“Consequential Loss” Exclusions: Context is Everything.

Star Polaris LLC and HHIC-PHIL Inc [2016] EWHC 2941 (Comm)

Recent Guidance from the English Court illustrates that tried-and-tested phrases can mean something very different depending on the nature of the contract and the context.

SIMON RAINEY Q.C.

The words “consequential loss” in an exclusion or indemnity provision frequently give rise to argument. This is despite the fact that, following a long line of decided cases dating back to 1934 (: Millers Machinery v David Way (1934) 40 Com. Cas. 204), the term (and common variants or combinations of it, e.g. ‘”consequential or special” or “indirect or consequential”) have acquired a well-settled meaning in the most common context in which they are used, namely as part of a free-standing unilateral exclusion clause or as a form of mutual exclusion clause (as, for example, in the suite of BIMCO marine and offshore industry forms, the LOGIC offshore forms and many construction contracts).

Well-settled it may be, but that does not necessarily make it a popular or well-accepted settled meaning.

The English Courts have construed the concept of “consequential loss” as not covering loss which directly and naturally results in the ordinary course of events from the breach and which would be ordinarily foreseeable but as applying only to loss which is not ordinarily foreseeable and which would be recoverable only if the special circumstances out of which it arises were known to the parties when contracting. In lawyer-speak, it covers Hadley v Baxendale ‘Limb 2’ but not ‘Limb 1’ losses: see the locus classicus in Croudace Construction Ltd v. Cawoods Products Ltd [1978] 2 Lloyd’s Rep. 55. Such a clause will often therefore cover only what would not be recoverable in any event, because it was not ordinarily foreseeable and there was no knowledge of the special circumstances out of which the loss arises.

That highly technical meaning has been criticised as very unlikely to be one which commercial parties ever really intended: see the recent comments of the Court of Appeal in Transocean Drilling UK Ltd v Providence Resources Plc [2016] EWCA Civ 372 per Moore-Bick LJ at [15] and Leggatt J. in Scottish Power UK Plc v BP Exploration Operating Co. Ltd [2015] EWHC 2658 (Comm). Other common law jurisdictions such as Australia have effectively ditched the English law approach.

The recent decision of the Commercial Court in Star Polaris LLC v HHIC-PHIL Inc [2016] EWHC 2941 (Comm) illustrates that the fact that the wording has a well-settled meaning will not always provide the answer. One cannot simply fall back on the way in which the phrase has previously been interpreted in stand-alone contexts and expect to arrive at the same result.

The case concerned a shipbuilding contract. As is common in such contracts, the builder gave a twelve month warranty and guarantee (Article IX). The builder undertook to be responsible during that period for any defects, due to matters for which it was contractually responsible, such as bad design or workmanship, and to carry out all necessary repairs. As is similarly common, Article IX stated that the builder was to be under no other responsibility or liability whatsoever in connection with the vessel or under the contract once the vessel had been delivered to the buyer other than under Article IX. Any implied conditions, for example, under statute (such as the Sale of Goods Act 1979) were similarly excluded. Article IX was therefore understandably described by the arbitrators and by the Judge as “a complete code for the determination of liability” as between builder and buyer.

It was in this special context that Article IX went on to exclude “liability or responsibility … arising for or in connection with any consequential or special losses, damages or expenses unless otherwise stated herein”.

During the guarantee period, the vessel, a Capesize bulker, suffered a serious main engine failure. The buyer alleged that this was due to bad workmanship in breach of contract (weld spatter left in the piping). It took the vessel to a Korean yard for repair and then claimed damages under three heads: the costs of the repair; various incidental towage, survey and other expenses and off-hire; a claim for the diminution in value of the vessel as a new bulker given the engine failure.

It was argued forcefully by the buyer that, objectively, and given the settled meaning, it was to be presumed that the parties would use the term “consequential loss” in accordance with that well-known meaning and the losses in question were not excluded as they were all ‘direct’, ordinarily foreseeable and ‘limb 1’. Reliance was placed by the buyer on the decision in Ferryways v. Associated British Ports [2008] 1 Lloyd’s Rep 639, where the Judge held that a Court should not lightly depart from that meaning, now that it had become settled and effectively a term of art. However, Ferryways dealt only with the typical form of stand-alone exclusion.

