Over the years the phrase "consequential losses" has acquired an established meaning as losses which do not naturally or directly arise from the breach of the agreement itself and which fall within the second limb of the test set out in Hadley v Baxendale (1854) 9 Ex 341 (Hadley v Baxendale).
However, the recent High Court decision in Star Polaris LLC V HHIC-PHIL Inc. has challenged this traditional meaning in favour of a wider interpretation, demonstrating that the Courts' reading of exclusion of liability clauses may differ according to the facts and nature of the contract in question.
The case also serves as a useful reminder of the Courts' current willingness to find the meaning of a contract by looking at the plain words agreed by the parties, even if this means departing from the meaning given to certain phrases in previous decisions. Practically, therefore, it is important to give careful consideration to the use of well-settled words and phrases when drafting exclusion of liability provisions, to ensure that the wording used reflects the true intention of the parties.
The two limb test in Hadley v Baxendale has traditionally been used by the Courts to determine whether a party is able to recover damages for a breach of contract. It is well established that "consequential losses" fall under limb two of this test as losses arising from special circumstances which the aggrieved party may only recover if the defaulting party knew of such special circumstances at the time the contract was made.
HHIC-PHIL Inc, (the Seller) and Star Polaris LLC (the Buyer) entered into a shipbuilding contract (the Agreement) to build and purchase a ship, the Star Polaris. Not long after delivery, the ship suffered a serious engine failure and the Buyer commenced arbitration proceedings against the Seller for breaches of contract. The Buyer sought compensation for: (a) the cost of repairs to the ship; (b) diminution of the value of the ship; and (c) associated costs caused by the ship's engine failure, namely: towage fees, agency fees, survey fees, off-hire and off-hire bunkers.
The Agreement expressly stated that the Seller would not be liable or responsible for any "consequential or special losses, damages or expenses unless otherwise stated herein." The Agreement also included a 12-month guarantee from the Seller against any defects or damages caused by "defective materials, design error, construction miscalculation and/or poor workmanship" which was intended to "replace and exclude any other liability" whether "imposed or implied by statute, common law, custom or otherwise".
The arbitration tribunal found that the Buyer was able to recover its losses for the cost of repairs to the ship under the guarantee. However, all other losses were expressly excluded. In reaching its conclusion the tribunal interpreted the word "consequential" in its cause-and-effect sense as meaning “following as a result or consequence". The associated financial costs caused by the ship's engine failure and its diminution in value were a consequence and/or result of the breach and therefore not recoverable.
On appeal to the Commercial Court, the Buyer argued inter alia that "consequential losses" should be interpreted in accordance with its established meaning under the second limb of the rule in Hadley v Baxendale. The Buyer also contended that the pairing of the words "special losses" alongside "consequential loss" in the exclusion clause was illustrative of the parties' intention that these losses should fall under the second limb of the Hadley v Baxendale test, and the diminution in the ship's value and associated financial costs were in the reasonable contemplation of both parties and so should be recoverable.
The Commercial Court rejected the Buyer's arguments and upheld the tribunal's ruling. It asserted that the extent of the Seller's liability to the Buyer should be determined in the context of the entire Agreement and not restricted to a review of the relevant exclusion provisions. The Agreement clearly distinguished between consequential losses (which the parties had excluded under the contract) and defects and damage to the ship (which could be recovered under the guarantee). Therefore, the Buyer to could claim damages for the cost of the repairs and physical damage to the ship but "any other liability… imposed or implied by…common law" had been explicitly excluded.