Developments in contract: Consequential loss

The principles

• In 1854 Hadley v Baxendale established two types of recoverable losses for breach of contract:
  • direct losses: losses arising naturally/in the usual course of things, and
  • indirect losses: losses arising from some special circumstances that the defaulting party knew of at the time of entering into the contract.
• The Court of Appeal has consistently interpreted the term “consequential loss” to mean losses falling within the second type of Hadley v Baxendale losses.

Recent developments

• In Star Polaris LLC v HHIC-Phil Inc, the Commercial Court was asked to interpret the meaning of excluding liability for “consequential or special losses, damages or expenses” in a shipbuilding contract.

• The exclusion was contained in a clause that was a complete code for the determination of the shipbuilder’s liability. The court therefore needed to ascertain not only what liability was excluded but also what liability was undertaken.

• The court held that the exclusion was not limited to the losses of the second type in Hadley v Baxendale but that the phrase had a wider meaning of financial losses caused by “guaranteed defects” (above and beyond the cost of replacement and repair of physical damage).

• It was sufficiently clear from the clause as a whole that the exclusion of liability for consequential losses meant to exclude liability for any losses over and above those specifically undertaken by the shipbuilder in the clause (ie replacement and repair of physical damage). The well-recognised meaning of the phrase “consequential loss” (ie losses of the second type in Hadley v Baxendale) “was not the intended meaning of the parties and […] the line of authorities is therefore nothing to the point.”

What this means

• While Star Polaris does not change the law, it illustrates that the courts will not necessarily follow the traditional rigid interpretation of “consequential loss” as losses within the second type of Hadley v Baxendale and may construe limitations of liability in the context of the contract as a whole.

• Indeed, last year, the Court of Appeal in Transocean Drilling UK Ltd v Providence Resources PLC questioned whether some of the cases that established the traditional interpretation of “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 remains to be seen whether a more flexible, context-based interpretation will prevail over the rigid judicially determined one in many cases.

• In the meantime, parties are advised to draft limitation of liability clauses very carefully, identifying potential contractual losses and stating in clear, unambiguous language which liabilities they will accept and which they will not.