Ip Ming Kin v. Wong Siu Lan

CACV 201/2012

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 201 OF 2012

(ON APPEAL FROM DCCJ NO. 1236 OF 2010)

________________________

BETWEEN

________________________

J U D G M E N T

________________________

Hon Cheung JA:

1.I agree with the judgment of Kwan JA.

Hon Kwan JA:

2.This is an appeal of the defendant landlord, Madam Wong Siu Lan (“the Landlord”), against the judgment of HH Judge Leung given on 30 March 2012.  Leave to appeal was given by this court (Yuen and Kwan JJA) on 6 September 2012.

3.The only issue on appeal relates to the enforceability of a provision in the tenancy agreement, depending on whether it was a penalty or a genuine pre-estimate of loss on a true construction of this term.

4.The background matters, the judgment below and the arguments on appeal may first be stated as follows.

The background

5.The Landlord was a retired person for four years at the time of the tenancy agreement.  She acquired real properties one after the other with her savings and in early March 2010, she owned five shop premises, all of which were let.  She had the experience of dealing with estate agents and entering into written agreements[1].

6.The plaintiff tenant, Mr Ip Ming Kin (“the Tenant”), was in the business of a contractor of interior design and decoration.  In 2009, he and his partner set up a shop at the Lam Tin Estate to take on business for interior decoration from customers about to move into new flats at that public housing estate.  At the end of 2009, he was looking for shop premises at Lok Hin Terrace in Chai Wan, with the view to repeating his mode of business in Lam Tin, as the new public housing units at the Chai Wan Estate were about to be occupied[2].

7.The Tenant had attempted once to rent the shop premises in question at Lok Hin Terrace from the Landlord at the end of December 2009.  He offered $15,000 as monthly rent but was turned down[3]. On his second attempt to rent the shop premises, he successfully reached an agreement with the Landlord.

8.The parties entered into a tenancy agreement in a standard form in Chinese dated 13 January 2010 in respect of the shop premises in Chai Wan (“the Shop”), by which the Landlord agreed to let the shop to the Tenant for 12 months commencing on 15 March 2010 at a monthly rental of $17,300.

9.Two of the handwritten clauses inserted at the end of the agreement are of particular importance.  These terms in Chinese read as follows:

“租客預交10個月租金共HK$173,000

業主如未能於15/3/2010將上述單位交吉給租客需雙倍租金賠償”

10.My translation of these terms would read:

“The Tenant is to pay in advance 10 months’ rent totalling HK$173,000

The Landlord, if not able to deliver up vacant possession of the aforesaid premises to the Tenant on 15/3/2010, is required to compensate double the amount of rent”.

11.Clause 5 in the standard terms provided that the Tenant was to pay two months’ rent as rental deposit in the amount of $34,600.  The standard receipt clause at the end of the agreement was altered by characters inserted by hand at the end so it read:

“茲收到本租約 (五) 租金之按金港幣参萬仟陸佰加租金10个月壹拾柒万参仟元”

12.My translation of this would be:

“Received under [clause] (5) in this tenancy agreement deposit of HK$34,600 plus rental of 10 months HK$173,000”.

13.Upon signing of the tenancy agreement, the Tenant gave the Landlord a cheque dated 13 January 2010 in the sum of $207, 600, which was equivalent to the rentals for the whole term of 12 months.

14.On 19 January 2010, the Landlord returned the amount paid by the Tenant’s cheque to him by depositing the sum into his bank account, without prior notice to him.  On 6 February 2010, the Tenant by a letter of his solicitors informed the Landlord of his election to affirm the tenancy agreement notwithstanding the Landlord’s return of the money and sent her a cheque of his solicitors dated 5 February for $207,600.  She was requested to deliver up vacant possession pursuant to the tenancy agreement, failing which she should compensate him with a sum equivalent to the amount of rental paid by him as liquidated damages together with refund of all monies paid by him under the agreement.

15.The solicitors’ cheque was never presented for payment by the Landlord.

