The Importance of Being Earnest, a Tragic Tale for Defaulting Purchasers
30 September 2014
Ji Voon discusses a case that established the law on forfeiture of deposits in Malaysia.
The decision of the Privy Council in Linggi Plantations Ltd v Jagatheesan  1 MLJ 89 laid to rest the question as to whether a vendor is entitled to forfeit a deposit paid on a contract for the sale of real property following its non-completion due to the default by the purchaser, notwithstanding that the vendor is not in a position to prove actual damage flowing from the purchaser’s breach of the contract.
By a contract dated 25 May 1962 (“Contract”), Linggi Plantations Ltd (“Vendor”) agreed to sell 1,488 acres of estate land to AN Karuthan Chettiar (“original purchaser”) for $3,775,000.
By clause 1 of the Contract, it was, inter alia, acknowledged that the Vendor’s agent had received a sum of RM377,500 amounting to 10% of the purchase price “by way of deposit and part payment” prior to the execution of the Contract.
Subsequently, the original purchaser assigned his rights and obligations under the Contract to Jagatheesan who passed away before the appeal to the Federal Court in this case. The executrix of Jagatheesan’s estate continued those proceedings on behalf of the creditors of the estate. In this article, the expression “Purchaser” refers to Jagatheesan and where appropriate, to his estate, represented by the executrix.
The Contract required the Purchaser to pay the balance of the purchase price by 24 August 1962. However, the completion did not take place in due time and the Vendor notified the Purchaser that the Contract was at an end and forfeited the deposit under clause 5 of the Contract which, inter alia, provided that if the purchase is not completed due to any default of the Purchaser, the Vendor would be entitled, by notice in writing, to declare the Contract to be at an end and “the sum of $377,500 … referred to in clause 1 hereof shall be forfeited to the vendor to account of damages for breach of contract.”
The Purchaser commenced proceedings against the Vendor in the High Court for a refund of the deposit. During the hearing, the Purchaser called evidence that no damage had been suffered by the Vendor who did not call any evidence to rebut the Purchaser’s evidence.
THE LEGAL MATRIX
The issues in this case concerned the construction of clauses 1 and 5 of the Contract and the application of sections 65 and 75 of the Contracts (Malay States) Ordinance 1950 (“Ordinance”) to these provisions.
Section 65 of the Ordinance requires, inter alia, a party who rescinds a voidable contract to restore to another party to the contract, any benefit which the first mentioned party has received from that other party.
On the other hand, section 75 provides, inter alia, that where a contract stipulates an amount to be paid in case of a breach, the non-defaulting party is entitled, whether or not actual damage or loss is proved, to receive from the defaulting party, reasonable compensation not exceeding the amount or penalty so stipulated.
It is to be noted that sections 65 and 75 of the Ordinance are identical to sections 64 and 74 respectively of the Indian Contracts Act (“ICA”).
DECISION OF THE HIGH COURT
The High Court ruled in favour of the Vendor. According to Gill J (as he then was), the Vendor could forfeit the deposit when the Contract is terminated in accordance with the terms of the Contract. According to the learned judge, the phrase at the end of clause 5 “to account of damages for breach of contract” meant liquidated damages. His Lordship further held that neither section 65 nor section 75 of the Ordinance applied to the forfeiture of deposits.
DECISION OF THE FEDERAL COURT
The Federal Court reversed the decision of the High Court. According to Ong CJ, the words at the end of clause 5 of the Contract meant that in the event of non-completion by the Purchaser, the Vendor was entitled to claim more than the amount of deposit if the damages or loss exceeded the sum of $377,500 and that equally, the Purchaser was entitled to a refund of such part of the deposit which exceeded the damage proved.
Suffian FJ was of the view that there was ambiguity in clause 5 and that such ambiguity should be resolved in favour of the Purchaser. Accordingly, His Lordship held that the sum of $377,500 was not “earnest money” and therefore liable to be refunded on a strict interpretation of the Contract.
Both Ong CJ and Suffian LP held that section 75 of the Ordinance applied to the circumstances of this case. Ong CJ further held that section 65 applied and that the deposit was a benefit under the Contract and had to be returned by the Vendor upon its recission of the Contract. Suffian FJ did not agree with this point.
The Federal Court allowed the Purchaser’s appeal and ordered the Vendor to refund the sum of RM377,500 to the Purchaser.
