Consequential loss, thought you knew it all?

A recent commercial court case has put the proverbial ‘cat amongst the pigeons’ in terms of upending the renowned case of Hadley -v- Baxendale and the interpretation of what is meant by the term ‘consequential loss’.

In Star Polaris LLC -v- HHIC-PHIL INC [2016]EWHC 2941 (Comm), a different approach to the meaning of consequential loss was adopted from the traditional approach found in Hadley –v- Baxendale.

Re-cap on Hadley -v- Baxendale 

Briefly, this case provided longestablished authority for dividing the classification of recoverable losses for breach of contract into two: 

1. losses which occur ‘in the ordinary course of things’ i.e. sometimes referred to as direct losses, which are recoverable – first limb 
2. losses which arise due to special circumstances which are outside the ordinary course of things i.e. consequential losses, which are only recoverable where the circumstances were communicated to the defendant or known by the parties – second limb

A clause excluding liability for consequential losses only excludes losses under the second limb not the First.

The facts

Star Polaris LLC (‘Star Polaris’) entered into a contract (‘contract’) with the defendant shipyard (‘shipyard’) to purchase the “STAR POLARIS” vessel, which was delivered on 14 November 2011. Less than a year later on 29 June 2012 the vessel suffered a serious engine failure and was subsequently towed to South Korea for repairs. The shipyard denied all liability for the incident and Star Polaris commenced arbitration proceedings to recover damages including the cost of:

1. repairing the vessel
2. towage fees, survey fees and other costs incurred as a result of the engine failure (‘fees’) and 
3. diminution in value of the vessel.

The arbitral tribunal published its award, finding that certain repair costs were recoverable but also holding that the contract excluded liability for ‘consequential or special losses, damages or expenses’ including the Fees and the diminution in value claim.

Star Polaris appealed and one of the issues the court was required to determine was the correct construction of the phrase: ‘consequential or special losses, damages or expenses;’ in the contract. In particular, whether the phrase meant such losses, damages or expenses that fell within the second limb of Hadley -v- Baxendale, or a ‘cause-and-effect’ meaning i.e. losses caused as a knock-on effect of the engine failure, as held by the arbitral tribunal. 

The contractual terms

The obligations agreed to in the contract by the shipyard included express provisions: 

1. to make all necessary repairs or replacements in respect of defects directly caused by defective materials, design error, construction miscalculation and/or poor workmanship at its expense (either at the shipyard or elsewhere)
2. alternatively, to compensate Star Polaris in an amount equal to the cost of making the repairs and/or replacements and 
3. to compensate Star Polaris for any documented expenses incurred by it in this process.

The contract also contained an exclusion of liability clause which provided:

‘Except as expressly provided in this Paragraph, in no circumstances and on no ground whatsoever shall the [shipyard] 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. Further, but without in any way limiting the generality of the foregoing, the [shipyard] 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.’

The decision

Star Polaris contended that the meaning of ‘consequential or special losses’ in the exclusion clause should be construed in the context of the second limb of Hadley -v- Baxendale – that being, losses outside the ordinary course. By contrast, the shipyard submitted that the phrase should be construed within the context of the contract itself. 

The Commercial Court disagreed with Star Polaris’ interpretation and held that Star Polaris could only claim the costs of the repair works. The remaining losses fell within the consequential loss exclusion and were not recoverable. It found that the exclusion clause set out a code, excluding other liabilities imposed by statute, common law, custom or otherwise. The extent of the shipyard’s guarantee was expressly set out in the contract. The only express provision of responsibility and liability on the shipyard postdelivery of the vessel was the liability of the yard for defects directly caused by defective materials, design error, construction, miscalculation and/or poor workmanship. Nothing more. 

The effect of the relevant provisions was that the obligations undertaken by the shipyard in respect of the guarantee were only to repair or replace defective items of the kind described above and the physical damage caused thereby, with all other financial consequences falling on Star Polaris. As a result, any potential claim for fees and diminution in value would fall within the latter category. The reality was that there was no express provision that Star Polaris could point to which gave rise to a claim for financial loss, lost profit or diminution of value. 

In line with the judgment of the arbitral tribunal, the Commercial Court held that ‘consequential or special losses, damages or expenses’ did not mean such losses, damages or expenses as falling within the second limb of Hadley -v- Baxendale but had the wider meaning of financial losses caused by guaranteed defects, above and beyond the cost of replacement and repair of physical damage.

Is the decision a good or bad thing?

Of course, it depends where you are sitting and whether you are trying to rely on an exclusion clause to exclude/limit your liability under a contract or to dis-apply the exclusion clause allowing you to claim wider incurred losses. The case has certainly increased the uncertainty around which losses will be classified as consequential losses and what is clear is that we are likely to see more disputes where parties seek to take the point that the definition of ‘consequential losses’is not a rigid one.