16.The Landlord failed to deliver up vacant possession on the contractual date of 15 March.  By a letter of his solicitors dated 19 March 2010, the Tenant informed the Landlord he accepted her repudiation of the agreement and demanded compensation of $173,000 and the agency fee of $8,650 paid by him to the estate agent.

17.The Landlord attended the office of the Tenant’s solicitors on 24 March 2010 with an offer to deliver up vacant possession.  This was turned down by the Tenant, who issued the writ in this action against the Landlord on 12 April 2010.

The judgment below

18.The Tenant claimed against the Landlord damages for repudiation of the tenancy agreement in the sum of $207,600 being “the agreed compensation” under the agreement and $8,650 being the agency fee paid by him to the estate agent, as pleaded in Amended Statement of Claim, para 10.  In the prayer for relief, the Tenant claimed the sum of $216,250 as pleaded in para 10 and “further or in the alternative damages for breach of the Tenancy Agreement”.

19.After a four-day trial, the judge resolved all the issues of liability in favour of the Tenant.  He held that the Landlord had repudiated the agreement and the Tenant had accepted her repudiation.

20.The judge then turned to the contractual provision relied on by the Tenant to claim compensation.  He resolved the dispute on the correct construction of “需雙倍租金賠償” (translated as “required to compensate double the amount of rent”) in favour of the Tenant.  As there was an ambiguity whether the rent referred to was the monthly rent or the rent for the whole term of one year, he permitted the parties to give evidence of what they had allegedly agreed.  He preferred the Tenant’s evidence in this respect.  He rejected the Landlord’s contention that this meant double the amount of the monthly rent in the sum of $34,600.  He held that the correct meaning was double the amount of 12 months’ rent payable for the entire term of the tenancy[4].  There is no appeal from this holding.

21.The next issue the judge dealt with was the dispute whether the contractual provision for compensation would amount to a penalty and hence unenforceable.  As stated by the judge, this is a question of construction to be decided upon the terms and inherent circumstances of a particular contract, judged of at the time of the making of the contract, not as at the time of the breach, and that the test is objective.  Having referred to the well-known guidance given by Lord Dunedin in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79 at 86 to 88, and considering all the circumstances prevailing at the time of the tenancy agreement objectively, he held that the provision specifying the agreed damages equivalent to double the amount of rent for the 12-month term was not a penalty but a genuine pre-estimate of loss[5].

22.In view of the above findings, there was no need to deal with the alternative claim of the Tenant for unliquidated damages.  The judge only mentioned that the pleading of the alleged loss or damage for the alternative claim is lacking and he doubted whether the alleged loss was proved by the evidence adduced before him[6].

23.The judge rejected the additional claim for estate agency commission as the parties had agreed the liquidated damages in the event of the Landlord’s failure to deliver up vacant possession and the amount of double the amount of rent for the 12-month term would be the compensation payable irrespective of the actual loss incurred[7].

24.He gave judgment to the Tenant in the sum of $207,600 with interest and costs.

The Landlord’s arguments on appeal

25.Mr Lincoln Cheung, who appeared for the Landlord in this appeal but not below, did not suggest that the judge was in error in respect of his statement of the legal principles.  What was challenged by counsel is the application of the principles to the present case.

26.His arguments may be summarised as follows:

(1)  The judge failed to hold or infer on the evidence that the predominant and overriding purpose of the relevant provision was not to provide compensation for breach but to hold the Landlord in terrorem, and to deter her from breaking the contract.  The real purpose of the provision was not to provide compensation for breach at all but to compel the Landlord to perform the obligation of delivering up vacant possession on the specified date and to afford the Tenant a substantial guarantee against the risk of not having the Shop rented.

(2)  The judge should hold on the evidence there was no genuine effort by the parties to pre-estimate the likely loss that the Tenant would suffer in the event of breach.  On the Tenant’s evidence, which was accepted by the judge, the amount of double the rent was a figure given by the Landlord “arbitrarily”.  Further, the unusual stipulation of an equal fixed sum against both parties equivalent to the rent for the entire term in the event of breach by either in itself amounts to an extravagant penalty.

