Hong Kong Court of Appeal takes a practical view on the penalties rule upholding a liquidated damages clause
- Gareth Thomas, Dominic Geiser, Priya Aswani
In the recent case of Brio Electronic Commerce Limited v Tradelink Electronic Commerce Limited CACV 271/2013, the Hong Kong Court of Appeal (CA) held that a clause in the contract setting a sum of HK$5 million as liquidated damages in relation to an obligation of non-solicitation was not a penalty and was therefore enforceable. The CA affirmed the century-old traditional legal test for determining whether a clause is a liquidated damages clause – i.e., whether a clause that took effect on breach was a "genuine pre-estimate of loss" and therefore compensatory, or whether it was aimed at deterring a breach and therefore penal (Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79). In that regard, Hong Kong law now diverges from the latest position in England, which has recently over-ruled Dunlop.
Despite this recent development on the rule on penalties in England (click here and here to read our previous posts on the new rule on penalties in England), Hong Kong courts have not yet followed suit. Nevertheless, it does appear that the Hong Kong Courts are more open to the idea of taking a broad approach, which may have implications for parties entering into commercial contracts in Hong Kong going forward.
Background
Both the plaintiff and the defendant operated in a niche market of providing electronic trade declaration facilities. In 2003, the Government increased competition in the market by issuing a new licence. The plaintiff and the defendant entered into an agreement where the plaintiff agreed to cooperate solely with the defendant and not with the defendant's new competitor. The defendant ensured that none of the plaintiff's clients would connect with the service provided by the defendant's competitor, while the defendant agreed not to seek to persuade the plaintiff's customers from leaving the plaintiff to use the defendant's own services instead.
In 2006, the defendant poached two of the plaintiff's most important customers. The dispute was resolved by settlement with the defendant paying the plaintiff about HK$1.9 million and entering into a second agreement. The second agreement was similar to the first agreement, but there was a liquidated damages clause of HK$5 million in the second agreement. The plaintiff brought an action against the defendant for breach of the second agreement.
At the Court of First Instance, the defendant contended that the liquidated damages clause was a penalty and was therefore unenforceable. The defendant's argument was rejected by the lower court on the basis that, among various things, the second agreement was a commercial agreement entered into by parties who were very familiar with the trade, the agreement was made only after lengthy negotiations, and that the agreed amount of HK$5 million was the parties' best pre-estimate of the damages that were likely to be suffered in the event of a breach of the contractual obligations, the amount of which was not extravagant or unconscionable.