Penalty Clauses

• Law Firm: Adsan Law
• Subject Matter: Corporate/Commercial Law, Litigation, Mediation & Arbitration, Contracts and Commercial Law, Trials & Appeals & Compensation
• Author: Mr Lance Ang
• Published date: 25 May 2023

OVERVIEW

Freedom of contract is a fundamental principle of Singapore contract law. The Singapore courts generally uphold the freedom of parties to determine their respective contractual obligations. However, contractual freedom is not absolute and the courts will not enforce a contractual provision which is found to be a penalty clause pursuant to the rule against penalties. This is seen most recently in the Court of Appeal decision in Ethoz Capital Ltd v Im8ex Pte Ltd and others [2023] SGCA 3.

Briefly, in Ethoz, Ethoz Capital Ltd ("Ethoz") extended loan facilities to Im8ex Pte Ltd ("Im8ex") of a principal amount of $6.3 million at an interest rate of 3.75% per annum, with instalment payments to be made monthly over 180 months. Im8ex defaulted on payment and was subject to the payment of default interest of 0.0650% per day with monthly rests (the "Default Interest"), as well as the full and immediate payment of total interest due on the principal amount (that would otherwise have been payable only on instalment) (the "Total Interest").

RULE AGAINST PENALTIES

What is a Penalty Clause?

The Court of Appeal reaffirmed the prevailing test in Singapore to determine if a provision is a penalty clause as set out in Dunlop Pneumatic Tyre Co, Ltd v New Garage and Motor Co, Ltd [1915] AC 79. Under the Dunlop test, a provision that requires the payment of money in terrorem of the defaulting party an unenforceable penalty clause. However, if it is a genuine pre-estimate of loss by the non-defaulting party at the time of contracting, it would be an enforceable liquidated damages clause.

In determining whether a clause is a penalty, the courts will consider the following:

1. whether "the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach" (the "Greatest Loss Test");
2. whether "the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid" (the "Greater Sum Test"); and
3. whether "a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage" (the "Single Lump Sum Test").

The approach by the Singapore courts in this regard departs from the English approach, under which a provision is a penalty if it imposes a detriment on the defaulting party "out of all proportion to any...