(3)  The relevant provision could be invoked not just where the Landlord had failed to deliver up vacant possession at all, but could also be invoked where the breach was trivial, such as where there was a slight delay in delivering up possession or where the Landlord had failed to remove all her chattels in delivering up possession.  There is a presumption that the provision is a penalty when a single lump sum is made payable by way of compensation, on the occurrence of one or more of several events, some of which may occasion serious and others but trifling damage (Lord Elphinstone v The Monkland Iron & Coal Co Ltd (1886) 11 App Cas 332 at 342, per Lord Watson; Ariston SRL v Charly Records Ltd, English Court of Appeal, 13 March 1990).  And although the parties would probably have confined the payment of the single lump sum to the major breach, yet as they have omitted to do so, it must be taken that their intention was that the sum should stand as a security for the payment of the damages actually incurred by any one of the breaches (Boys v Ansell (1839) 5 Bing NC 390 at 398, per Erskine J).

(4)  The profit the Tenant had expected to make from the business to be operated in the Shop was too speculative and could not form the basis of any genuine pre-estimate of loss.  He had merely lost the opportunity for the making of uncertain profit from a new business he intended to start.  The Tenant’s loss of opportunity to make a profit would not be recoverable at common law as it was too remote and the Landlord did not know of the special circumstances of the Tenant that would make her liable for the enhanced loss under the second rule in Hadley v Baxendale (1854) 9 Ex 341.  Besides, the damages the Tenant was entitled to recover must be the net loss after taking into account his expected ability to mitigate his loss.  There was no evidence that this aspect was taken into account when the parties agreed on the sum to be paid as compensation in the event of breach.

The evidence on the inherent circumstances of the contract

27.Before I examine the cases, it is appropriate to mention the relevant evidence on the inherent circumstances of the tenancy agreement, as Lord Dunedin made clear in the Dunlop case, supra at 87, that although the issue is one of construction of the contract, the court is not confined to the terms of the agreement and may look at the “inherent circumstances of each particular contract, judged of as at the time of the contract, not as at the time of the breach”.

28.In Murray v Leisureplay Plc [2005] IRLR 946, which is an important decision of the English Court of Appeal re-examining the whole issue of liquidated damages and penalties but was not cited to us, it was said by Arden LJ at para 52 that the inherent circumstances to which the court may have regard “extend beyond those which may be adduced in evidence for the purposes of determining the true interpretation of the agreement under the well known test in the Investors’ Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896”.  The purpose of adducing that evidence “is not so that the parties can demonstrate that they agreed to opt out of the remedies regime provided by the common law but rather that the reasons that they had for doing so constitute adequate justification for the discrepancy between the contractual measure of damages and that provided by the common law.”

29.Here, according to the tenant’s evidence, which was accepted by the judge, apparently not much was said by the parties in their negotiation when they agreed on the provision for compensation, nor was there much questioning of the parties at the trial as to their reasons for doing so.  But the sparse nature of the evidence does not mean that the court should be handicapped in approaching this task.  I quote again from the judgment of Arden LJ at para 55:

“What happens if there is no evidence about the reasons for the clause? There would in my judgment be no reason why the court could not draw inferences of fact as to the reasons and as to the genuineness of those reasons. What if it appears from the evidence that is given (or from the inferences that the court makes from the facts) that the decision to include the damages clause was included on the basis of a mistaken belief that the damages at common law would be assessed on a materially more generous basis than in fact would occur? … In my judgment, the good faith belief of the parties is not the deciding factor here. The court would look at the result and (bearing in mind that the onus is on the party challenging the clause to establish that it is a penalty) ask whether it is satisfied that the parties could not, if they had had the proper information or considerations in front of them, genuinely have considered that the damages payable under the contractual provision were a realistic pre-estimate of the damages payable on breach at common law. In other words, in the context of Lord Dunedin’s speech, the test of genuineness is objective. A pre-estimate is genuine if it is not unreasonable in all the circumstances of the case.”

