LAD: Special & Exceptional Type of Damage that Must Be Communicated

On Thursday, 1 October 2020, I was led by my partner Conrad Young in the hearing of 2 related appeals in the Court of Appeal. After hearing submissions by counsel, the Court of Appeal held that liquidated and ascertained damages ("LAD") paid to a non-contracting party is not a damage which can be said to arise naturally from a breach of a contract, but is instead a special and exceptional type of damage which must be communicated to the defendant before the defendant can be made liable to pay. This is an interesting statement of the law, which may have some practical consequences in contractual communications, especially in the construction industry where LAD clauses are prevalent, if not customary.

The appeals arose in this way. The Plaintiff in the High Court suit entered into the "Main Contract" with its employer in respect of a construction project. In this Main Contract, there was an LAD clause.

The Plaintiff subsequently engaged the Defendant through a "Gensets Contract" to provide generator sets for the project. There is no LAD clause in this Gensets Contract. Critically, although the Plaintiff disclosed to the Defendant that the generator sets were to be provided for the project and to the employer, the existence and terms of the LAD clause in the Main Contract was not made known to the Defendant.

Unfortunately, there was a delay in the completion of the Gensets Contract. The Plaintiff alleged that this caused a delay in its completion of the Main Contract (which the Defendant denied), thus exposing the Plaintiff to an LAD claim of RM3.2 million by its employer, which the Plaintiff paid. The Plaintiff sued the Defendant, seeking, among other things, to recover the RM3.2 million it paid to its employer ("LAD Claim").

The issue turned upon whether the LAD Claim fell within the definition of loss or damage claimable under Section 74 of the Contracts Act 1950 (1). Section 74 provides as follows:-

74. (1) When a contract has been broken, the party who suffers by the breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from the breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it.

(2) Such compensation is not to be given for any remote and indirect loss or damage sustained by reason of the breach.

As there was no provision for LAD in the Gensets Contract, it was generally accepted that the LAD Claim is not damage which naturally arose in the usual course of things from the breach. The principal issue for determination in the Court of Appeal turned on whether it was something which the parties knew to be likely to have resulted from a breach. In determining this, the Court of Appeal panel appeared to have been guided by the following passage in Grebert-Borgnis v Nugent (1885) 15 QBD 85 at p 90:-

But where the sub-contract was fully made known to him in all its terms, in my opinion the defendant would be liable; and the proper inference, and one which the jury might infer, would be that he had contracted with the plaintiff upon the terms that if he broke his contract he should be liable for all the consequences of a failure by the plaintiff to perform his sub-contract.

Still, however, it seems to me, according to what has been decided, that the original vendor, in such a case as this, is only liable, in the case of a breach of contract, for the natural consequences of so much of the sub-contract as was made known to him. If he were told, for instance, that the contract was that if I do not supply my purchaser with the goods which I am ordering from him, my vendor, I shall have to pay my purchaser 4l. a ton for every ton which I do not deliver, then, if there be a breach of the contract, the original vendor would have to pay the 4l. a ton. But supposing there was in the sub-contract between myself and my purchaser not only a stipulation that I should pay 4l. a ton, but, besides that, I should be liable to a penalty of 5l. a day, although that is in the sub-contract, yet if that part of it was not made known to the original vendor, then for that reason and because it is not a natural consequence of his bargain, he would not be liable to pay the penalty of 5l. a day. It seems to me that the cases establish that the original vendor is to be liable to so much of the sub-contract as was made known to him, but only to that extent.

The Court of Appeal ultimately held that LAD clauses in a separate contract is not a form of damage which arises naturally from a breach of the subject contract. Instead, such LAD is something special and exceptional. Therefore, before the Defendant can be made so liable, there must first be a similar LAD clause in the Gensets Contract or that the existence and terms of the LAD clause in the Main Contract must be communicated to the Defendant before the Gensets Contract was entered into.

As the LAD clause was not communicated to the Defendant before the Gensets Contract was entered into, the Defendant was not liable to pay the RM3.2 million claimed. The Court of Appeal further held that the RM500,000.00 awarded by the High Court to the Plaintiff was in error as it was effectively an arbitrary award in lieu of LAD, with there being no evidence was led of the actual damage suffered by the Plaintiff or its employer.

As a matter of practice, in cases where a party wishes to be indemnified by its suppliers or sub-contractors against LAD claims by its employer, it may be prudent to either have back-to-back LAD clauses or at the very least, ensure that the LAD clause in the employer or main contract is sufficiently communicated.

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(1) The statutory recognition of the Hadley v Baxendale rule on loss and damages.