The meaning of consequential loss - context is key

The meaning of consequential loss - context is key

In Star Polaris LLC v HHIC-PHIL INC [2016] EWHC 2941 (Comm), the High Court has found that the context in which an exclusion of “consequential loss” is drafted can mean the term extends beyond its established meaning set out in the second limb of Hadley v Baxendale.

A contract was entered between Star Polaris LLC (“Polaris”) and a shipbuilder, HHIC-PHIL INC, for the construction of a ship. Less than a year after delivery, the ship was sent for repair following serious engine failure and Polaris commenced arbitration proceedings against the shipbuilder.  Polaris claimed compensation for the cost of repairing the ship and various costs caused by the engine failure and, at the arbitration hearing, indicated that it also wished to claim for diminution in value of the ship.

Consequential loss
The contract between the parties contained a limitation of liability clause, which 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”.

“Consequential loss” has an established legal meaning as loss which is recoverable only because it falls within the second limb of the rule on remoteness of damage established in Hadley v Baxendale.  The rule states, in summary, that an innocent party will be able to recover losses:

i. “arising naturally, i.e. according to the usual course of things” from the breach (the first limb); and

ii. “as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach.” (the second limb).

Arbitration Tribunal decision
The Tribunal held that, in the context of the agreement, the reference to consequential losses was used in the “cause-and-effect sense”, meaning following as a result or consequence, rather than having the narrower meaning under the second limb of Hadley v Baxendale.  This meant that only the costs of repair of the ship were recoverable as the other losses were consequential losses in the above “cause and effect sense”.

It was highly significant to the Tribunal’s reasoning that the liability clause provided a “complete code” for the losses to be recoverable.  In other words, the contract was drafted so that it was not a question of determining what liability was excluded, but ascertaining what liability was accepted by the shipbuilder.  The clause stated that: “Except as expressly provided in this Paragraph, in no circumstances and on no ground whatsoever shall the BUILDER have any responsibility or liability whatsoever or howsoever arising in respect of or in connection with the VESSEL or this CONTRACT after the delivery of the VESSEL.” The “complete code” then culminated in the statement that: “The guarantees contained as hereinabove in this Article replace and exclude any other liability, guarantee, warranty and/or condition imposed or implied by statute, common law, custom or otherwise on the part of the BUILDER by reason of the construction and sale of the VESSEL for and to the BUYER”. 

As the only liability undertaken by the shipbuilder under the relevant guarantees was for the repair or replacement of defects and physical damage caused by them, the Tribunal found that it was clear that the parties did not intend the shipbuilder’s liability to extend beyond those obligations. As a result, it held that the exclusion of consequential losses referred to everything that followed as a consequence of the defects and physical damage, including all other financial loss. 

The appeal
Polaris appealed to the High Court with the following questions:

i. what is the correct interpretation of the phrase “consequential or special losses, damages or expenses” and does this fall within the second limb of Hadley v Baxendale?

ii. if the phrase is taken to have a cause-and-effect meaning, does the diminution in value of the ship fall within this meaning?

The court, in dismissing the appeal, agreed with the Tribunal that in the context, the phrase had a wider meaning of losses above and beyond the cost of replacement and repair of physical damage. In that context, diminution in value was considered to amount to consequential loss.

Despite this, the Judge made clear that he endorsed the comments of Teare J on the meaning of consequential loss in Ferryways NV v Associated British Ports [2008] 1 CLC 117 that: “In the light of the well- recognised meaning which has been accorded to such words in a variety of exemption clauses by the courts from 1934-1999 it would require very clear words indeed to indicate that the parties' intentions when using such word was to exclude losses which fall outside that well recognised meaning.”

It was however of “fundamental importance” in this case that the exclusion clauses created a complete code which excluded all liability apart from that specifically accepted under the guarantees.  It was in that context that the meaning of consequential loss took on a wider meaning.

This case is consistent with the modern approach to contract interpretation – interpret the words of the clause in the context of the contract as a whole in light of the relevant factual matrix.  In this instance, the exclusion of consequential loss was arguably a secondary issue once it had been established that the liability clauses set out a “complete code” under which a liability must be positively and expressly included to be recoverable.

Some commentators have said this decision may represent a change in the way the courts view exclusions of consequential loss, moving away from the traditional interpretation.  This is not necessarily the case.  Clear drafting will still be required to rebut the “usual” Hadley v Baxendale  approach to the meaning of consequential loss, but this case highlights that  its meaning will always be subject not only to the wording of the clause in which it  appears, but also to the other contract terms.  When interpreted in that way, significantly different interpretations may arise.

It is interesting to see how the shipyard protected its position with a more holistic approach to its liability provisions by making sure that the exclusion clause complimented the primary obligations. In many ways the case is less about the meaning of the exclusion of consequential loss but more about the drafting of liability provisions to establish a complete code setting out the liabilities accepted.

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