18 Jun 2017

"Consequential Loss" has had a clearly defined meaning since the case of Hadley v Baxendale in 1854 but that has now changed with the ruling in Star Polaris v HHIC-Phil Inc ([2016] EWHC 2941 (Comm)) where the High Court has given a broader meaning to the term "consequential loss".

Hadley v Baxendale

The court in in this case determined the circumstances in which damages may be recoverable for breach of contract. An entitlement to damages arises (i) if the loss can fairly and reasonably be considered to have arisen naturally from the breach (direct loss); or (ii) if the loss can reasonably be presumed to have been in the contemplation of the parties when the contract was formed (indirect loss that is not too remote).

"Consequential losses" have long been established as falling within limb two of the test in Hadley v Baxendale. The party deemed to have suffered such losses can recover from the other party if both parties were aware, when entering into the contract, that such loss was likely to occur if there was a breach of the contract. Financial losses such as loss of profit have generally been determined by the courts as being a direct loss and thus excluded from the losses recoverable as "consequential loss" under the second limb of Hadley v Baxendale.

Facts of Star Polaris v HHIC-Phil Inc

The Star Polaris was a vessel built by HHIC-Phil Inc (Seller) and delivered on 14 November 2011 to Star Polaris LLC (Buyer) under a contract dated 6 April 2010. On 29 June 2012 the vessel suffered a serious engine failure and was towed to port in South Korea for repairs.

The Seller denied all liability for the incident and the Buyer commenced arbitration against the Seller on the basis that the engine failure was caused by the Seller's breaches of contract, and claimed compensation. The Buyer sought compensation for (i) the cost of repairs of the vessel; (ii) towage fees, survey fees, off-hire and off-hire bunkers caused by the engine failure; and (iii) diminution in value of the vessel.

Under the contract, the Seller gave the Buyer a 12 month guarantee of material and workmanship, guaranteeing such things as defective materials, design errors, construction miscalculations and/or poor workmanship, which were not caused by perils of the sea, normal wear and tear or mismanagement of the vessel. For defects that fell within the guarantee the Seller had an obligation to remedy them at its own expense. However, the Seller's liability was limited by Paragraph 4(a) of Article 9 which stipulated that that the Seller had "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."

Outcome

On appeal from an award at arbitration, the High Court held that the Seller's liability did not extend beyond the obligation to remedy any defect by making all necessary repairs and replacements to cover financial losses which resulted from the defect. The Appeal was therefore dismissed and the decision of the Tribunal upheld.

It was accepted that the meaning of "consequential loss" in an exemption clause usually meant the exclusion of losses falling within the second limb of Hadley v Baxendale. However, the Tribunal and the High Court were of the opinion that, within the context of this particular contract, the word "consequential" was used in a cause and effect sense and not in its traditional legal context. Consequently, what followed as result or consequence of physical damage, such as financial losses, were what were deemed to be "consequential" within the meaning of the contract. Article 9 of the contract set out a code which excluded liabilities imposed by statute, common law and custom. The only positive obligations undertaken by the Seller in respect of the guarantee were to repair or replace defective items, such as defective materials or design errors, and repair or replace any physical damage caused thereby. It was therefore apparent from the construction of the contract that all financial losses (such as towage fees, survey fees etc.) were to fall on the Buyer and the Seller's liability was not to extend beyond the repair or replacement of defective items. The High Court and Tribunal both interpreted "consequential loss" as having a wider meaning than those losses falling within the second limb of Hadley v Baxendale so as to include financial losses caused by the defects which were under the guarantee.

The ruling is important as it shows that the traditional interpretation of "consequential loss" as being those losses which fall within limb two of Hadley v Baxendale will not always be followed. Instead the actual construction of the contract is likely to be looked at and may form the basis of the interpretation of "consequential loss". Parties should therefore always try and ensure that when negotiating and drafting a contract that they clearly and comprehensively outline what liabilities are and are not excluded.