Indemnity for Penal Sanctions, Reasonableness and Severability

In the recent Singapore High Court case of Kay Lim Construction & Trading Pte Ltd v Soon Douglas (Pte) Ltd and anor, [2012] SGHC 186, the High Court gave guidance on indemnity clauses for penal (criminal) sanctions and severability of such provisions to save the overall indemnity clause. The High Court also held that the Unfair Contract Terms Act (Cap. 396) would apply even in contracts between commercial parties when one party deals with the other on a standard terms contract.

This matter arose out of a crane collapse at a Housing Development Board (HDB) construction site. The plaintiff, Kay Lim, secured a contract to construct seven blocks of HBD residential units. The defendant, Soon Douglas, carried on the business of renting and leasing out, inter alia, tower cranes. Soon Douglas was accredited by the Ministry of Manpower as an Approved Crane Contractor under the Workplace Safety and Health (Operation of Cranes) Regulations.

Under the Rental Agreement entered into between Kay Lim and Soon Douglas, Soon Douglas was responsible for the delivery, erection, as well as the dismantling and removal of the Tower Cranes from the site. Soon Douglas subcontracted out the dismantling of a particular crane to another Approved Crane Contractor. Subsequently, the subcontractor dismantled a crane which suddenly collapsed midway and killed one worker while injuring another three. There was no dispute that the improper dismantling of the crane by the subcontractor was the cause of the collapse and subsequently death and injuries (materially, after the accident, that subcontractor ceased to be active in the market and its insurers had repudiated liability).

The issue of Soon Douglas’ liability revolved around whether the Rental Agreement contained implied terms to the effect that Soon Douglas would provide properly skilled and qualified labour and trained personnel to dismantle the Tower Cranes and that Soon Douglas would ensure that the dismantling and removal of the Tower Cranes would be done in a skilful and proper manner in accordance with any operating instructions issued for them (see paragraph [13]). That issue was resolved in favour of Kay Lim when the High Court found that such implied terms existed and Soon Douglas was in breach of those terms.

The matter therefore turned to the indemnity and exclusion provisions which Soon Douglas (or rather its insurer) sought to rely on in order to excuse their liability under the Rental Agreement.

The Indemnity / Exclusion Provision

The relevant indemnity / exclusion provisions were as follows:

3. HIRER’S COVENANTS

The Hirer [i.e. Kay Lim]…agrees:

3.7 INDEMNITY

3.7.1 To indemnify the Owner against all loss actions claims demands proceedings (whether criminal or civil) costs legal expenses (on a full indemnity basis) insurance premiums and calls liabilities judgments damages or other sanctions arising directly or indirectly from the Hirer’s failure or alleged failure to carry out its duties under this Agreement or by reason of any loss injury or damage suffered by any person from the presence of the Equipment or the delivery possession use operation removal dismantling or return of them from any defects in the Equipment.

3.7.2 The Owner shall not be liable or responsible for any direct or consequential loss suffered by the Hirer in consequence of any downtime, stoppage of work, compliance with any order or directive from any judicial or governmental authority or by reason of any loss injury or damage suffered by any person from the presence of the Equipment or the delivery possession use operation removal dismantling or return of them or from any defects in the Equipment.”

Indemnity for Criminal Proceedings – Void for Illegality?

Soon Douglas (as Owner) sought to rely on the indemnity clause in 3.7.1 to avoid liability. In turn, Kay Lim argued that the entire clause ought to be impugned insofar as the clause “purport[ed] to impose an obligation on Kay Lim to indemnify Soon Douglas against ‘all loss actions claims demands proceedings (whether criminal or civil)’ [emphasis added]. It [wa]s against public policy for a party to indemnify another against loss, actions, claims, demands or proceedings arising out of or from the consequences of a crime” (see paragraph [33]).

Furthermore, Kay Lian sought to argue that the doctrine of severance could not operate at all to save the clause on the basis that the clause purported to cover all forms of criminal conduct and should be confined to categories of clauses like restraint of trade provisions [see paragraph (33)]. In this respect, Halsbury’s Laws of Singapore 2009 reissue Vol 7: Contract at para 80.363 states that:

“…there are degrees of illegality, and it is reasonable to suppose that the more extreme or virulent forms of illegality will preclude the doctrine of severance from operating at all…the vast majority of cases where severance has not only been considered but has also been permitted are those dealing with contracts in restraint of trade. As we have already seen, such contracts are not considered contracts that are at the higher or upper levels, as it were, on the scale of illegality. Albeit by no means conclusive, particularly (as alluded to above) from a strictly rationalistic viewpoint, it is suggested nevertheless that the doctrine of severance is confined, in the main (if not solely), to contracts in restraint of trade…”

Soon Douglas accept that the clause was “contrary to public policy insofar as it purported to provide an indemnity against criminal liability“, but argued that the so-called blue pencil test could be invoked to sever only the impugned portion of the indemnity clause and the rest upheld by the court.

The High Court rejected Kay Lim’s “restrictive” reading of severability (see paragraph [34]). Instead, it held that,

“The overarching question with respect to severability is not whether the illegal contract falls within a particular category (eg, restraint of trade), but whether the nature and degree of the illegality is such that it taints the entire clause or contract and renders it contrary to public policy to enforce even the unobjectionable portion. This approach necessarily requires the consideration of public policy based on the specific fact situation in each case and the exercise of discretion by the courts and there cannot be any hard and fast rules on the exact scope and limits of the doctrine of severance”. 

