Corporate
Corporate Tip 3: Drafting a Liquidated Damages Clause
Under Singapore law, liquidated damages refer to a contractually agreed amount payable when one party breaches the contract. The main purpose of liquidated damages is to provide both parties with certainty about the compensation in case of a breach, which is particularly useful when it is challenging to determine the exact loss. For a liquidated damages clause to be valid, it must represent a genuine pre-estimate of the potential loss; otherwise, it may be deemed an unenforceable penalty.
Despite being labelled as liquidated damages, the courts scrutinise such clauses to ensure they do not function as penalties. As per the ruling in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79, a clause qualifies as a penalty if it is deemed "extravagant and unconscionable" in comparison to the potential loss. Conversely, while the case of Cavendish Square Holding BV v Makdessi [2016] AC 1172 introduced the notion of "legitimate interests" in the UK, Singapore courts, as reiterated in Denka Advantech Private Limited v Seraya Energy Pte Ltd [2021] 1 SLR 631; [2020] SGCA 119, adhere to the principle of genuine pre-estimate of loss established in Dunlop.
When drafting a liquidated damages clause, it is critical to ensure that the stipulated rate can be justified as a genuine pre-estimate of potential damages. This can be achieved by documenting the rationale behind the rate during contractual negotiations. Clarity is essential, especially if the contract includes a formula for calculating the rate instead of a fixed amount. The clause should also specify the start and end dates for imposing liquidated damages with certainty, and if phased completion is anticipated, the rate should correspond to the amount of work completed to avoid disputes over its validity.
Reference:
Sim Chee Siong, Soh Lip San and Matthew Koh, “Singapore” in Contract Laws of Asia: Liquidated Damages and Penalty Clauses (Asia Business Law Institute and the Singapore Academy of Law, 2023), available from the LawNet store.
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