Mutual indemnities and exclusion of consequential losses in commercial contract upheld by the Court of Appeal
Transocean Drilling UK Ltd v Providence Resources Plc  EWCA Civ 372
The Court of Appeal has reversed the High Court's decision in Transocean Drilling UK Ltd v Providence Resources Plc  EWHC 4260 (Comm) which found that a contractor was entitled to recover consequential losses for a delay caused by a breach of contract by the other party.
Clauses that seek to exclude a party's right to damages are often subject to restrictive interpretation by the courts. However, in this case, the parties were of equal bargaining power and the Court held that the mutual indemnities which extended to consequential losses should stand. The case considered the extent of the freedom of two commercial parties to determine the terms on which they wish to do business.
The parties in this case were the owner of a semi-submersible drilling rig and a contractor who entered into an agreement for the hire of the rig to drill in an area off the south coast of the Republic of Ireland.
As a result of a failure of the rig, drilling operations had to be suspended for 27 days. The delay resulted in a number of disputes between the parties including whether the delay was caused by the owner's breach of contract. Another dispute was whether the contractor had a right to recover additional overheads or 'spread costs' resulting from the delay to the drilling operations and extended period of work.
The High Court found that the delay had been caused by the owner's breach of contract as the rig had not been in good working condition on delivery. There was no appeal to that aspect of the High Court's judgment.
The appeal related to the contractor's right to recover the 'spread costs' and turned on the construction of a few clauses in the contract namely:
- the mutual indemnities (or 'knock-for-knock' provisions as they are known in the oil & gas industry) whereby losses arising from the performance of the contract were allocated between the two parties including a mutual undertaking by the owner and the contractor to indemnify each other against its own consequential losses; and
- whether the owner's 'spread costs' (overheads such as the costs of personnel, equipment and services contracted from third parties which were wasted as a result of the delay) were within the meaning of consequential losses set out in the mutual indemnities.
In the High Court the judge had invoked the contra proferentem principle of contract interpretation which says that where a term of contract is ambiguous, it should be interpreted against the party which proposed or drafted the contract or clause. This interpretation led the High Court to decide the contractor was entitled to recover the 'spread costs'. However, on appeal this was held to be wrong as it was inappropriate to apply this principle of interpretation where the meaning of the words was clear, or where a clause favoured both parties equally, particularly in this case where the parties were of equal bargaining power.
The specific wording of the exclusion clause and mutual indemnities included the following wording:
"...loss of use (including without limitation, loss of use or the cost of use of property, equipment, materials and services including without limitation, those provided by contractors or subcontractors of every tier or by third parties)...".
This wording was said to expand the exclusion clause to include the costs of services from third parties such as those being claimed by the contractor as 'spread costs'. The mutual nature of the clause also showed the parties intended this to have a wide meaning.
It was decided that the principle of freedom of contact required the Court to give effect to the parties' agreement and the contractor was not entitled to recover consequential losses for the period of delay as the contractor was obliged to indemnify the owner against the contractor's own consequential losses.
A separate argument put forward by the contractor was that regardless of the construction of the mutual indemnities, the contractor should be entitled to recover its 'spread costs' by setting them off against monies payable under the contract. The Court decided that this 'set-off' argument put forward by the contractor was unacceptable. The clause in question merely gave the contractor a right to withhold disputed sums pending resolution of a dispute and did not give rise to substantive rights. To have a right of set-off it would have been necessary for the contractor to have a right to recover a sum of money, but any such right was eliminated by the clause excluding consequential losses.
The Court noted that an interesting feature of the contract in question was the extent to which the parties had agreed to accept responsibility for losses that might otherwise have been recoverable as damages for breach of contract.
It was relevant to the interpretation applied by the Court in this case that the parties were of equal bargaining power. The reasoning would likely differ if this was a more typical exclusion clause by which a stronger party sought to exclude liability for its own breaches of contract. It is also worth noting that cases dealing generally with the concept of consequential loss may be interpreted quite differently.
The detailed consideration by the Court of the words "loss of use" and the subsequent wording in brackets serves as a reminder of the importance of careful and considered drafting of exclusion clauses to reflect clearly the intention of the parties.
This article was written by Tanya Wilkie. For more information please contact Tanya on +44 (0)20 7427 5058 or at email@example.com
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