Archive for April, 2017
Consequential Loss Re-examined
The traditional meaning of damages for consequential loss was established by Hadley v Baxendale (1854) 9 Exch 341, but has recently been re-examined by the High Court in Star Polaris LLC V HHIC-PHIL Inc  EWHC 2941.
Star Polaris LLC (the Buyer) entered into a contract with HHIC-PHIL Inc (the Seller) to build a ship, the Star Polaris. About eight months after its delivery, the ship suffered serious engine failure and had to be towed to a port for repairs. The Buyer commenced arbitration proceedings against the Seller for breach of contract, seeking compensation for: (i) the cost of repairs to the ship, (ii) various costs arising from the engine failure (namely: towage fees, agency fees, survey fees, off-hire and off-hire bunkers); and (iii) the diminution in value of the ship.
The Seller relied on Article IX of the contract, which set out the Seller’s liability for defects in the ship. It stated that the Seller would provide a 12-month guarantee against any defects or damages caused by “defective materials, design error, construction miscalculation and/or poor workmanship”. Article IX.4 provided that the Seller was to have no other liability in respect of the ship after delivery and the contract expressly excluded “consequential or special losses, damages or expenses unless otherwise stated herein.” The contract also set out that the obligations and liabilities within Article IX were intended to “replace and exclude any other liability” whether under law, custom or otherwise.
The arbitration tribunal found in the Seller’s favour, holding that the Buyer was only entitled to recover its losses for the repair or replacement of defects and any physical damage caused by such defects. In reaching its decision the tribunal noted the clear distinction in the contract between the cost of repair or replacement and the wider costs that can arise as a consequence of the need for a repair or replacement. In this context the word “consequential” had to mean that which follows as a result or consequence of physical damage. The costs arising from the engine failure and the diminution in value of the Star Polaris were a consequence of the breach and therefore specifically excluded under the contract.
The Buyer appealed to the High Court, arguing firstly that the correct interpretation for “consequential loss” should be the meaning as established under the second limb of the Hadley v Baxendale definition. This case identified two types of losses that arise when a contract is breached:
Firstly, direct losses – being those losses arising naturally, or in the usual course of things, or that may reasonably be in the contemplation of the parties when the contract was made.
Secondly indirect and consequential losses – being those losses that result from special circumstances, which will only be recoverable if the defaulting party knew of such special circumstances at the time the contract was made.
Moreover the Buyer sought to argue that the Article IX.4 exclusion’s reference to “special losses” as well as “consequential loss” showed that it was the parties’ intention that the damages sought should fall under the second limb of that test given that the costs arising from the engine failure and the diminution in value of the ship were losses that arose from special circumstances, which the Seller was aware of at the time the contract was made. The Buyer claimed that its Hadley v Baxendale interpretation was supported by numerous Court of Appeal cases and that the tribunal, as a court of first instance, should not have departed from such precedent.
In its judgment, the High Court noted that under Article IX the contract clearly set out the extent of the Seller’s liability and contained “no express provision” that gave the Buyer “a claim for financial loss, lost profit or diminution of value.” The Court determined that the obligation to repair and replace any damage under the guarantee was therefore exhaustive and nothing else was recoverable above and beyond that. The obligation of the Seller was only to replace or repair or bear the cost thereof and any other losses were specifically excluded. The tribunal’s ruling was therefore upheld and the appeal dismissed.
The decision is an example of the Courts refusing to adhere to rigid precedent where it considers that the strict rules run counter to the terms objectively agreed by the parties and laid out in the contract. Careful consideration should therefore be given when drafting provisions that exclude liability on the part of either party. Parties should ensure that their specific intentions are clearly set out in the agreement without ambiguity or reliance on the assumed effect of standardised wording.
The recent Finance Act 2016, which came into force on 15 September 2016, introduces a new “targeted anti avoidance” (“TAAR”) provision with a sweeping, and yet potentially unintended, scope in the context of company winding up.
The intention behind the new provision in section 35 of the Act is to ensure that the rules around the payment of tax on a distribution in a company winding up are not abused. Such a distribution, in the hands of the former company owner, will typically attract capital gains tax (CGT) as a gain on the return of capital at the rate of 10% or 20%. Conversely, dividend payments from the company would usually attract income tax at a much higher rate (potentially up to 38%).