30.The Tenant’s evidence in the relevant part of the transcript[8] was as follows:

“問: 係，係，你不斷咁聯絡黃小姐 --係呢度我想問清楚你，不斷咁聯絡個陣時，你係咪同佢講「你要交鋪，如果唔係你要賠償，賠十幾萬俾我」咁樣樣，你係咪咁同佢講？

答: 我就冇講話佢要賠幾多錢俾我，咁我有話俾佢聽，我話「妳咁樣就會毀約喎」咁樣，「咁就需要賠償喎」咁樣。咁其實佢呢個賠償佢自己都知既，因為我地之前電話個個對話傾租約、傾「盛」既時間，我俾一年租佢，黃小姐自己係好清楚既。佢話「我收得你一年租，如果我到時唔租俾你」-  因為之前有個個案就係話我地第一次簽左臨時合約佢都可以反悔呀嘛，咁我亦都怕左佢反悔，所以我曾經係個電話個個對話個度都曾經講過呢句 -- 呢段說話既。咁我話我俾一年租你，你收左一年租，咁我話你咁大租。咁佢就話，「如果我收左你租仲係係度玩退租既話，咁我要賠雙倍俾你架喎」，咁個銀碼係佢自己講既。”

(Emphasis supplied)

31.What the Tenant said in his evidence was that when he and the Landlord negotiated on the telephone, the Landlord told him as she was to receive one year’s rent in advance, if she should play tricks and refuse to rent the Shop to him, she would compensate him with double the rent.  The Tenant said there was a previous occasion when they signed a provisional agreement and she had reneged on it, that he had concerns she might renege again, so he brought up the matter he had to pay a year’s rent in advance and the Landlord said she would pay double the rent as compensation if she should refuse to rent.  The amount of compensation was a figure mentioned by the Landlord.

32.Mr Cheung submitted it is apparent from the above that both parties did not envisage the pre-estimation of loss at the time of the formation of the contract.  The Tenant did not suggest at the time that the sum the Landlord mentioned was a genuine pre-estimate of his loss.  And both had never attempted to estimate in advance the loss that the Tenant would suffer.  He submitted it is clear from the above conversation that the figure was just an arbitrary sum mentioned by the Landlord, and the purpose of the provision for compensation was to deter her from breaking the contract.

33.Whether that is the appropriate inference and finding to be drawn on the evidence is a matter I would come back to.

General observations

34.I would start with some general observations in the case law pertinent to the present case.

35.The public policy that the court will not enforce a penalty clause so as to permit a party to a contract to recover in an action a sum greater than the measure of damages to which he would be entitled at common law, though well established at law, is anomalous and appears to be sui generis, as the court has no jurisdiction to re-write the terms of a contract because it thinks them unduly onerous to one of the parties (Robophone Facilities Ltd v Blank [1966] 1 WLR 1428 at 1446F to 1447B, per Diplock LJ).

36.There is no reason in public policy why the parties to a contract should not enter into a sensible arrangement under which each would know in advance with a reasonable degree of certainty the financial consequence in the event of a breach by the other party, and the more difficult it is to prove and assess the loss, the greater the advantages to both of fixing by the terms of the contract a readily ascertainable sum to be paid, thereby avoiding litigation, and, if this is not possible, reducing the legal costs of proving the loss.  The courts should not be astute to descry a clause in a contract which stipulates a sum to be payable by the party in breach (Robophone Facilities Ltd, at 1447B to E, and 1449D to E, per Diplock LJ), lest they impinge on the parties’ freedom to settle for themselves the rights and liabilities following a breach of contract (AMEV UDC Finance Ltd v Austin (1986) 162 CLR 170 at 193).  See also the judgment of the Privy Council in Philips Hong Kong Ltd v The Attorney General of Hong Kong [1993] 1 HKLR 269 at 278 to 279, per Lord Woolf.

