remedy specified was exorbitant, out of all proportion or unconscionable to the legitimate interests of the innocent party. The legitimate interests of the innocent party could include other commercial interests beyond the damage directly caused by the breach. In doing so the judgments adopted the modern interpretation of the test in Dunlop given by the UK Supreme Court in Cavendish (although not adopting other aspects of the Cavendish decision that would be inconsistent with Andrews).

Practically what does this mean for construction contracts:

• potentially a wider range of charges/fees could be considered penalties under Australian law, and
• it will be more difficult to draft to avoid the penalty doctrine by structuring the clause to be a primary obligation.

Nevertheless in considering whether or not a charge/fee/liquidated damages clause is a penalty, an Australian court will look at the wider commercial justifications for such a clause.

Hong Kong

While English law is highly persuasive in Hong Kong, in a decision of the Hong Kong Court of Appeal8 concerning penalties handed down on 05 May 2016 no reference was made to Cavendish Square. In that decision, the Court reaffirmed the principal in Dunlop with Hon Barma JA delivering the leading judgment stating that “there is much to be said for the first proposition stated by Lord Dunedin in Dunlop - that a clause will be held to be a penalty where the amount stipulated for is extravagant compared with the greatest loss that could be proved to flow from the breach.”

Accordingly, Hong Kong law continues to follow the traditional pre-Cavendish Square position on the law of penalties. Whether the Hong Kong Courts will apply Cavendish Square if raised by the parties in the future remains to be seen.

The Court of First Instance has previously made reference to Cavendish Square9 however only for the purposes of answering a question on relief from forfeiture.

Civil law jurisdictions

France

Article 1152 of the French Civil code regulates liquidated damages under French law. Pursuant to article 1152, the party who has breached the contract must pay to the other party damages in the amount agreed in the contract. Like under English law, 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 even without such a request, either lower or increase the contractually stipulated damages if it is obviously excessively high or low.

Based on article 1152, articles 1226 to 1233 of the French Civil Code regulate penalty clauses (clause pénale) pursuant to which a party undertakes to do something - not only to pay damages - in the event of non-performance or delayed performance of its main obligation, in order to compensate the other party for the loss suffered. As mentioned above, the judge can intervene and lower or increase the penalty.

The declared purpose of the penalty clause is to ensure the performance of the contract. It is still debatable in French case law and doctrine whether the penalty clause may only compensate for the loss caused to the non-defaulting party or whether it can also have a punitive function.

The reform of the French Civil Code that will be effective as of 01 October 2016 sheds a light on this debate. Pursuant to the new article 1231-5 of the French Civil Code, the penalty clause becomes equivalent to the liquidated damages, under a unique regime. Thus, the amount of the liquidated damages should put the non-defaulting party in the same position as it would have been in, had there been no breach; should the stipulated indemnity be obviously excessive or ridiculously low, the judge can either lower or increase it.

Spain

There are two types of penalty clauses recognised in Spanish law:

• the penalty can be a substitute for the damage compensation, or
• the penalty can be cumulative to the damage compensation.

However the parties shall not be exempted from fulfilling their obligations under the contract by paying the penalty, unless there has been an agreement to the contrary.

In any case, the courts are entitled to moderate the amount of the penalty in the following cases:

• if the main obligation has been partially or irregularly fulfilled (art. 1154 Spanish Civil Code), or
• if the amount is deemed to be unreasonably high, based on equity reasons. (Art. 1103 Spanish Civil Code)

Spanish and English law both allow the parties to pre-agree damages that will be payable automatically in certain circumstances. In Spanish and English law there are also restrictions - equity reasons (Spanish law)/genuine pre-estimate of loss (English law) - on the level at which the liquidated damages may be set. Under Spanish law, the parties also need to consider the impact of partial performance on the ability to recover liquidated damages.

Peoples Republic of China

Under PRC law, the right to apply liquidated damages is stipulated under Article 114 of the PRC Contract Law which provides that “parties may agree on the amount based on the circumstances of breach of contract, or the method of calculating the amount”. This is subject to the following caveats:

• if the agreed amount is lower than the actual losses incurred the court or arbitration institution may increase the agreed amount, and
• if the agreed amount is excessively higher than the losses incurred the agreed amount may be appropriately reduced.

According to the 2nd Interpretation of Contract Law from the PRC Supreme People’s Court and Supreme Court Case Gazette, the court may deem liquidated damages excessively high if they exceed the actual loss by 30%. Further, when considering “excessively high” liquidated damages, the court shall take the actual loss to both parties as the basis, and take the performance of the contract, the degree of each party’s fault and expected profits into considerations, and then make a decision weighing the principles of equity and good faith. Importantly, even after paying the agreed damages, the party in breach will still be required to perform any outstanding obligations under the contract.

UAE

Liquidated damages are often applied in construction contracts in the UAE. However, pursuant to Article 390 of the Law of Civil Transactions of the State of the United Arab Emirates, Federal Law No. 5 of 1985, the courts retain the discretion to increase or decrease the damages awarded to ensure that the compensation is equal to the harm caused.

The courts however apply a considerable burden of proof on the challenging party in this regard. For example, the contractor seeking to reduce the liquidated damages will need to prove that the employer suffered no loss or a lower amount of loss than the contract provides. Equally, if an employer is seeking to increase the liquidated damages amount, it will need to prove that the loss suffered exceeds the contractual amount.

Any attempt to contract out of Article 390 will be treated as void.

Netherlands

Under Dutch law, there is no distinction between a liquidated damages clause and a penalty clause. Section 6:91 of the Dutch Civil Code (DCC) states in this respect that any clause which provides that, if a party should fail in the performance of its obligation, it must pay a sum of money or perform another obligation, is considered to be a penalty clause, irrespective of whether this is to repair damage or only to encourage performance.

Whatever is due pursuant to a penalty clause takes the place of damages due by law, unless the parties explicitly agree otherwise (Section 6:92 sub 2 DCC). This means that, unlike under English law, under Dutch law there is no need to agree upon a reasonable sum in relation to the damages that it is supposed to cover.

Although a liquidated damages/penalty provision cannot be set aside due to the unreasonableness of the agreed sum, the court may reduce the sum upon the demand of the paying party if it is evident that fairness so requires. The court, however, may not award the receiving or innocent party less than the damages due by law for failure in the performance (Section 5:94 sub 1 DCC).

On the other hand, the court may award supplementary damages upon the demand of the innocent party if it is evident that fairness so requires; these are in addition to the stipulated penalty intended to take the place of damages due by law (Section 5:94 sub 2 DCC). These exceptions are, however, rarely applied. Normally, the contract is followed even if the actual damage is only a fraction of the sum due. 

2 It was most recently reaffirmed by the Singapore Court of Appeal in Xia Zhengyan v Geng Changqing [2015] 3 SLR 732; [2015] SGCA 22 citing Lord Dunedin’s speech in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79.
3 iTronic Holdings Pte Ltd v Tan Swee Leon and another suit, [2016] 3 SLR 663; [2016] SGHC 77
4 Pun Serge v Joy Head Investments Ltd [2010] 4 SLR 478
5 Hong Leong Finance Ltd v Tan Gin Huay [1999] 1 SLR(R) 755
6 Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 (Andrews)
7 Paciocco v Australia and New Zealand Banking Group
8 Brio Electronic Commerce Limited v Tradelink Electronic Commerce Limited [2016] HKCA 164 
9 Leung Wan Kee Shipyard Ltd v. Dragon Pearl Night Club Restaurant Ltd and Another [2015] HKCFI 2225