Are you sufficiently protected under a LAD clause, come rain or shine?
Imagine this. Your contract has been breached. You wish to seek recourse but aren’t sure of your what you should do next in recovering compensation for the said breach.
In such a situation, you should firstly examine the contract (or have a lawyer review it for you) to check whether your contract contains a Liquidated Ascertained Damages (“LAD”) clause. Recovering compensation will be an easier process if there is such a clause as per the case of Cubic Electronics Sdn Bhd (in liquidation) v Mars Telecommunications Sdn Bhd [2019] 6 MLJ 15, subject to certain conditions.
What is a Liquidated Ascertained Damages clause?
It is a clause which specifies an agreed-upon amount of money to be paid to the party that did not breach the contract, if such a breach occurs. This amount has been determined and approved by both parties prior to entering into the contract. Section 75 of the Contracts Act 1950 covers compensation by way of a LAD clause or penalty clause, in that:
“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.”
My contract contains an LAD clause. How do I enforce it?
The previous position in Selva Kumar Murugiah v Thiagarajah Retnasamy [1995] 1 MLJ 817 stated that although a breach of contract was proven, the party making the claim still had to demonstrate the damages they had incurred with strict evidence, even if the contract included a clause specifying liquidated damages.
However, In a recent ruling, the Federal Court stated in Cubic Electronics Sdn Bhd (in liquidation) v Mars Telecommunications Sdn Bhd [2019] 6 MLJ 15 that the need to prove actual loss or damage is not necessary if the contract includes a LAD clause.
“[65] With respect and for reasons we shall set out below, we are of the view that there is no necessity for proof of actual loss or damage in every case where the innocent party seeks to enforce a damages clause...”
This change in the approach to claiming compensation through a LAD clause results in two significant alterations:
a. The party that did not breach the contract is no longer obliged to demonstrate actual damages for the LAD clause to be applicable; and
b. The party that did not breach the contract only needs to establish that there was a breach of contract and that the contract has a LAD clause.
After these requirements have been met, the party that breached the contract is responsible for demonstrating that the amount stated in the LAD clause is unreasonable.
How do we prevent the likelihood of a LAD clause from being deemed unreasonable?, You may ask.
Here are some useful pointers to consider when including a LAD clause in your contract:
a. Make certain that the amount specified in the LAD clause is an authentic estimation of the potential loss that could result from a breach; and
b. Ensure that the sum specified in the LAD clause is reasonable and appropriate to safeguard your lawful interest in the fulfillment of the contract.
Although the obligation to demonstrate actual damages is no longer necessary, it is essential to bear in mind that evidence of such losses can still be a valuable initial reference for the court when evaluating the reasonableness of the LAD clause
Therefore, it would be advisable to maintain a written record of any damages or expenses suffered as a consequence of the breach.
Conclusion
The recent shift in the court's approach to enforcing a LAD clause without the requirement to prove actual loss has been widely praised. This significant ruling by the Federal Court has effectively guided lower courts, as demonstrated in the cases of Leong Keng Chiang v Prema Bonanza Sdn Bhd [2021] MLJU 714 and Lam Su See v Prema Bonanza Sdn Bhd [2021] MLJU 713.
If you intend to use a LAD clause in a contract for risk management purposes, such as strengthening your claim for compensation or establishing a predetermined amount for breach, it is essential to draft the clause with precision and care to ensure its legal validity. At RGCOLaw, we offer free consultation in reviewing your contracts in checking the enforceability of a LAD clause or the lack thereof. Contact us now to schedule an appointment.
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