Consequential loss – a new approach?

19 / 07 / 2017

The recent Commercial Court case of Star Polaris v HHIC-Phil has emphasised the risks of excluding liability for “consequential loss” under a contract. The case has cast doubt over the long established principle that excluding consequential loss is interpreted by reference to losses falling under the second limb of Hadley v Baxendale , namely losses that result from special circumstances which are known by the other party.

It is an important reminder that the courts may not interpret an exclusion clause narrowly and will consider the wording in the context of the contract in question.

The traditional approach

The case of Hadley v Baxendale identified two types of loss where a contract is breached:

  • First Limb – Direct losses – losses which arise naturally in the ordinary course of things.  These losses may include loss of profit or other losses flowing from the breach.
  • Second Limb – Indirect or consequential losses – loss resulting from special circumstances which are only recoverable if the other party knows of such circumstances.  Loss of profit/earnings would not necessarily be excluded under this limb.

Star Polaris – the facts

The Commercial Court in Star Polaris considered the meaning of “consequential loss” in the context of a ship building contract. Star Polaris (the buyer) had entered into a contract with the HHIC-Phil (the Yard) to build a ship. Following delivery some months later, the ship suffered serious engine failure and was towed to a ship yard for repairs. The buyer commenced arbitration against the Yard on the basis that it was responsible for the engine failure and claimed costs for repairs and other costs such as towage and agency fees.

The tribunal awarded the buyer costs of repair, however costs other than repair were excluded on the basis that they fell within the exclusion “consequential or special losses, damages or expenses” set out in the contract.

The Commercial Court decision

The buyer appealed against the decision of the arbitration tribunal and argued that “consequential or special losses” should be given the traditional interpretation, of losses under the second limb in Hadley v Baxendale.  While the Court recognised the traditional meaning of consequential loss, it held that the court was not bound by it and found that the parties had intended the phrase to mean something different from the established interpretation.

The Commercial Court agreed with the tribunal and dismissed the buyer’s claims. There was then an appeal to the Court of Appeal. When considering the exclusion clause, the Court of Appeal looked at the contract as a whole and found that the parties had intended the phrase to bear a wider meaning of financial losses.

It is worth noting that the contract included a complete code to determine liability.

Change in approach? 

A shift from the traditional interpretation was seen in the earlier Court of Appeal case of Transocean Drilling v Providence Resources[1].  The Court of Appeal cast doubt over whether earlier cases which interpreted exclusion of “consequential loss” by reference to the second limb under Hadley v Baxendale would be decided in the same way today.  The Court of Appeal looked at the phrase in the context of the contract as a whole and demonstrated the willingness of the courts “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“.

However, it is worth noting that in each of the cases mentioned above, the contracts went into substantial detail to describe exactly which losses of liability should be included or excluded.  It is yet to be seen if the courts will diverge from the traditional approach where the exclusions of liability are not set out in such detail.

What can we learn?

It goes without saying that exclusion of liability clauses should be clearly and unambiguously drafted. If there are particular losses that a party is concerned about, these should be expressly included and any remedies clearly identified. The allocation of risk and any limitations on liability should reflect the expectations of the parties.

The case of Star v Polarisdoes not set out any new legal principles nor does it provide guidance on how to draft exclusion clauses. However it does suggest that where exclusion clauses in commercial contracts are drafted by sophisticated parties the courts are likely to look at the ordinary meaning of the wording and consider the clause in the context of the contract as a whole.

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