37.Because the rule about penalties is an anomaly within the law of contract, the courts are pre-disposed, where possible, to upholding contractual terms which set the level of damages for breach, especially in commercial contracts made between parties of comparable bargaining power (Alfred McAlpine Capital Projects Ltd v Tilebox Ltd [2005] Build LR 271 at para 48).  As Lord Woolf has said in the Philips case at 280, “the fact that two parties who should be well capable of protecting their respective commercial interests agreed the allegedly penal provision suggests that the formula for calculating liquidated damages is unlikely to be oppressive.”

38.The onus of showing that a contractual provision is a penalty clause lies on the party who is sued upon it (Robophone Facilities Ltd, at 1447F, per Diplock LJ).

39.The essence of a penalty is a payment of money stipulated as in terrorem of the offending party, whereas the essence of liquidated damages is a genuine pre-estimate of damage (Dunlop case, supra at 86).  The phrase “in terrorem” should not obscure the fact that “penalties may quite easily be undertaken by parties who are not in the least terrorised by the prospect of having to pay them” (Campbell Discount Co Ltd v Bridge [1962] AC 600 at 622, per Lord Radcliffe).  See also Murray v Leisureplay Plc at paras 47, 106, 109 and 110.

40.Colman J has given a more modern and accessible paraphrase of the concept of penalty in Lordsvale Finance Plc v Bank of Zambia [1996] QB 752 at 762G to H:

“… whether a provision is to be treated as a penalty is a matter of construction to be resolved by asking whether at the time the contract was entered into the predominant contractual function of the provision was to deter a party from breaking the contract or to compensate the innocent party for breach. That the contractual function is deterrent rather than compensatory can be deduced by comparing the amount that would be payable on breach with the loss that might be sustained if breach occurred.”

The tests in distinguishing between a liquidated damages clause and

penalty

41.To assist in the task of construction, Lord Dunedin set out various tests in the Dunlop case, supra at 87 to 88, which may prove “helpful, or even conclusive”, in determining whether a provision is a valid liquidated damages clause or a penalty.  Such are:

“(a) It will be held to be penalty if 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. (Illustration given by Lord Halsbury in Clydesbank Case [1905] AC 6).

(b) It will be held to be a penalty if 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 (Kemble v. Farren (1829) 6 Bing. 141.) ...

(c) There is a presumption (but no more) that it is penalty when ‘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’ (Lord Watson in Lord Elphinstone v. Monkland Iron and Coal Co. 11 App Cas 332).

On the other hand:

(d) It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of the breach are such as to make precise pre-estimation almost an impossibility. On the contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties (Lord Halsbury, Clydebank Case [1905] AC 11; Lord Mersey, Webster v. Bosanquet [1912] AC 398).”

42.It should be noted that the proposition in (c) is a presumption only and may be rebutted.  Further, Lord Woolf in the Philips case has warned against the danger inherent in arguments based on hypothetical situations where it is said that the loss might be less than the sum specified as payable as liquidated damages.  “Arguments of this nature should not be allowed to divert attention from the correct test as to what is a penalty provision – namely, is it a genuine pre-estimate of what the loss is likely to be? – to the different question, namely, are there possible circumstances where a lesser loss would be suffered?” (at 283).  Lord Woolf also stated at 279 to 280:

“Except possibly in the case of situations where one of the parties to the contract is able to dominate the other as to the choice of the terms of a contract, it will normally be insufficient to establish that a provision is objectionably penal to identify situations where the application of the provision could result in a larger sum being recovered by the injured party than his actual loss. Even in such situations so long as the sum payable in the event of non-compliance with the contract is not extravagant, having regard to the range of losses that it could reasonably be anticipated it would have to cover at the time the contract was made, it can still be a genuine pre-estimate of the loss that would be suffered and so a perfectly valid liquidated damage provision. The use in argument of unlikely illustrations should therefore not assist a party to defeat a provision as to liquidated damages.”

