Case Update: Ricardo Leiman v Noble Resources [2018] SGHC 166 – Contractual Discretion and Legal Doctrine of Penalties

Significance: Singapore High Court held that contractual discretion in employment contract is subject to an implied term that the discretion is exercised rationally, not arbitrarily or capriciously, in good faith, and consistent with its contractual purpose. Further, the Court applied the new UK Supreme Court test for penalty clauses in Cavendish Square Holding BV v Makdessi [2016] AC 1172 (UKSC) (“Cavendish“), observing that the clause in question is not a straightforward damages clause, hence the usefulness in applying the Cavendish test.

Contractual Discretion

At [112]-[113]: where a party to a contract is given the power to exercise a discretion, the courts will seek to ensure that such powers are not abused by implying a term as to the manner in which such powers may be exercised. Such a term may vary according to the terms of the contract and the context in which the decision-making power is given: Braganza v BP Shipping Limited [2015] UKSC 17 (“Braganza“) at [18]. The court will imply “a term that the decision-making process be lawful and rational in the public law sense, [and] that the decision is made rationally (as well as in good faith) and consistently with its contractual purpose”: Braganza at [30]. “[I]n the absence of very clear language to the contrary, a contractual discretion must be exercised in good faith and not arbitrarily or capriciously”: British Telecommunications plc v Telefonica O2 UK Ltd [2014] UKSC 42 at [37]. This approach has previously been applied in MGA International Pte Ltd v Wajilam Exports (Singapore) Pte Ltd [2010] SGHC 319.

Tests to be applied for Penalty clauses

[195]: Cavendish makes the point that Lord Dunedin’s traditional test in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79 (“Dunlop“) remains “perfectly adequate” to determine the validity of “a straightforward damages clause”, but in other cases, “compensation is not necessarily the only legitimate interest that the innocent party may have in the performance of the defaulter’s primary obligations” (at [32]). In other words, “[a] damages clause may properly be justified by some other consideration than the desire to recover compensation for a breach”, and this will “depend on whether the innocent party has a legitimate interest in performance extending beyond the prospect of pecuniary compensation flowing directly from the breach in question” (at [28]).

[196]: The rule does not empower courts to review the fairness of parties’ primary obligations. Cavendish has also been cited for “the strong initial presumption” in negotiated contracts between properly advised parties of comparable bargaining power that “the parties themselves are the best judges of what is legitimate in a provision dealing with the consequences of breach”: iTronic Holdings Pte Ltd v Tan Swee Leon and another suit [2016] 3 SLR 663 (“iTronic”) at [177], citing Cavendish at [35]. It is not for the courts to relieve a party from the consequences of what may prove to be an onerous or possibly even a commercially imprudent bargain: iTronic at [177].

[197]: On the facts, the clause in question is not “a straightforward damages clause”. It provides for the employee’s entitlement to exercise share options, subject to his forbearance to act in a way detrimental to the employer. In this connection, concepts such as “in terrorem” and “genuine pre-estimate of loss” mentioned in Lord Dunedin’s speech in Dunlop fit rather uneasily, just as Lord Neuberger and Lord Sumption observed in Cavendish. In such circumstances, the Cavendish inquiry as to whether the secondary obligation “imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation” offers the most appropriate guidance.

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