HMRC considers that this tax differential is being exploited by close company stakeholders who contrive to wind up a company, pay a lower amount of CGT on distributions made to them and then start up a new company operating the same or a very similar business (and perhaps repeat the same process routinely). The new TAAR is focused on inhibiting such “phoenixism”. Unfortunately, the new TAAR rules have introduced significant uncertainty.
The TAAR rules apply to certain distributions made in the winding up of a UK company and where one or more of the shareholders has at least a 5% interest. The basic rule in section 35 applies where, within two years of the winding up, such a shareholder carries on, whether as a sole trader, partner or through another company, “a trade or activity which is the same as, or similar to” (emphasis added) the activities of the wound up company or any of its 51% subsidiaries (or is otherwise involved with a connected individual who is so carrying on such a trade or activity) and “that it is reasonable to assume that the main purpose or one of the main purposes of the winding up is the avoidance or reduction of a charge to income tax”.
There are several elements of this which are less than well defined. Whilst it should be fairly easy to tell whether one business is the same as another, it is much less clear whether one is “similar to” that other (or, more pertinently, whether HMRC would construe it to be). Being “involved with the carrying on” of a trade or business is very vague. On the face of it, the requirement for an intention to avoid paying income tax should be clearer, but this potentially goes right to the heart of many a winding up where the process is, per se, a tax saving measure.
Clear evidence of an intent to avoid income tax is one thing, but the provisions do not appear to recognise what is a fairly common commercial structure, namely the use of a once only special purpose vehicle for a particular project or site specific business arrangement. There are good reasons for structuring a project or arrangement in such a way. Can it fairly be said that the repeated use of such a process, with the winding up of the entity involved at the end of the project or arrangement, is indicative of an intention to avoid (or reduce) a charge to income tax?
A tax clearance process is provided for in the legislation, but HMRC have stated that it will not be used for the purpose of potentially clearing distributions in windings up subject to section 35. Instead, HMRC has indicated that it will publish guidance on the new rules which will focus on the areas of concern which have already been raised in the public consultation process and will include examples of the types of transaction to which TAAR it believes that TAAR will apply. It is, however, arguably unsatisfactory to have a situation where taxpayers will need to rely on non-statutory guidance for their relief where the scope of new rules is so broad as to potentially (and, one assumes, unintentionally) capture ordinary commercial transactions.
The decision to commence Court proceedings can be a daunting one. Litigation is expensive, time consuming and there is no guarantee of success. There are, however, alternatives to traditional costly Court proceedings:
Mediation is an effective tool used to resolve disputes of all values and complexities at a fraction of the cost of litigation. The usual format involves a mediator (usually a lawyer) bringing opposing parties together in one location for a day or half a day. There is often an “all parties” initial meeting followed by “shuttle diplomacy” during which the mediator will shuttle between the parties who will be located in separate rooms. The aim is for the mediator to try to narrow the issues and focus the parties’ minds on the legal and commercial realities of their dispute so that they may be more agreeable to settling. Mediation can be used whether or not proceedings have been issued.
2.“Shorter Trial”/“Flexible Trial” schemes
These are currently being piloted in the High Court and are aimed at enabling business related disputes to be resolved in a shorter and earlier trial, and at reasonable and proportionate cost – for instance by limiting disclosure and/or the length of the trial. The first dispute to go to trial under the Short Trial scheme was National Bank of Abu Dhabi PJSC -v- BP Oil International Limited  EWHC 2892 (Comm) and resulted in a $68 million dispute being decided in one day, with the whole claim being resolved within 9 months from commencement.
This option is generally provided for by contract before a dispute arises. However, parties can agree to have a dispute referred to arbitration after it has arisen. Arbitration clauses are particularly common in complex international commercial contracts. Whilst arbitrations are generally no less expensive than litigation, it is possible for parties to agree a short form procedure such that the dispute must be concluded within a relatively short period of time. In addition, arbitration provides an element of confidentiality and can therefore be an attractive alternative to Court proceedings.
Where a dispute is likely to be of a particularly technical or specialist nature, parties can opt in their contracts for the matter to be determined by an independent expert. The expert’s decision will be binding and will be almost impossible to challenge.
5.Early neutral evaluation
This involves the appointment of an impartial evaluator (usually a lawyer) to give a non-binding view on the strengths and weaknesses of each party’s case. Like mediation, it can be used either before or after proceedings have been issued and the aim is to provide the parties with a realistic and objective view on their prospects of success, which can then serve as a basis for negotiations.
Informal negotiation (whether in correspondence, on the phone or at a round-table meeting) can be a very cost effective way to resolve disputes.
