The meaning of “consequential loss” reconsidered – Star Polaris LLC v HHIC-Phil Inc

The High Court has considered the meaning of the phrase "consequential or special losses, damages or expenses" within the context of a limitation of liability clause and ruled that it has a wider meaning than those losses falling within the second limb of Hadley v Baxendale.

A long line of cases have established that, within the context of a limitation clause, "consequential" and "indirect" mean damages recoverable under the second limb of the test in Hadley v Baxendale. These are losses arising not naturally from the breach of contract, but from a special circumstance of the case. These types of losses are only recoverable if the defaulting party knew or should have known of the special circumstance when it made the contract.

Whilst the phrase "indirect and consequential loss" has a fixed meaning in the eyes of the courts, unfortunately this interpretation is at odds with contracting commercial parties who generally understand the phrase to mean all those losses which are not the "normal loss" that would be suffered by any claimant in that position.

Background

In the case of Star Polaris, the court was asked to interpret a shipbuilding contract to ascertain the extent of the liability of the defendant shipbuilder (the "Builder") for defects occurring post-delivery of the vessel, the Star Polaris, to the claimant (the "Buyer").

The vessel was delivered to the Buyer on 14 November 2011, however, on 2 September 2012 it experienced a serious engine failure and it was necessary to tow the ship to South Korea for repairs.

The Buyer commenced arbitration proceedings against the Builder, claiming the engine failure was due to breach of contract by the Builder. The Buyer claimed compensation for:

(a) the cost of repairs to the vessel;

(b) the costs caused by the engine failure, including towage fees, agency fees, survey fees, off-hire and off-hire bunkers; and

(c) a further claim at the arbitration hearing for diminution in the vessel's value.

Article IX.1 of the contract between the parties provided a 12-month guarantee of material and workmanship from the date of delivery of the vessel. The Builder's positive obligations as to remedy of defects were set out in Article IX.3. Article IX.4 provided for the extent of the Builder's liability, with art.IX.4(a) limiting that liability after delivery of the vessel to the Buyer, or in connection with any "consequential or special losses, damages or expenses unless otherwise stated herein". The guarantee was expressed to "replace and exclude any other liability, guarantee, warranty and/or condition imposed or implied by statute, common law, custom or otherwise...".

Arbitration Tribunal Decision

The Tribunal found in the Builder's favour, holding that the word "consequential" was used by the parties in the contract in its cause-and-effect sense, as meaning following as a result or consequence of the engine failure. The Tribunal held that the only express obligations undertaken by the Builder, as described in Article IX, were to repair or replace defective items and the physical damage caused as a result of such defects, with all other financial consequences to fall on the Buyer.

In the context of this shipbuilding contract, consequential or special losses was deemed to have a wider meaning than in the second limb of Hadley v Baxendale. Reading Article IX as a whole, the parties had clearly not intended for the Builder's liability to extend beyond the obligation to remedy any defect and they had agreed that financial loss consequent upon physical damage was excluded.

The Buyer appealed against the Tribunal's decision maintaining that:

1. The use of the words "consequential and special losses" by the parties had, at the time the parties entered into the contract, a well-established meaning as being those losses falling within the second limb of Hadley v Baxendale. Relying on the case Ferryways NV v Associated British Ports [2008] 1 CLC 117, the judgment of Teare J was cited, highlighting that in the context of the normal meaning of "indirect" or "consequential" loss "it would require very clear words to indicate that the parties' intentions when using such word was to exclude losses which fall outside that well recognised meaning".
2. The contractual wording had specifically paired "consequential" losses with the word "special" losses and this was therefore a strong indication that the parties intended to refer to such losses set out in the second limb of Hadley v Baxendale.

High Court Decision

The High Court dismissed the appeal, agreeing with the Tribunal that the extent of the Builder's liability in Article IX.4 of the contract should be not be interpreted in isolation, but by considering Article IX as a whole. It was crucial in this case that Article IX constituted a complete code for the determination of liability. It was clear that the Builder's liability was governed not just by Article IX.4, but by the earlier paragraphs in Article IX.

Sir Jeremy Cooke's judgment pointed towards a purposeful distinction between the cost of physical defects and damage on the one hand and the broader consequential damage on the other.

The High Court held that Article IX.4(a) made it plain that the Builder was subject to no liability above and beyond the express obligations undertaken by the Builder in the contract. The Builder was therefore limited to those positive obligations set out in Article IX.3, namely the obligation to "remedy, at its expense, any defects against which the vessel is guaranteed" which was to be done by "making all necessary repairs or replacements at the shipyard, if reasonably practical or elsewhere".

Therefore, given the only positive obligations assumed under the guarantee were for the repair and replacement of defects and physical damage caused by such defects, "consequential or special losses" did not mean such losses, damages or expenses falling within the second limb of Hadley v Baxendale. In the particular circumstances, the word "consequential" had the wider meaning of additional financial losses caused by guaranteed defects above and beyond the cost of replacement and repair of physical damage. As a consequence, the parties had agreed that financial loss resulting from physical damage was excluded.

Ultimately, there was no express provision that the Buyer could point to which gives rise to claim for financial loss or lost profit.

The claim for diminution of value of the vessel was also considered a claim for "consequential or special loss" and, given that the obligation of the Builder to repair the vessel was exhaustive, nothing else was recoverable above and beyond that.

Comment

Whilst this case does not change any law it is an interesting development and shows a readiness for the court to move away from the traditionally strict interpretation of "consequential loss", meaning those damages falling within the second limb of Hadley v Baxendale, towards more fluid contractual construction taking into account the contract as a whole. It also highlights that the contractual context is key; an identical term in another contract may well be interpreted differently and an altogether different meaning reached.

Parties should consider at the outset what types of loss may arise from the specific contract being negotiated and not rely on a precedent without thinking about the limitation of liability wording carefully. As always, it is vitally important for parties to take care to draft their contractual liability in clear and unambiguous language, setting out exactly what liability is excluded and what is accepted.

This article was written by Annabel Madewell. For more information, please contact Annabel on +44 (0)20 74271063 or at annabel.madewell@crsblaw.com.