43.A pre-estimate of damages does not have to be right to be reasonable.  For a pre-estimate to be unreasonable, there must be a substantial discrepancy between the estimated damages and the level of damages likely to be suffered (Alfred McAlpine Capital, supra at para 48).  As was stated by Arden LJ in Murray v Leisureplay Plc, supra at para 43: “The parties are allowed a generous margin”.  “The real question is whether the sums for which the parties have provided to be paid on breach differ substantially from the sums that would be recoverable at common law and whether there is shown to be justification for that” (Murray v Leisureplay Plc at para 46).

44.The members of the court in Murray v Leisureplay Plc reached the unanimous result that a provision for compensation in a contract of employment was not a penalty but adopted different approaches in arriving at the result, with Buxton LJ and Clarke LJ favouring a broader approach to that of Arden LJ.

45.Arden LJ set out in para 54 a series of questions which the court should ask:

“(i) To what breaches of contract does the contractual damages provision apply?

(ii) What amount is payable on breach under that clause in the parties’ agreement?

(iii) What amount would be payable if a claim for damages for breach of contract was brought under common law?

(iv) What were the parties’ reasons for agreeing to the relevant clause?

(v) Has the party who seeks to establish that the clause is a penalty shown that the amount payable under the clause was imposed in terrorem, or that it does not constitute a genuine pre-estimate of loss for the purpose of the Dunlop case, and, if he has shown the latter, is there some other reason which justifies the discrepancy between (i) and (ii) above[9]?”

46.Buxton LJ at para 114 took the view that the above approach introduced a “rigid and inflexible element into what should be a broad and general question” and is “inconsistent with warnings by judges of high authority that, at least in connection with commercial contracts, great caution should be exercised before striking down a clause as penal”.  He said that “exclusive concentration on the factual difference between the liquidated and contractual damages” overlooks a principal test of Lord Dunedin in the Dunlop case, namely that a provision will be held to be a penalty if the sum stipulated for is extravagant and unconscionable.  In the case before the court, it was clear that neither the literal wording nor the spirit of that test applied.  He did not think the traditional learning as to penalty clauses is likely to fit into the dynamics of an employment contract, at least when the penalty is said to be imposed on the employer (at para 115).

47.Whilst Clarke LJ expressed a preference for the broader approach of Buxton LJ (at para 105), he agreed also with the factors taken into account by Arden LJ in deciding whether there was commercial justification for the contractual provision in that case (at para 106).

Applying the principles to this case

48.I return to the facts and circumstances of the present case.

49.Although the evidence as to how the parties had arrived at an agreement of the compensation provision is sparse, it is sufficiently clear that this was directly linked to another term they agreed, namely that the Tenant was to pay one year’s rent in advance.  I do not agree with Mr Cheung’s submission that it should be inferred the purpose of the compensation provision was to deter the Landlord from breaking the contract.  The amount of compensation was not a figure imposed on the Landlord but was freely offered by her, to justify her requirement for the Tenant to pay upfront the rent for the entire period of letting.  It was more of a reassurance from her that he would be properly or adequately compensated if she should refuse to rent the Shop to him.  I note also it was a term agreed between equal parties at arm’s length, so it could not be said that there was oppression for the Landlord having to pay the stipulated compensation.

50.Mr Cheung submitted that the figure offered by the Landlord was arbitrary in that there was no discussion of the parties showing that they had attempted to estimate in advance the probable loss of the Tenant.  I do not think it material for the parties to have discussed or negotiated on the estimate of probable loss.  The important thing is that the Tenant accepted the figure of compensation offered by the Landlord.  It is unnecessary for him to tell her his reasons for acceptance or his estimate, provided that the amount agreed as compensation was not extravagant or unconscionable, or that there is justification for the agreed compensation.

