DENKA ADVANTECH PTE LTD V SERAYA ENERGY PTE LTD: UPDATE ON THE LAW ON CONTRACTUAL PENALTIES

The Court of Appeal in its recent decision of Denka Advantech Pte Ltd and another v Seraya Energy Pte Ltd and another and other appeals [2020] SGCA 119 (“Denka v Seraya”) dealt with the position of liquidated damages in Singapore in light of the Australian decision of Andrews and others v Australia and New Zealand Banking Group Limited (2012) 247 CLR 205 (“Andrews”) and the United Kingdom Supreme Court decision of Cavendish Square Holding BV v Makdessi [2016] AC 1172 (“Cavendish Square Holding”). 

Dunlop Pneumatic. The seminal decision on the law on contractual penalties (the “penalty rule”) was the 1914 House of Lords decision of Dunlop Pneumatic Tyre Company, Limited v New Garage and Motor Company, Limited [1915] AC 79 (“Dunlop Pneumatic”). As summarised at [66] Denka v Seraya, Lord Dunedin set out four principles on the law on contractual penalties:  

“66 To assist the court’s construction of the contract, Lord Dunedin posited four principles, which became the leading statement of the law on penalties for most of the last century: (a) that the provision would be penal if the sum stipulated for is extravagant and unconscionable in comparison with the greatest loss that could conceivably be proved to have followed from the breach; (b) that the provision would be penal if the breach consisted only in the non-payment of money and it provided for the payment of a larger sum; (c) that there was a rebuttable presumption that the provision would be penal if the sum stipulated for was payable on a number of events of varying gravity; and (d) that the provision would not be penal because of the impossibility of precise pre-estimation in the circumstances of the true loss (see generally Dunlop at 87−88). We will return to these principles in greater detail when discussing the criteria applicable to the Penalty Rule below.”

However, in 2012, the High Court of Australia in Andrews departed from Dunlop Pneumatic by holding that the scope of the penalty rule was not limited to clauses purporting to take effect upon a breach of contract ([67] Denka v Seraya).

Then in 2015, the United Kingdom Supreme Court in Cavendish Square Holding held that (contrary to Andrews) the scope of the penalty rule in English law was limited to situations involving a breach of contract ([69] Denka v Seraya).

But in the leading judgment in Cavendish Square Holding, the penalty rule was re-formulated as “whether the impugned provision is a secondary obligation which 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” (the legitimate interest approach) ([70] Denka v Seraya).

Hence, there was uncertainty over whether the approach in Singapore should follow either Andrews or Cavendish Square Holding.

Andrews not followed. In Denka v Seraya, the Court of Appeal held that the law relating to contractual penalties (as set out by Lord Dunedin in Dunlop Pneumatic) should be limited to situations of breach, unlike the position set out in Andrews ([82] Denka v Seraya).

A key concern of the Court of Appeal was that an extension of the penalty rule would lead to uncertainty and would amount to an incursion into the parties’ freedom of contract:

“… On the contrary, any extension of the Penalty Rule in the manner just described would vest in the courts a discretion that is at once both wide as well as uncertain. Just as importantly, such a discretion would permit the courts to review a wide range of clauses on substantive (and not merely procedural) grounds, thus constituting a general, uncertain and significant legal incursion into the freedom of contract that hitherto existed between the parties concerned. We would respectfully endorse the concern of Lord Neuberger and Lord Sumption that the approach taken in Andrews “[transforms] a rule for controlling remedies for breach of contract into a jurisdiction to review the content of the substantive obligations which the parties have agreed” (see Cavendish Square Holding at [42]). Given that freedom of contract is the rule rather than the exception in the context of the law of contract, this would – in and of itself – be an insuperable objection to such an extension of the Penalty Rule. And it certainly could not be argued that such a discretion is sound because it is one that originates in equity for that would, with respect, be a circular argument.”

