The Meaning of "Consequential Damages"

May 2017

03 The Meaning of Consequential Loss

In a High Court decision in late 2016 Mr Justice Cooke considered the construction and meaning of the term “consequential and special damages” in the context of a limitation of liability clause included in a standard form SAJ shipbuilding contact. Consequential loss has been construed by the English Courts as applying only to loss which is not ordinarily foreseeable, and which would be recoverable only if the special circumstances out of which the loss arises were known to the parties when contracting. That is the well-known second limb of Hadley v Baxendale. Therefore, a clause excluding consequential loss will only exclude what would not be recoverable in any event, because it was not ordinarily foreseeable and there was no knowledge of the special circumstances out of which that loss arose.

However, for the reasons explained below, the conclusion of Cooke J was that these words were not necessarily confined to this well-settled meaning and will depend on the specific context in which the words are used - Star Polaris LLC and HHIC-PHIL Inc [2016] EWHC 2941 (Comm).

The Facts
The claimant, Star Polaris LLC (the “Buyer”), entered into a shipbuilding contract dated 6 April 2010 on an amended SAJ form (the “Contract”) with the defendant, HHIC-PHIL INC (the “Yard”) for the build and purchase of a bulk carrier, the “Star Polaris” (the “Vessel”). The Vessel was delivered to the Buyer on 14 November 2011, and subsequently on or around 29 June 2012 suffered a serious engine breakdown necessitating towage to South Korea for repairs. The Buyers commenced arbitration against the Yard, and claimed: 

(i) The cost of repairs to the Vessel;

(ii) The costs caused by the failed engine, including towage fees, agency fees, survey fees, off- hire and off-hire bunkers; and

(iii) Diminution in value of the Vessel.

The material provisions of the Contract were, inter alia:

Article IX (1): A 12 month guarantee of material and workmanship commencing from the date of delivery;
Article IX (3): An express undertaking on the part of the Yard to remedy at its expense any defects;
Article IX (4): The extent of the Yard’s liability, with article IX(4)(a) specifically limiting liability after delivery of the Vessel and excluding liability for any “consequential or special losses, damages or expenses unless otherwise stated herein.” This provision was expressed to “replace and exclude any other liability, guarantee, warranty and/or condition imposed or implied by statute, common law, custom or otherwise…”(Article XI(4)(d)).

Hadley v Baxendale
A key aspect of this case was the parties’ understanding of the meaning of “consequential or special losses”. English law has long recognised these words according to the decision in Hadley v Baxendale, which identified the circumstances in which a party could recover losses, before becoming too remote, namely:

(i) Direct losses (limb 1): losses which are reasonably in contemplation of both parties at the time the contract was made i.e. losses which a reasonable person might expect to result from the breach in ordinary circumstances; and

(ii) Consequential losses (limb 2): actual knowledge of special circumstances outside the ordinary course of things, but that was communicated to the defendant or otherwise known by the parties.

Since Hadley v Baxendale there have a been a number of decisions attempting to define the meaning of “consequential loss”, including - Saint Line Ltd v Richardsons, Westgarth & Co Ltd (1940) 67 Ll L Rep, Croudace Construction Ltd v Cawoods Concrete Products Ltd [1978] 2 Lloyd's Rep and Deepak Fertilisers and Petrochemicals Corporation v ICI Chemicals & Polymers Ltd [1999] 1 Lloyd's Rep. However, in The GSF ARCTIC III Moore-Bick LJ observed that “It is questionable whether some of those cases would be decided in the same way today, when 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.” (see below).

The Tribunal Decision
The Buyer’s claim was based on an argument that the losses claimed were not excluded as they were all direct, ordinarily foreseeable and, therefore, within ‘limb 1’ of Hadley v Baxendale, and were not “consequential or special losses”.

The Tribunal decided in favour of the Yard, holding that Article IX was a “complete code” defining the context in which the Yard’s responsibility was to be understood. Therefore, the Yard’s obligations were limited to the express wording contained within the contract i.e. to repair or replace defective items and/or the physical damage caused as a result of such defects. The Tribunal went on to state that by virtue of the express exclusion in clause IX(4)(d) it was clear that the Yard had not assumed any responsibility for any losses other than the remedy of defects, financial or otherwise.

As a result of this the Buyer’s claims for items (ii) and (iii) were dismissed.

High Court Decision
The Buyer appealed the award on two grounds:

1. The words “consequential and special losses” excludes liability only for damages falling within the second limb of the rule in Hadley v Baxendale and claims (ii) and (iii) fell within the first limb. To exclude losses falling outside that well recognised meaning, would require very clear and unambiguous wording.

2. The words “special losses” when used with the words “consequential losses” are indicative of an intention to refer to the specific losses falling within the second limb of Hadley v Baxendale.

The High Court agreed with the Tribunal’s decision concluding that the words “consequential loss” or “special loss” had a cause and effect meaning, and were intended to have a much wider meaning than the limited context argued by the Buyer. That is, “in such circumstances, the word ‘consequential’ had to mean that which follows as a result or consequence of physical damage, namely additional financial loss other than the cost of repair or replacement” (Cooke J).

Therefore, the Yard’s liability was limited by the positive obligations in Article IX (3) to remedy any defects and Article IX (4) made it plain that the Yard has no liability above and beyond those express obligations. When considered as a whole, the contract expressly excluded financial losses which resulted as a consequence of the engine failure (beyond the costs of replacement and repair of physical damage to the engine).

In summary, the obligation to repair and replace was exhaustive and the Buyer’s appeal was, therefore, dismissed.

Comment
Although unlikely to alter the English law interpretation of the meaning of “consequential and special losses”, the decision does suggest that, dependent on the wording of the relevant clause or clauses of a particular contract, the term may have a much wider meaning. As such the decision underlines the need for careful consideration when drafting and negotiating exclusion and/or limitation clauses. To avoid ambiguity, wherever possible parties should set out expressly the losses they agree to be responsible for, and those which are expressly excluded. Parties should also bear in mind the contra proferentem rule i.e. where there is ambiguity in a contract the words will generally be construed against the party who seeks to rely them.

By way of postscript it is also noteworthy that in the recent case of Transocean Drilling UK Ltd v Providence Resources PLC (The GSF Arctic III 2 Lloyd’s Rep (2016) the Court of Appeal considered how consequential loss clauses should be interpreted in the context of a drilling contract. In that case it was held that sophisticated commercial parties are free to enter into contracts which limit or exclude liability in the event of breach, and in such circumstances the well-recognised meaning of the term consequential losses may not be appropriate, especially in light of the particular context in any given contract.

 

 

 



Article by Jasmin Sandhu
Syndicate Executive
Eastern Syndicate