51.I reject also Mr Cheung’s interpretation of the provision for compensation that it was for an equal fixed sum against both parties in the event of breach by either.  The wording of the provision is clear: the Landlord is required to compensate double the amount of rent if she is not able to deliver up vacant possession.  It did not provide for payment of compensation to the Landlord if the Tenant should be in breach.  Insofar as the judge has held that the Landlord was entitled to keep the one year’s rent paid in advance, if the Tenant wrongfully refused to take possession of the Shop when she delivered up vacant possession to him[10], I think the judge may be in error.  In the tenancy agreement, a distinction was drawn between the deposit (being two months’ rent) and the rent paid in advance of ten months.  There is no doubt about the Landlord’s entitlement to forfeit the deposit in the event of the Tenant’s breach, but an advance payment which is not a deposit may well be recoverable by the Tenant (Polyset Ltd v Panhandat Ltd (2002) 5 HKCFAR 234 at paras 56 to 62).

52.As for Mr Cheung’s argument that the agreed compensation could be payable where the breach was trivial, such as where there was a slight delay in delivering up vacant possession or where the Landlord had failed to remove all her chattels in delivering up possession, it seems to me these unlikely hypothetical situations should not assist the Landlord to defeat the provision here, see the statements of Lord Woolf in the Philips case mentioned earlier.  The case of Ariston SRL v Charly Records Ltd relied on by Mr Cheung was an extreme case, the provision there required a fixed amount of compensation to be paid for wrongful failure to return items, regardless of whether many items or just a few were withheld.  In the present case, as the judge has found, the Tenant was after a short term tenancy to repeat his mode of business a year ago, time would be lost if he was not able to take possession of the Shop as agreed, he considered the Shop optimum for his purpose and renewed his effort to rent it even offering to pay the rent for the entire term upfront[11].  It is unlikely he would have invoked the provision for compensation and refused to take possession if there was just a slight delay or that the Landlord had failed to remove some chattels in delivering up possession.

53.On the evidence accepted by the judge, the Tenant rented the Shop with the intention to repeat his mode of business at the Lam Tin Estate in 2009.  The profit from that business was just above $1,400,000[12].  The Tenant projected that the income from the business he intended to operate at the Shop could have been in the region of $2,800,000 to $3 million and the profit could have been about $800,000 to $1 million[13].  The amount of double the rent payable in the event of breach by the Landlord was $415,200.  I agree with the judge that the agreed compensation was neither extravagant nor unconscionable in the circumstances, even taking into account the expected ability of the Tenant to mitigate his loss[14].

54.I reject Mr Cheung’s contention that the profit the Tenant had expected to make from the new business was too speculative and could not form the basis of any genuine pre-estimate of loss.  It was precisely because of the inherent difficulty of estimating the future losses of the Tenant that made it particularly sensible for the parties to have agreed on an amount to be paid in the event of a breach by the Landlord.  It would be difficult to predict what the damages payable would be for the loss of opportunity of the Tenant in making profits had he been able to start his business in the Shop.  This is proposition (d) of Lord Dunedin in the Dunlop case, in which he referred to Lord Halsbury’s statement in Clydesbank Engineering & Shipbuilding Co Ltd v Don Jose Ramos Yzquierdo y Castaneda [1905] AC 6 at 11: “The very reason why the parties do in fact agree to such stipulation is that sometimes, although undoubtedly there is damage and undoubtedly damage ought to be recovered, the nature of the damage is such that proof of it is extremely complex, difficult and expensive.”

55.Mr Cheung argued that the Tenant’s loss of opportunity to make a profit would not be recoverable at common law under the second rule in Hadley v Baxendale, as the Landlord did not know of the special circumstances of the Tenant.  As Diplock LJ had explained in Robophone Facilities Ltd, at 1448D to G, if the contract contained an express undertaking by the defendant to be responsible for all actual loss to the plaintiff occasioned by the defendant’s breach, whatever that loss might turn out to be, it would not affect the defendant’s liability for the loss actually sustained by the plaintiff that the defendant did not know of the special circumstances which were likely to cause any enhancement of the plaintiff’s loss.  This is the usefulness of an agreed liquidated damages provision, as it would be enforceable “whether or not the defendant knows what are the special circumstances which make the loss likely to be [the amount agreed] rather than some lesser sum which it would be likely to be in the ordinary course of things”.