DECISION OF THE PRIVY COUNCIL
The Vendor appealed to the Privy Council.
According to Lord Hailsham LC, who delivered the judgment of the Board of the Judicial Committee of the Privy Council, the appeal raised three points:
On the first point, the Privy Council upheld the High Court’s ruling (save for Gill J’s construction of the phrase “to account of damages for breach of contract” in clause 5 of the Contract as a reference to liquidated damages). The Privy Council followed the decision in an English case, Howe v Smith (1884) 27 Ch. D 89, and interpreted the phrase to mean that the Vendor in forfeiting the deposit “must give credit for the amount of the deposit paid before he claims damages in excess of (that) amount”.
The Privy Council also placed emphasis on the phrase in clause 1 of the Contract which described the sum of $377,500 as a payment “by way of deposit and part payment”. In the Board’s view, the Contract meant unambiguously, that in the event of a notice of termination being issued under clause 5 as a result of the Purchaser’s failure to complete the transaction, the Vendor would be at liberty to forfeit the deposit and claim for any damage which it has suffered over and above the amount of the deposit, after giving credit for the amount of the deposit.
On the second point, the Privy Council supported the decision of an Indian court in Naresh Chandra Guha v Ram Chandra Samanta and Others A.I.R. 1952 Cal. 93 where PM Mookerjee J observed that a long series of decisions in the Indian Courts had consistently held that section 74 of the ICA did not apply to the forfeiture by a vendor of a reasonable deposit in a contract for the sale of land.
The Privy Council held that although section 74 of the ICA and section 75 of the Ordinance were intended to cut through the technical rules of English law relating to liquidated damages and penalties, these rules developed separately from, and did not apply to, the law relating to deposits.
Lord Hailsham LC referred to Howe v Smith where Fry LJ said:
“It (the deposit) is not merely part payment, but is then also an earnest to bind the bargain so entered into, and creates by fear of its forfeiture a motive in the payer to perform the rest of the contract.”
The learned Lord Chancellor also referred to the judgment by Cotton LJ in Howe v Smith where the latter, adopting the words of James LJ in Ex Parte Barrell LR 10 Ch 512, described a deposit in the following terms:
“The deposit … is a guarantee that the contract shall be performed. If the sale goes on … it goes in part payment of the purchase money for which it is deposited; but if on default of the purchaser the contract goes off, that is to say, if he repudiates the contract, then … he can have no right to recover the deposit.”
His Lordship further expressed the view that the expressions “deposit” and “earnest money” whenever used, bear the same meaning. The learned judge also observed that “there is nothing unusual or extortionate in a 10% deposit on a contract for the sale of land.”
As the Board had, in relation to the first point, concluded that the sum of $377,500 was paid as a true deposit, section 75 of the Ordinance would not apply and the sum was liable to be forfeited as a result of the failure by the Purchaser to complete, whether or not damage is proved.
As for the third question, the Privy Council disagreed with Ong CJ and held that section 65 of the Ordinance did not apply. In the opinion of the Board, Ong CJ’s view could not be sustained as it had been held in a number of cases, such as Natesa Aiyar v Appavu Padayachi I.L.R. 38 Mad. 178, Naresh Chandra Guha v Ram Chandra Samanta and Others and P.M. Pillay v Kampur Rubber and Tin Company Limited (an unreported decision of the Malayan High Court), that a deposit is not a benefit received under a contract within the meaning of section 65 of the Ordinance but was “a security that the purchaser would fulfil his contract and ancillary to the contract for the sale of land.”
Accordingly, the Board advised the Yang di Pertuan Agung to allow the Vendor’s appeal and restore the judgment of the High Court in dismissing the Purchaser’s claim.
The decision of the Privy Council in Linggi Plantations Ltd v Jagatheesan affirmed the application in Malaysia of the principles laid down in Howe v Smith and the decisions of the Indian Courts on the treatment of a deposit paid for the purchase of land. It established beyond doubt that a reasonable sum paid by a purchaser by way of a deposit is forfeitable by a vendor without proof of loss or damage suffered as a result of the failure by the purchaser to complete the transaction.
Linggi Plantations Ltd v Jagatheesan also made it clear that sections 65 and 75 of the Ordinance (now Contracts Act 1950) do not apply to the forfeiture of deposits. The principles laid down in this case remain applicable to this day, notwithstanding that more than 40 years have passed since the judgment of the Privy Council was delivered on 7 December 1971.