The Court of Appeal held that the pre-requisite of a breach of contract is to be preferred as it restricts the scope of the penalty rule to secondary obligations only and does not interfere with the primary obligations between the contracting parties. The Court of Appeal highlighted that the distinction between primary and secondary obligations is vital to the way modern contract law has developed, citing [13] Cavendish Square Holding with approval. (See [91] – [93] Denka v Seraya).

 

Cavendish Square Holding not followed. The Court of Appeal also declined to follow the legitimate interest approach as set out in Cavendish Square Holding and endorsed the statement of principles set out by Lord Dunedin in Dunlop Pneumatic instead ([151] Denka v Seraya).

The Court of Appeal held that insofar as the legitimate interest approach contemplates that there “could be situations in which the clauses which operate upon a breach are not genuine pre-estimates of the likely loss but which are nevertheless commercially justifiable and therefore not penalties” (emphasis in original), then this would be normatively at variance with the distinction between primary and secondary obligation ([152] Denka v Seraya).

“152 We do so because the test as to whether or not the contractual provision concerned provided a genuine pre-estimate of the likely loss is wholly consistent with the fact that the focus is on the secondary obligation on the part of the defendant to pay damages by way of compensation. Indeed, the court in Cavendish Square Holding was of the same view inasmuch as it endorsed the distinction between the primary obligations of the parties on the one hand and their secondary obligations on the other (see above at [92]). If indeed this is the case, then, with respect, the approach of the court in Cavendish Square Holding in holding that there could be situations in which the clauses which operate upon a breach are not genuine pre-estimates of the likely loss but which are nevertheless commercially justifiable and therefore not penalties would be at variance with the aforementioned distinction. Put simply, a contractual provision which stipulates for an amount of damages to be paid in the event of breach that is more than the pre-estimate of the likely loss must necessarily be (on a normative level) penal, as opposed to compensatory, in nature – notwithstanding that it might have been in the commercial interests of the plaintiff to have included such a provision or clause on a factual level. Looked at another way, the “legitimate interest” (or commercial interest) of the plaintiff, whilst grounded in practical factual circumstances, has no role to play at the level of legal principle – except to the extent that the “legitimate interest” concerned is coterminous with that of compensation.”

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In rejecting the legitimate interest approach, the Court of Appeal highlighted that this approach is consistent with the earlier decision of PH Hydraulics & Engineering Pte Ltd v Airtrust (Hongkong) Ltd and another appeal [2017] 2 SLR 129, which held that as a general rule punitive damages cannot be awarded ([154] Denka v Seraya).

The Court of Appeal further held that the concept of “legitimate interest” is “a very general concept that could be utilised in myriad of ways, particularly in the process of application to the relevant facts and circumstances”. Hence, it may be utilised too flexibly, leading to too much uncertainty and encouraging litigation ([155] Denka v Seraya). 

The Court of Appeal also made clear that the rejection of the legitimate interest test does not mean that the key elements which weighed heavily with the court in Cavendish Square Holding are entirely irrelevant ([153] Denka v Seraya).

Conclusion. Denka v Seraya is a welcomed decision which makes clear that the law on penalty in Singapore remains that as set out in Dunlop Pneumatic. This will, no doubt, be a relief for many contractors as the legitimate interest approach can create a huge amount of uncertainty over what may be regarded as a “legitimate interest”, which is a key issue as highlighted by the Court of Appeal in Denka v Seraya.

However, it is also important to remember that while the law remains as that set out in Dunlop Pneumatic, liquidated damages provisions must still be properly drafted in order to be enforceable. For instance, it is important to ensure that there is a provision dealing with extensions of time in the construction contract (especially for acts of prevention), lest time be set at large rendering the liquidated damages provision moot.

 

This publication is not intended to be, nor should it be taken as, legal advice; it is not a substitute for specific legal advice for specific circumstances. You should not take, nor refrain from taking, actions based on this publication. Chancery Law Corporation is not responsible for, and does not accept any responsibility for, any loss or damage that may arise from any reliance based on this publication.

Xian Ying Tan