High Court interprets clause excluding liability for 'consequential and special losses'
Market Insight 18 January 2017 18 January 2017
UK & Europe
In the case of Star Polaris LLC ("Star") v HHIC-Phil Inc ("HHIC")  EWHC 2941, the High Court departed from the usual interpretation of 'consequential and special losses' as falling within the second limb of Hadley v Baxendale (1854) 9 Ex 341. A clause in a shipbuilding contract (the 'Contract') excluding liability for "consequential and special losses, damages or expenses" was interpreted widely so as to exclude liability for all financial losses above the cost of repair or replacement of physical damage.
The Star Polaris ('the Vessel') was built by HHIC under the Contract which was largely based on the Shipbuilders Association of Japan standard form. Shortly after delivery, the Vessel suffered a serious engine failure and was towed to a ship yard for repairs. HHIC denied liability for the engine failure, leading Star to launch arbitration proceedings to recover repair costs, towage fees, lost profit and diminution in value of the Vessel.
The arbitration tribunal decided that the engine failed as a result of HHIC's breach of its warranty of quality in the Contract as there were weld spatters on the pipe work at delivery. The tribunal therefore allowed Star to recover the cost of repairs caused by HHIC's breach and HHIC had expressly agreed to repair or pay for the physical damage caused by the engine defect.
However, Article IX(4)(a) of the Contract excluded liability for "consequential or special losses, damages or expenses". It followed that by excluding liability for "consequential or special losses, damages or expenses", the parties intended to exclude all financial losses, consequent on physical damage. The Tribunal interpreted 'consequential loss' by applying its 'cause and effect' meaning and concluded that all of Star's remaining losses were consequential under the Contract and therefore not recoverable.
Hadley v Baxendale
In contract, the traditional test of remoteness established by Hadley v Baxendale (1854) EWHC 9 Exch 341 includes the following two limbs of loss:
- Limb one - Direct losses. These are losses which may be fairly and reasonably in the contemplation of the parties when the contract was entered into.
- Limb two - Indirect losses and consequential losses. These require actual knowledge of special circumstances outside the ordinary course of things but that were communicated to the defendant or otherwise known by the parties.
On appeal of the arbitration award by Star, the Court considered the application of Hadley v Baxendale in respect of the following two questions:
- What is the correct construction of the phrase "consequential or special losses, damages or expenses" and in particular does that phrase mean such losses or damages that fall within the second limb of Hadley v Baxendale?; and
- Should exclusion clauses be interpreted narrowly or widely to give effect to the intention of the parties?
Meaning of the phrase 'consequential losses'
Star argued that the towage fees, lost profit and diminution in value directly flowed from HHIC's breach and should therefore be recoverable. Whilst it was undisputed that the financial losses incurred would have been classed as direct losses in the Hadley v Baxendale sense, the Court determined that the provisions of the Contract clearly intended to limit HHIC's liability for repairs and that "the obligation to repair/replace is exhaustive and nothing else is recoverable above and beyond that" (Para 40 of the Judgement).
The Court determined that the 'Contract shows that this well recognised meaning was not the intended meaning of the parties and that the line of authorities is therefore nothing to the point' (Para 18 of the Judgement), thereby giving the wider meaning to 'consequential loss' so as to give effect to the intention of the parties when entering into the Contract. Judgment was therefore handed down in favour of HHIC as the paying party.
The interpretation of exclusion clauses
In this instance, it was held that "although it can no longer be said that exclusion clauses are to be read narrowly when they appear in commercial contracts between sophisticated parties – the wording must be given its ordinary meaning – where there is ambiguity the contra proferentum rule may play a role" (Para 10 of the Judgement). Reflective of the recent Supreme Court decision in Impact Funding Solutions Limited v AIG Europe Insurance Ltd  UKSC 57, the decision suggests that going forwards the Courts are unlikely to construe exclusion clauses agreed between commercial parties narrowly.
The case shows the Court's willingness to give effect to the intention of the parties in commercial contracts by giving phrases their ordinary meaning but having regard to the context and notwithstanding even judicial commentary on the particular terminology used. It indicates a broadening of the court's interpretation of clauses excluding liability for 'consequential loss' by looking outside the definition of indirect losses falling within Hadley v Baxendale. Therefore a clause which has the effect of excluding 'consequential or special losses, damages or expenses' may now encompass losses otherwise deemed to be direct losses arising from a breach of contract.
This express departure from well-established case law when determining the recoverability of losses demonstrates the court's willingness to interpret contracts flexibly where appropriate. To avoid the uncertainties this may create, caution should be exercised when negotiating terms of this sort. Examples of the sorts of losses intended to be included and excluded would likely be of assistance.