56.Irrespective of whether the approach of Arden LJ or that of the majority in Murray v Leisureplay Plc is adopted, I would have arrived at the same conclusion that the contractual function of the provision in the tenancy agreement is compensatory rather than deterrent.

57.I would answer the five questions posed by Arden LJ in this way:

(1)  The provision applied to the situation when the Landlord failed to deliver up vacant possession of the Shop on 15 March 2010.

(2)  The amount payable by the Landlord as provided by the term was double the amount of 12 months’ rent.

(3)  If a claim for damages for breach of contract was brought under common law, it is possible that the Tenant might not be able to recover the enhancement of his loss attributable to the profits he would have earned from setting up his business at that particular time and in that particular location, as the special circumstances of the Tenant were not known to the Landlord.

(4)  The parties did not give evidence of the reasons they had for agreeing the provision for compensation.  Notwithstanding that, the court can draw inferences as to the reasons and the genuineness of the reasons.  The relevant question is whether the parties could not, if they had had the proper information or considerations in front of them, genuinely have considered that the damages payable under the contractual provision were a realistic pre-estimate of the damages payable on breach at common law.  This question will be answered in (5) below.

(5)  There was no evidence that the agreed compensation was imposed on the Landlord in terrorem. To the contrary, the amount of compensation was offered by the Landlord to justify her requiring the Tenant to pay upfront 12 months’ rent.  And if the parties had before them the relevant information regarding the business that the Tenant was about to set up, the profits he had made in a similar business not long ago, the projected profits he expected to make in the new business, in other words the special circumstances of the Tenant why it was important for him to rent the Shop at that particular time, it could not be shown that the agreed compensation of double the 12 months’ rent would not be a genuine pre-estimate of damage or that it was not otherwise justifiable.

58.If a broad approach is adopted following that of the majority in Murray v Leisureplay Plc, taking the circumstances as a whole and viewing this as at the time the bargain was made, I could discern no great disparity between the sum agreed and the conceivable loss the Tenant would probably suffer in the event that the Landlord should fail to deliver possession of the Shop, leading to the foreseeable consequence that he would not be able to rent suitable alternative premises in the vicinity within time.  There was justification for the agreed compensation, having regard to the amount of rent the Tenant was required to pay upfront and that it was not substantially above the amount of damages he would have recovered at common law, with regard to the range of losses that it could reasonably be anticipated.  The Landlord has failed to show that the amount of compensation she had agreed to pay is so exorbitant and extravagant that it could not possibly have been regarded as damages for any possible breach which was in the contemplation of the parties.  She has failed to discharge the onus of showing that the provision for compensation was a penalty.

59.For the above reasons, I would dismiss the Landlord’s appeal with costs, to be assessed summarily if not agreed within 14 days from the handing down of our judgment.

Hon Lam JA:

60.I respectfully agree with the judgment of Kwan JA.  For my part, I prefer the broader approach of Buxton and Clark LJJ in Murray v Leisureplay plc, supra.  In addition to the paragraphs cited by my Lady, I would also highlight the following parts of the judgment in that case,

(a)   at para 51, Arden LJ expressed the view that in considering whether it is a genuine pre-estimate of loss, “it is a relatively low level of review” and “parties do not have to make an accurate assessment of the damages that would have been awarded at common law”;

(b)   at para 106(xi), Clark LJ stressed,

“It is in my opinion important to avoid nice calculations but to look at the question in the round. It was not for [the party relying on the clause] to justify the clause but for the respondent to show that it was a penalty.”;

(c)   at para 111, Buxton LJ explained the meaning of ‘genuine pre-estimate of loss’,

“ ‘Genuine’ in this context does not mean ‘honest’; and much less … that the sum stipulated must be in fact an accurate statement of the loss. Rather, the expression merely underlines the requirement that the clause should be compensatory rather than deterrent.”

With respect, Mr Cheung’s approach calls for a pre-contractual exercise involving detail assessment of damages before a clause can be upheld as genuine pre-estimate of loss.  The flaw of that approach is completely exposed by these observations.