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Facing the consequences: excluding consequential loss

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Introduction

The recent Commercial Court case of Star Polaris LLC v HHIC-Phil Inc [2016] offers an important reminder of the pitfalls of excluding liability for “consequential loss”. The court found that here, excluding liability for “consequential loss” meant excluding financial losses caused as a result of physical damage. This is a departure from precedent going back many years.  It will be important to draft contracts carefully to avoid any ambiguity. 

Facts

Star Polaris (the Buyer ) entered into a contract with HHIC Phil (the Yard) to build a ship (the Star Polaris). After delivery the vessel suffered a serious engine failure. The Buyer commenced an arbitration against the Yard, seeking to recover (a) the cost of repairs to the vessel and (b) other costs such as towage fees, agency fees and off-hire fees.

The tribunal found that the Yard was in breach of its warranty of quality, and awarded the Buyer part of the costs of repair. However, the Buyer was not entitled to recover the second category of losses because the contract excluded liability for “consequential or special losses, damages or expenses”.  The Buyer appealed the tribunal’s decision in the Commercial Court.

Background

The established meaning of “consequential loss” is summarised in Lewison on the Interpretation of Contracts (5th Ed), section 12.14:

The cases lay down the principle of interpretation that a clause which excludes liability for consequential loss excludes liability only for damages falling within the second limb in the rule [in Hadley v Baxendale].

Losses recoverable under the first limb of Hadley v Baxendale are those losses which occur "in the ordinary course of things". Losses recoverable under the second limb are losses which arise due to special circumstances which are outside the ordinary course of things but which were communicated to the defendant or otherwise known by the parties.

Losses falling under the first limb may include loss of profit or other losses which could reasonably be expected to flow from the breach.

There is a very long line of cases which have held that a clause excluding consequential losses only excludes losses which fall under the second limb and will therefore not automatically exclude losses such as loss of profit or management time, which often fall under the first limb.  

However, the recent Court of Appeal case of Transocean Drilling v Providence Resources [2016] case some doubt on this case law, suggesting that some of those cases might be decided differently today. That paved the way for the decision in Star Polaris.

The Commercial Court’s decision

The Buyer argued that the words the parties had chosen had an established meaning as a matter of law, and that was part of the relevant factual matrix. There is also authority that the words “special losses” (used in the contract with “consequential losses”) means the second limb of Hadley v Baxendale, and using these two phrases together was a strong indication of the parties’ intention. Further, the parties had deleted the exclusion of damages for loss of use from the standard form that they used.

These are convincing arguments which are supported by a substantial body of case law. Nevertheless, the court found, in favour of the Yard, that the parties had agreed objectively that financial loss consequent on physical damage was excluded.

In reaching this conclusion, the court placed a heavy emphasis on reading the contract as a whole:

  • The contract “set out a code” for the extent of the Yard’s guarantee for workmanship, excluding all other liabilities imposed by statute, common law or otherwise.
  • The court held that the exclusion for “consequential or special losses, damages or expenses” did not have the effect of making the Yard liable for losses within the first limb of Hadley v Baxendale when such losses had been specifically excluded.
  • Therefore, in the context as whole, the exclusion did not mean such losses as fall within the second limb of Hadley v Baxendale, but had the wider meaning of financial losses caused by physical defects.

Points to note

  • Excluding “consequential losses” has always been, and remains, dangerous. This case has increased the uncertainty around which losses will be consequential. When drafting exclusion clauses it is best to specify which types of loss are excluded.
  • Every case will be decided on its facts, and judicial precedent has limited value in contract interpretation cases. This first instance case was decided despite Court of Appeal authority on the meaning of exclusions for “consequential loss”.
  • It is important to read the contract as a whole, and understand the “scheme of the contract” particularly where the contract includes guarantees and remedy provisions. If the contract provides for these remedies to be exclusive, then the court will respect that.

 

 

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