English Commercial Court considers the meaning of consequential loss

Clear drafting of exclusion and limitation clauses is fundamental to ensuring that the agreed risk allocation between contracting parties is upheld in the event of a dispute. One way of limiting a party's liability is to exclude liability for indirect or consequential loss. 

Established case law has interpreted exclusion clauses which exclude liability for "consequential loss" by reference to the second limb of losses set out in Hadley v Baxendale, namely losses that result from special circumstances, which will only be recoverable if the other party knows of those circumstances. 

The Commercial Court in Star Polaris, however, held that the exclusion clause which excluded liability for "consequential or special loss, damages or expenses" was not limited in this way and should be interpreted to exclude a range of losses arising as a "consequence of breach".

This case serves as a reminder that exclusion clauses will not be interpreted in isolation. They will be viewed in the context of the contractual liability regime as a whole. That being so, using precedent formulations which have been tested by the courts provides no guarantee in a different contractual context.

Facts

In Star Polaris the Commercial Court considered the meaning of the phrase "consequential or special losses, damages or expenses" as it appeared in an exclusion clause in a contract for the construction of a vessel (the Contract).

The claimant (the Buyer) bought the vessel (Star Polaris) from the defendant (the Yard). The Contract guaranteed the vessel for 12 months against all defects due to defective materials, design error, construction miscalculation or poor workmanship (but not other causes such as perils of the sea or normal wear and tear).

The Contract provided that the Yard would have "no liability or responsibility whatsoever or howsoever arising for or in connection with any consequential or special losses, damages or expenses unless otherwise stated herein." The guarantee was expressed to "replace or exclude any other liability…implied by statute, common law, custom or otherwise." The Contract therefore represented an exhaustive liability regime. 

Within several months the vessel suffered an engine failure and was towed to a dockyard for repairs. 

The Buyer commenced arbitration on the basis that the Yard was responsible for the engine failure and claimed damages in respect of the cost of repairs, towage fees, agency fees, survey fees and off-hire, as well as for the diminution in value of the vessel. 

The Tribunal's decision

The Tribunal held that the Buyer's claims, above and beyond the cost of repairs, were excluded under the Contract as they fell within the exclusion of "consequential or special losses, damages or expenses." In doing so, the Tribunal held that the phrase "consequential losses" was not limited to losses or damages which fell within the second limb of Hadley v Baxendale, but instead extended to exclude any losses which were consequential to the direct loss in the sense of following on as a result or consequence of that loss. 

The Buyer appealed the Tribunal's award to the Commercial Court on the basis that the phrase "consequential or special losses" should be interpreted more narrowly. While accepting that it was possible that the parties intended the words to be used in a different sense, the Buyer contended that very clear words would be needed to indicate this. Furthermore, the fact that the term "consequential" had been used in conjunction with "special losses" indicated that the parties intended the phrase to be interpreted as it was in Hadley v Baxendale. 

The Commercial Court's decision

The appeal was dismissed. The Court held that the words should not be viewed in isolation but viewed in the context of the contract as a whole. In this regard it was considered material that:

• The contractual framework agreed between the parties provided a complete code for dealing with liability. As such, the Court had to determine what liability had been included, as well as what liability had been excluded. 
• The Contract required the Buyer to give notice to the Yard with "full particulars of the defect and the extent of the damage caused thereby, but excluding consequential damage, as hereinafter provided".
• The Contract provided that, subject to the Yard's consent, the repairs could be performed elsewhere and the Yard would reimburse the Buyer for the cost. However, the Contract provided that the Buyer would pay the cost of moving the Vessel to the place of repair. 
• The Contract provided that the Yard could forward replacement parts, or send a representative to the yard where the work was being done as long as that did not delay the operation of the vessel.

The Court held that these provisions demonstrated that the liability regime agreed between the parties distinguished between the costs of repairs on the one hand, and losses flowing from the need for those repairs on the other (e.g. the cost of moving the vessel to a yard for the works to be undertaken and any losses resulting from loss of use of the vessel). They also demonstrated that the Yard was not responsible for the cost of any delay, as illustrated by the fact that the provision allowing the Yard to send a representative to the yard where the vessel was being repaired was qualified by the requirement that in doing so the Yard would not delay the operation of the vessel. 

For these reasons, the Court agreed with the Tribunal that the parties had intended to exclude all losses other than the cost of repairs expressly provided for in the Contract. It followed that the Buyer's claim for towage fees, agency fees, survey fees, off-hire, as well as for the diminution in value of the vessel, failed. Viewing the Contract as a whole, the exclusion of "consequential or special losses" was to be interpreted as an exclusion of losses which were consequential to the defects in the sense of following on as a result or consequence of that loss. The interpretation of this phrase should not be limited by reference to the meaning those words are held to bear in the second limb of Hadley v Baxendale. 

Comment

This change in approach was prefigured by the Court of Appeal in Transocean Drilling v Providence Resources, which concerned the hire of a drilling rig. In that case the Court of Appeal questioned the traditional approach to the construction of the phrase "consequential loss" observing that courts are more willing to recognise that words take their meaning from their particular context and that the same word or phrase may mean different things in different documents.

The practical consequence of Star Polaris is that the traditional interpretation of the phrase "consequential loss" as meaning losses falling within the second limb of Hadley v Baxendale must be treated with caution. The case confirms that exclusion clauses will not be interpreted in isolation, but will be viewed in the context of the contractual liability regime as a whole, and the admissible factual matrix. That being so, even using precedent formulations which have been tested by the courts provides no guarantee in a different contractual context. Clear and unambiguous wording must be used to avoid disputes. If in doubt, define the term as is seen in, for example, both the AIPN and Oil & Gas UK standard Joint Operating Agreements

Cases referred to:

Star Polaris LLC v HHIC-PHIL INC [2016] EWHC 2941 (Comm)

Transocean Drilling UK Ltd v Providence Resources PLC [2016] EWCA Civ 372

Hadley v Baxendale (1854) 9 Ex 341