Consequential loss, but not as we know it: Commercial Court upholds a wide interpretation of a consequential loss exclusion

A Commercial Court judgment has given a wide interpretation of a contractual exclusion for “consequential or special losses, damages or expenses“, going beyond the traditional, narrower interpretation of consequential loss which most practitioners will be familiar with. The decision comes against the background of other judicial commentary questioning the traditional position and may mark a change in the court’s approach, something which we will be watching closely.

Consequential or indirect loss

There is well established Court of Appeal authority which provides “consequential loss”, when used in an exclusion clause, means such losses as recoverable under the second limb of Hadley v Baxendale (1854) EWHC 9 Exch 341. That is, losses that result from special circumstances, which will only be recoverable if the other party has knowledge of those special circumstances at the time it contracts. As such, the traditional interpretation of “consequential loss” is rather a counter-intuitive definition, not really being losses which arise as a “consequence” of a breach at all.

As the recent Star Polaris LLC v HHIC-Phil Inc case demonstrates, however, circumstances and contractual drafting may illustrate a different meaning to the traditional one intended by the parties.

Star Polaris: the facts

A buyer engaged a shipbuilder (HHIC) to build it a ship, the Star Polaris. Around eight months after the Star Polaris was completed, it suffered a significant engine failure and had to be towed to a port for repairs. The buyer commenced arbitration (as provided for by the contract between the parties), claiming the cost of the ship repairs, as well as other losses suffered as a result of the engine failure – such as towage and agency fees.

Under the contract, HHIC had provided a 12 month guarantee for the materials and workmanship and agreed to certain positive obligations in respect of remedying defects. Article IX.4 of the contract provided HHIC would have no further liability and excluded “consequential or special losses, damages or expenses unless otherwise stated herein“.

HHIC contended that losses caused as a result of the engine failure were excluded.

The arbitral tribunal found for HHIC on this point, giving the term “consequential” a cause and effect meaning. The Buyer appealed to the Commercial Court, citing a number of authorities in support of the established meaning of “consequential loss” and asserting that the parties had intended the traditional meaning to apply and that accordingly the term meant such losses as fall within the second limb of Hadley v Baxendale (and so the exclusion did not apply). In doing so it pointed to the use of the pairing of “consequential” with “special losses” in the contract arguing this strongly indicated the traditional meaning was intended.

The decision

Sir Jeremy Cooke, sitting as a High Court Judge, found for HHIC and dismissed the appeal. He accepted that, when read as a whole, the parties had not intended “consequential or special losses, damages or expenses” to bear the traditional meaning, but rather the wider meaning of financial losses caused by the guaranteed defects, above and beyond the cost of replacement and repair of the physical damage. Accordingly, like the tribunal before him, he gave the clause a cause and effect meaning. The contract set out a code of damages assumed by HHIC.

Commentary – a change in approach?

The Star Polaris decision follows obiter comments from the Court of Appeal in the April 2016 Transocean Drilling case, doubting “whether some of those cases [considering consequential loss] would be decided in the same way today, when courts are more willing to recognise that words take their meaning from their particular context and that the same word or phrase may mean different things in different documents“. It appears the interpretation of “consequential loss” as strictly meaning losses falling within the second limb of Hadley v Baxendale is under judicial challenge, but whether Star Polaris and Transocean will lead the way for a new judicial approach to the meaning of this phrase remains to be seen.

In the meantime, the Star Polaris decision demonstrates that, where a contract is clearly drafted, carefully setting out what losses might flow and what liability is accepted and what is excluded (to form a code of liability), the courts are willing to accept that as effective.