The Singapore Court of Appeal had previously considered the blue pencil test in Man Financial (S) Pte Ltd (Formerly known as E D & F Man International (S) Pte Ltd) v Wong Bark Chuan David [2008] 1 SLR(R) 663; [2007] SGCA 53 at [127] holding that by striking out the offending words, it must not thereby change the meaning of the provision or render it “senseless (whether in a grammatical sense or otherwise)” (see paragraph [127]). The Court of Appeal elaborated in CLAAS Medical Centre Pte Ltd v Ng Boon Ching [2010] 2 SLR 386; [2010] SGCA 3 at [70] that what is meant by not altering the meaning of the provision “just means not altering the sense of what remains of the clause after running the blue pencil through…the obnoxious portion must be capable of being removed without the necessity of adding to or modifying the wording of what remains” (see paragraph [36]).

The High Court considered that the offending phrase did prima facie impose an obligation on Kay Lim to indemnify Soon Douglas for any form of criminal liability. However, the High Court considered that in the context of the Rental Agreement (“a contract for the hire of specialised equipment in the construction industry“), the illegality contemplated was not such an “extreme or virulent form of illegality” so as to negate the operation of severance altogether. This is because the clause “seem[ed] to be mainly directed at criminal liability arising from strict liability and regulatory offences in the construction industry and those attributable to Kay Lim’s, and not Soon Douglas’s, own conduct or omissions“.

Accordingly, the potential illegality was not such that it permeated the entire clause so that even if the offending portion was excised, that the High Court would decline to enforce the rest of the clause on public policy grounds. The High Court held that,

Civil indemnity clauses are a common means by which parties allocate risks contractually, and generally speaking, I do not see any strong public policy reasons why the courts should decline to enforce such a term if commercial parties have seen fit to include it as part of their bargain“.

The High Court considered that it was easy to strike out the offending phrase “whether criminal or civil” from clause 3.7.1 without altering what remained of the clause or rendering it senseless and would therefore uphold the clause to the extent that it does not apply to liability in criminal proceedings (see paragraph [38]).

Scope of the Indemnity Clause – Unfair Contract Terms Act and Reasonableness

The High Court held that it was trite law that limitation and exemption clauses are to be construed strictly and that if a party sought to exclude or limit his liability, he must do so in clear words (see paragraph [40] and [41]). The High Court rejected Soon Douglas’s interpretation of clause 3.7.1 which would have obliged Kay Lim to indemnify Soon Douglas for losses to Kay Lim caused by Soon Douglas’ breaches of contract (see paragraph [44]).

The High Court held that “[i]n the absence of clear and unequivocal language in the indemnity clause, [the Court found ]it inherently improbable, and indeed bordering on commercial absurdity, that Kay Lim would have agreed to the circular obligation of indemnifying Soon Douglas for any claims brought by Kay Lim for loss and damage suffered as a result of Soon Douglas’s breach of contract” (see paragraph [45]).

In any event, Kay Lim also sought to argue that clause 3.7.1 and 3.7.2 were both unreasonable under the UCTA and therefore was void and unenforceable. The High Court disagreed that the clauses were unreasonable.

However, pertinently, the High Court held that the UCTA did in fact apply to the clause insofar as Kay Lian was dealing on Soon Douglas’s standard terms contract. The High Court rejected the argument that Kay Lian was not dealing as a consumer and therefore was not entitled to rely on the UCTA.

Section 3 of the UCTA states:

3.—(1) This section applies as between contracting parties where one of them deals as consumer or on the other’s written standard terms of business.

(2) As against that party, the other cannot by reference to any contract term —

(a) when himself in breach of contract, exclude or restrict any liability of his in respect of the breach; or

(b) claim to be entitled —

(i) to render a contractual performance substantially different from that which was reasonably expected of him; or

(ii) in respect of the whole or any part of his contractual obligation, to render no performance at all,

except in so far as (in any of the cases mentioned in this subsection) the contract term satisfies the requirement of reasonableness.”

The High Court considered that clause 3.7.2 fell squarely within section 3(2)(a). Similarly, given that clause 3.7.1 also had the effect of excluding or restricting liability, UCTA would apply as well (see paragraph [87]).

On its narrower and more restrictive interpretation of clause 3.7.1, the High Court held that it was reasonable. It also held that clause 3.7.2 was reasonable on the basis that “it is consistent with the allocation of contractual risk that two commercial parties of equal bargaining power are entitled to agree upon” (see paragraph [95]). In this respect, it was not the case that Kay Lim would not have been in a position to enter into the Rental Agreement without the clauses, or that it was forced to enter into the agreement on a take-it-or-leave-it position or that it had a weak bargaining position (see paragraph [96]).

However the High Court made a few pertinent comments (see paragraph [93]).

  1. A party is still entitled to invoke UTCA even if he had freely entered into the contract containing the impugned term or simply did not turn his attention to the term (see paragraph [93]);
  2. The fact that a party had repeatedly entered into agreements on similar terms without complaints previously does not make a term reasonable.
  3. The fact that both parties are commercial entities by itself does not make a term reasonable, although the court would be less quick to intervene in such circumstances.

Conclusion

Parties should be mindful when drafting their indemnity provisions not to provide for indemnification in respect of criminal proceedings as such provisions would be void and unenforceable on public policy grounds. While such clauses can be saved through the doctrine of severance and the blue pencil test, nonetheless, the more prudent course would be to avoid language relating to criminal proceedings and sanctions altogether.

Parties should also note that the UCTA does not just apply to consumers qua individuals but also commercial entities as well, especially when dealing on a standard terms contract basis.

About Shaun Lee

International Dispute Resolution and Arbitration lawyer. Fellow of the Chartered Institute of Arbitration. Panel of Arbitrators and Panelist for Domain Name Dispute Resolution at the KLRCA.
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One Response to Indemnity for Penal Sanctions, Reasonableness and Severability

  1. Pingback: Technology and Outsourcing Hot Spots: Pre-Contractual Negotiations | Singapore International Arbitration Blog

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