UK: Challenging The Traditional Meaning Of Consequential Loss

It was held that, in the context of this particular limitation of liability clause, the term had a wider meaning than the traditional narrow interpretation set out in Hadley v Baxendale.  

The judgment is in line with the shift towards the courts construing the plain meaning of words in the context of the contract as a whole. It highlights the need for extra care when drafting exclusion clauses, in particular when using phrases with well-established meanings, to ensure that the terms reflect the true intention of the parties.

Background – the traditional meaning of 'consequential loss'

The two limb test set out in Hadley v Baxendale has traditionally been used by the courts to establish whether losses for breach of contract are recoverable:

• Direct losses which arise naturally in the ordinary course of events flowing from the breach are recoverable and not too remote.
• Indirect losses and consequential losses which are likely to arise from the special circumstances of the case are foreseeable and recoverable if the defaulting party was made aware of the special circumstances when entering into the contract. If not, they are too remote. 

In traditional case law, it is well established that where a contract excludes a party's liability for 'consequential loss', this refers only to losses recoverable under the second limb in Hadley v Baxendale. This interpretation has often been criticised as contrary to the natural meaning of the phrase. Last year the Court of Appeal in Transocean Drilling UK Ltd v Providence Resources Plc [2016] EWCA Civ 372 also questioned whether some consequential loss cases would be still decided the same way today, acknowledging that these days "courts are more willing to recognise that words take their meaning from their particular context".

The Star Polaris case

In brief, the facts of Star Polaris LLC v HHIC-Phil Inc [2016] EWHC 2941 (Comm) were that the buyer contracted with a shipbuilder to build the Star Polaris. Within a year of delivery, the ship had to be towed to port for repairs due to engine failure. The buyer brought arbitration proceedings against the shipbuilder claiming compensation for the cost of repairs to the ship, together with various costs due to engine failure (such as towage fees) and the diminution in the value of the ship.

The contract provided that the shipbuilder guaranteed the vessel for 12 months and had specific obligations to remedy physical defects covered by the guarantee. The clause stated that the shipbuilder was to have no other liability following delivery and "consequential or special losses, damages or expenses unless otherwise stated herein" were expressly excluded.

The shipbuilder argued that the word 'consequential' was used widely, in a cause and effect sense rather than the narrow, established sense. The tribunal agreed. It considered that the clause was intended to be a complete code for recovery and was to be construed on its own wording, in the context of the agreement as a whole and its particular factual background. The award stated that the "word 'consequential' was used by the parties in this agreement in its cause-and-effect sense as meaning following as a result or consequence". As such, it found that all losses, other than the repair costs for physical damage to the ship, were unrecoverable. 

The buyer appealed to the High Court, the relevant question of law focussing on the correct construction of the phrase "consequential or special losses, damages or expenses" in the shipbuilding contract. The buyer argued that the excluded 'consequential losses' should be interpreted narrowly as losses falling within the second limb of Hadley v Baxendale, citing a series of Court of Appeal cases in support of the established meaning of the phrase. The shipbuilder contended that it was evident from the contract that the traditional meaning of the phrase 'consequential loss' was not intended by the parties and that authorities on the topic were therefore irrelevant.

The decision 

The High Court dismissed the buyer's appeal, agreeing with the shipbuilder's interpretation and upholding the tribunal's ruling. It was held that the parties intended the clause to be a complete code for determining liability. Under the particular contract "the obligation to repair/replace is exhaustive and nothing else is recoverable above and beyond that". In this case the phrase 'consequential or special losses, damages or expenses' does not mean such losses, damages or expenses as fall within the second limb of Hadley v Baxendale but does have the wider meaning of financial losses caused by the guaranteed defects, above and beyond the cost of replacement and repair of physical damage". The claim for diminution in value was also a 'consequential or special loss' and excluded from recovery under the contract. 

Implications

Commentators have long criticised the traditional meaning of 'consequential loss' and it appears that it is now also under challenge from the courts, both obiter in Transocean Drilling and in this High Court decision.  

The new approach highlights that exclusion clauses should be drafted with extra caution. Phrases will not necessarily be given their well-established meaning and the same expression may be attributed different meanings depending on the terms of the contract as a whole, and the facts of the case.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.