The arbitrators (a very experienced panel: Michael Collins QC, Richard Siberry QC and Sir David Steel) found for the buyer on liability and defective workmanship and allowed the claim for costs of repair (which were expressly recoverable under Article IX if the buyer elected to carry out repairs elsewhere than at the builder’s yard). They however held that the other two claims were excluded as “consequential loss” because they were consequences of the defect covered by the Article IX guarantee which was what the exclusion was directed at.

The Court (Sir Jeremy Cooke) upheld the Tribunal’s reasoning.

(1) While, importantly, the Judge recognised and sought to emphasise that he was not intending to cast doubt on the well-settled meaning of that term (referring to the usual line of cases with approval at [18]), he held that the specific context in which the wording was used, namely as part of a ‘complete code’ of builder’s responsibility, was crucial to a proper understanding of the term and of “fundamental importance in considering the ambit of Article IX” [10].

(2) The structure of Article IX was viewed by the Court as one of repair obligations expressly undertaken by the builder, coupled with the exclusion of everything else in terms of liability and responsibility. The clause differentiated between the cost of repair or replacement, on the one hand, and the broader financial consequences occasioned by the need for a repair or replacement on the other [36].

(3) The Court agreed with the arbitrators that “in such circumstances, the word ‘consequential’ had to mean that which follows as a result or consequence of physical damage, namely additional financial loss other than the cost of repair or replacement” [36]. In other words, the clause extended to all loss and damage which was a consequence of the defect covered under the guarantee and the word ‘consequential’ was used by the parties in this agreement in its cause-and-effect sense, as meaning ‘following as a result or consequence of’ [6].

(4) In the context of a guarantee and warranty clause which imposed a scheme of responsibilities on the builder, it was held to be unrealistic and strained to read the exclusion as saying that the builder accepted responsibility under the complete ‘code’ for all direct losses (limb 1) while excluding responsibility only for indirect ones (limb 2): [35].

The meaning given to the phrase “Consequential Loss” taken by the Court (and by the arbitrators below) mirrors that taken in the Australian cases where “consequential” has been construed as looking at losses which are simply consequential upon the breach and gives effect, in the specific context of Article IX of the particular contract under consideration,  to the dissenting view in the English textbooks that the English Court’s construction has robbed the phrase of its natural meaning which businessmen should be taken more realistically to have had in mind: see e.g. Macgregor on Damages, (19th Edn) at paras. 3-013 to 3-016, where the Australian cases are referred to. As an example, see Alstom Ltd v Yokogawa Australia Pty Ltd (No 7) [2012] SASC 49, a decision of the Supreme Court of South Australia, where the Court held that unless qualified by its context, “consequential loss” would normally extend to all damages suffered as a consequence of a breach of contract.

While confined to the particular contractual context, the implications of the Star Polaris decision are potentially wider, particularly for the use of a ‘consequential loss’ type exclusion in similar shipbuilding contract guarantee provisions.

In addition, the decision is a salutary lesson that a mechanistic application of the settled meaning of this phrase is inappropriate: the context and purpose may show that the parties used the term in a different and simpler sense. Given the expression of dissatisfaction in certain quarters with the Croudace meaning long given to the wording, it will be interesting to see if Star Polaris is henceforth used to try to press other different contexts as reasons for taking a different meaning. Negotiation of shipbuilding contracts by buyers may now need to be approached with some attention to the boilerplate of the standard form guarantee/ warranty provision (cf. the arguments in Star Polaris as to the amendment of the standard SAJ Article IX wording)

However, in the ordinary unilateral or mutual exclusion clause situation, the position remains, it is suggested, firmly the same: the Court was itself concerned to stress ‘no change’, expressly endorsing the Ferryways presumption that the words have been used in the settled sense understood in the English cases.

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