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Star Polaris case: "consequential loss" given wider meaning by High Court

Over the years, the words “consequential loss” have acquired a well-recognised meaning, with the Court of Appeal repeatedly affirming that where they are used in a contract (on a stand alone basis) to exclude one of the parties’ liability for consequential loss, they mean only that loss which is recoverable under the second limb of the Hadley v Baxendale[1]remoteness test”.

In Hadley v Baxendale the courts were asked to consider the extent to which losses could be recovered before becoming too remote.  In doing so, they identified two types of losses which a party can recover from the defaulting party in the event of a breach of contract:

  1. “Direct” losses (limb 1 of the test):  losses which arise naturally, i.e. according to the usual course of things, from the breach in question, or, that may reasonably be supposed to have been in the contemplation of both parties at the time the contract was made, as a probable result of the breach of it (i.e. loss which a reasonable person might expect would result from the breach under ordinary circumstances) – an objective test; and
  2. “Indirect” or “consequential” losses (limb 2 of the test):  losses which result from special circumstances, and will only be recoverable if such losses have been communicated to the defaulting party at the time when the contract was formed – a subjective test.

Any losses which fall outside these two limbs are not recoverable as they are too remote.

The meaning of consequential loss was again at the centre of a dispute between the parties in the recent case, Star Polaris LLC v HHIC-Phil Inc.[2]. On Appeal from a Tribunal Award dated 12 November 2015, the High Court of Justice (Commercial Court) was asked to consider the construction and meaning of the phrase “consequential loss or special losses, damages or expenses” in the context of a limitation of liability clause included in a shipbuilding contract[3].

Star Polaris:  the facts

In this case, Star Polaris LLC (the “Buyer”) and HHIC-PHIL Inc. (the “Shipbuilder”) entered into a contract for the construction of the STAR POLARIS (the “Vessel”). Under the contract, the Shipbuilder gave a 12 month guarantee of material and workmanship.  During this guarantee period, the Vessel suffered a serious engine failure and had to be towed to a shipyard in South Korea for repairs. The Buyer pursued a claim in arbitration against the Shipbuilder for breach of contract, and claimed the following damages: (i) the cost of repairs to the Vessel; (ii) towage and other fees caused by the engine failure; and (iii) diminution in value of the Vessel.

The extent of the Shipbuilder’s liability for defects and the Buyer’s remedies were set out in Article IX of the contract:

  • The Shipbuilder provided a 12 month warranty in Article IX.1 against (broadly) all defects due to defective materials, design error, construction miscalculation and/or poor workmanship. 
  • Article IX.3 obliged the Shipbuilder to remedy any defects which were the subject of the guarantee by making all necessary repairs and replacements at the shipyard. 
  • Article IX.4(a) stated that “…the Shipbuilder shall have no liability or responsibility whatsoever or howsoever arising for or in connection with any consequential or special losses, damages or expenses unless otherwise stated herein”.
  • In addition and notably, Article IX.4(d) stated that the guarantees included in Article IX replaced and excluded any other liability, guarantee, warranty and/or condition imposed or implied by statute, common law, custom or otherwise on the part of the Shipbuilder.

The Buyer contended that the words the parties had chosen to use (i.e. “consequential losses”) had, at the time the parties entered into the contract, an established meaning as a matter of law, namely, losses which fell within the second limb of the rule in Hadley v Baxendale.  The Buyer asserted that the parties contracted against the background of this well-established meaning[4].

The decision

Whilst the Arbitrators accepted that, on the authorities, the meaning of “consequential loss” in an exemption clause usually meant the exclusion of losses falling within the second limb of Hadley v Baxendale, they affirmed they were not necessarily bound to follow such decision[5]; any particular clause must be “construed on its own wording in the context of the particular agreement as a whole and its particular factual background”[6].

The Buyer and Shipbuilder agreed that Article IX provided a “complete code” for determining liability, and both the Tribunal and the High Court considered the existence of this code to be of fundamental importance to understanding the scope of Article IX. – In this case, it was not a question of simply determining what liability was excluded, but ascertaining what liability was actually undertaken[7]. The only positive obligations assumed by the Shipbuilder under the guarantee were the repair or replacement of defects and physical damage caused by such defects, and all other losses (financial or otherwise) were expressly excluded[8] by Article IX.4(d).

The High Court agreed with the Arbitrators’ decision that, in the context of this contract, consequential or special losses had a wider meaning than the second limb of Hadley v Baxendale. The word “consequential” was not used in the well-established sense in this case, but in a “cause and effect” sense, and referred to those losses which followed as a result or consequence of physical damage/engine failure (i.e. additional financial loss other than the cost of repair or replacement)[9]. In addition, there was no express provision that the Buyer could point to which gave rise to a claim for financial loss, lost profit or diminution of value[10]. Accordingly, the Buyer’s appeal was dismissed.

Lessons learned

The Star Polaris case does not change current law. It does, however, demonstrate that exclusion of liability wording which has a widely accepted meaning in law may not necessarily be construed in the same way as it has been in previous cases if the context or factual matrix in question is different and the parties intended a different meaning should apply. Specifically, there is a danger that the words “consequential loss” will not be given the meaning laid down in the second limb of the well-recognised rule in Hadley v Baxendale, depending on the facts of the particular case.

Applying the lessons learned from the decision in Star Polaris, businesses and contract drafters should bear in mind the following points when negotiating exclusions and limitations of liability in commercial agreements:

  • do not mechanistically replicate precedent exclusion of liability wording.  Only include precedent limitation of liability wording in a contract after having given its meaning careful consideration in the context of the agreement in question;
  • identify what type of loss the business concerned is most likely to suffer in the context of the contract being negotiated, and clearly and unambiguously set out in the agreement any losses which the parties intend will be recoverable (and whether they will fall within any agreed cap on liability) and those losses which will be excluded;
  • as a reminder, “loss of profits” can (depending on the circumstances) be classified as a direct or an indirect loss in contracts subject to English law.  In the case where a party is seeking to exclude liability for loss of profits, the parties should, therefore, make it clear whether they intend excluding liability for both direct and indirect losses of this type, or just indirect loss of profit.  Contrast the position in contracts subject to U.S. law where loss of profits is typically classified as an indirect loss and will therefore not be recoverable if a clause of the contract excludes indirect or consequential losses; and
  • bear in mind the contra proferentem rule – i.e. where the wording of an exclusion clause has been drafted ambiguously, it may be interpreted against the person seeking to rely on it.

Concluding thought

It is not yet clear whether the decision in Star Polaris will be used by the courts as grounds for moving away from the widely-accepted (but very technical) meaning of “consequential loss” in the second limb of Hadley v Baxendale in the future. This could be the case, particularly as a number of legal commentators and the courts have challenged the appropriateness of this rule. For example, Lord Justice Moore-Bick in Transocean Drilling U.K. Ltd v Providence Resources Plc[11] said of the leading authorities which support the established meaning of consequential loss “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”.

 

[1] 1854 EWHC 9 Exch 341

[2] 2016 EWHC 2941 (Comm)

[3] The shipbuilding contract was a based on the Shipbuilders Association of Japan (“SAJ”) standard form contract, as varied by the parties.

[4] Paragraphs 9 and 10 of the Judgment

[5] Unless the particular contractual provision with which they were concerned had been the subject of specific judicial consideration.

[6] Paragraph 24 of the Judgment.

[7] Paragraph 10 of the Judgment.

[8] Paragraphs 36 and 38 of the Judgment.

[9] Paragraphs 36, 38 and 40 of the Judgment.

[10] Paragraph 38 of the Judgment.

[11] 2016 EWCA Civ 372, at paragraph 15.