“Consequential or special losses” revisited – Star Polaris LLC v HHIC-PHIL Inc

In the recent case of Star Polaris LLC v HHIC-PHIL Inc [2016] EWHC 2941 (Comm), the High Court considered the meaning of the phrase “consequential or special losses” in the context of a limitation of liability clause in a shipbuilding contract.

Background

The courts have traditionally interpreted “indirect” or “consequential” loss to mean such loss as is recoverable under the second limb of the rule for recoverable loss in contract set out in Hadley v Baxendale (1854) 9 Ex 341. This rule set out two types of losses resulting from a breach of contract:

1. Direct losses – losses arising naturally, or in the usual course of things, or that may reasonably be in contemplation of the parties when the contract was made; and
2. Indirect losses and consequential losses – losses that result from special circumstances, which will only be recoverable if those circumstances are known to the other party.

Facts

Star Polaris LLC (the “Buyer”) entered into a contract with HHIC-PHIL Inc (the “Shipbuilder”) for the purchase of a ship, the Star Polaris (the “Ship”).

Under the contract, the Shipbuilder guaranteed the Ship for twelve months against all defects arising from defective materials, design error, construction miscalculation and/or poor workmanship. However, the Shipbuilder did not guarantee the Ship against defects arising from other causes including perils of the sea, normal wear and tear or negligence or wilful neglect of the Buyer. Furthermore, the contract stated that the Shipbuilder was to have no other liability in respect of the Ship and expressly excluded “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 Ship’s engines failed shortly after it was delivered to the Buyer, and it had to be towed to a port for repairs.

Arbitration

The Buyer alleged that the Ship’s engine failure was caused by the Shipbuilder’s breaches of contract. The Shipbuilder denied liability for the engine failure, and a dispute arose as to liability for the repair costs and financial losses arising from the failure. The Buyer commenced arbitration proceedings against the Shipbuilder, seeking compensation for the cost of repairs to the ship and for various costs including towage fees, agency fees, survey fees and off-hire.

The arbitration tribunal (the “Tribunal”) decided that the Buyer’s claims above the cost of repair of physical damage were “consequential or special losses, damages or expenses” and therefore they were excluded under the terms of the contract. The Tribunal held that the word “consequential” was used by the parties in a cause-and-effect sense as meaning losses following as a result or consequence of the engine failures. The Tribunal found that it was sufficiently clear from the wording of the defects clause that the Shipbuilder only undertook to repair or replace defects falling within the guarantee and that all other financial consequences would be borne by the Buyer.

The High Court’s Decision

The Buyer appealed against the Tribunal’s decision, arguing that “consequential or special losses” should be interpreted to mean losses falling within the second limb of the rule in Hadley v Baxendale and that the scope of the Shipbuilder’s liability under the contract was therefore broader.

Dismissing the appeal, the High Court agreed with the Tribunal’s interpretation of “consequential or special losses”. The High Court noted that the words “indirect or consequential loss” have acquired a well-recognised meaning (i.e. the losses contemplated by the second limb of the test in Hadley v Baxendale), but found that in this case the parties had intended “consequential loss” to have the wider meaning of financial losses caused by guaranteed damages or defects, above the cost of repair of such damages and defects.

In coming to its decision, the High Court stated that the clause excluding consequential or special losses should be considered in the context of the contract as a whole. The High Court found that the liability clause was clear that the Shipbuilder did not accept any liability beyond the express obligations undertaken in the guarantee. The contract made a distinction between defects and damage and consequential damage. In the circumstances, the word “consequential” meant that the parties had agreed to exclude liability for any damage which followed as a result of physical damage. The Shipbuilder therefore only accepted liability for certain defects and damage, and did not accept positive obligations to compensate the Buyer for financial losses resulting from physical damage.

Comment

While this is an English case (and, as such, is only persuasive in Scotland rather than legally binding), it demonstrates the courts’ approach to construction of limitation of liability clauses and highlights that the courts will interpret limitations of liability in the context of the contract as a whole. Although the courts traditionally interpreted “indirect” or “consequential” loss to mean such loss as is recoverable under the second limb of the rule of Hadley v Baxendale, this case shows a move away from a strict method of interpretation. Instead, the court’s interpretation will depend on the construction of the clause in question and the courts may find the words have a different meaning in certain contexts.

As a drafting tip, parties should ensure that contractual terms defining or limiting their liabilities are drafted clearly and unambiguously. This will help contracting parties to avoid unintended consequences and the potential of litigation like that in this case.

Co-authored by Michael Terry, trainee solicitor.