This route can only be used for undisputed debts. The process is usually started by serving a statutory demand, giving the debtor 21 days to pay the debt. If they do not, it may be possible to present a winding up petition (if the debtor is a company and owes £750 or more) or a bankruptcy petition (if the debtor is an individual and owes £5,000 or more). The process does not, however, guarantee that the debt will be re-paid and cannot be used simply as a means of debt recovery.
As the above indicates, there are alternatives to costly Court proceedings which may be considered in relation to any appropriate commercial dispute or claim.
The general principle of contract variation is that parties to a contract may vary its terms by mutual agreement, provided that consideration is given and any necessary formalities are followed.
On this basis, it would not be unreasonable to expect that if a variation clause in an agreement states that the agreement can only be varied by written agreement signed by both parties, any attempted oral variation would fall short of such a test. Such clauses are commonly referred to as “anti-oral variation clauses”, the intention of which is to ensure that verbal communications cannot be treated as variations to the contract…or so the parties may have thought.
Over the past 20 years, the Courts, particularly the Court of Appeal, have considered anti-oral variation clauses on a number of occasions. In United Bank Ltd v Asif (unreported, 11 February 2000) and World Online Telecom Ltd v I-Way Ltd  EWCA Civ 413, the Court of Appeal provided two conflicting decisions. Firstly, it held that a contract containing an anti-oral variation clause could not be varied based on a verbal agreement, only to contradict that decision two years later, deciding that a contract could be varied orally despite such a clause. In World Online Telecom, Schiemann LJ undermined what many believed to be the intention behind anti-oral variation clauses, stating that the purpose “is not to prevent the recognition of oral variations, but rather, casual and unfounded allegations of such variations being made”. Whilst the obiter comments of the Court of Appeal in Globe Motors Inc, and others v TRW Lucas Varity Electric Steering Ltd and another  EWCA Civ 396 showed preference for the decision in World Online Telecomm, the law in this area was not clarified until the Court of Appeal’s decision in MWB Business Exchange Centres Ltd v Rock Advertising Ltd  EWCA Civ 553.
In MWB, the Court of Appeal held that a contract could indeed be varied by oral agreement, regardless of whether or not an anti-oral variation clause was included. It held that the freedom of contract principle enables parties to agree, vary or discharge a contract as they see fit. In his judgment, Kitchin LJ cited the words of Cordozo J, who stated back in 1919 that “those who make a contract, may unmake it [and] the clause which forbids a change, may be changed like any others”. Whilst parties have the autonomy to agree to include an anti-oral variation provision in their contract, such agreement does not preclude them from subsequently agreeing a variation to that provision, whether orally or by conduct.
In light of the MWB case, it is clear that no clause restricting variations will prevent the parties’ ability to re-negotiate their contractual arrangements. The clause, like any other clause in a contract, may be varied by the will of the parties (whether in writing, orally or through conduct) and parties should be careful about post contract oral discussions, as a variation to the terms of the contract could arise. However, this is not to say that anti-oral variation clauses are now wholly irrelevant. In fact, the Court was keen to point out the importance of the clause. Firstly, by encouraging parties to record variations in writing as a matter of best practice and second, to help to avoid casual and unfounded allegations of oral variations being made by ensuring that a suitable evidentiary bar exists for such a claim to succeed.
The issue of who is an ‘employee’, who is a ‘worker’ and who falls into neither camp is clearly going to be one of the big issues of 2017. Following on from the Uber and Deliveroo cases we highlighted in our November 2016 bulletin, headlines were made recently by the case of Pimlico Plumbers Ltd v Smith in which a plumber is claiming that he should be able to bring a range of employment law claims even though his contractual documentation stressed that he was self-employed.
Mr Smith was engaged by Pimlico Plumbers in 2005. Many of the features of his work were clearly inconsistent with being employed under a contract of employment. He was responsible for purchasing his own raw materials, for example, and was able to charge a ‘mark-up’ to the company when he used them in the course of his work. He also took full advantage of his self-employed tax status by setting off a considerable amount of his earnings as expenses, and was registered for VAT. It could not have been a surprise that the employment tribunal ruled that he was not an employee and could not bring a claim for unfair dismissal.
However, the tribunal went on to find that he could bring claims under the Equality Act 2010 on the basis that he was disabled – and also claim holiday pay under the Working Time Regulations 1998. To bring these claims Mr Smith did not need to show that he had a contract of employment, merely a contract which required him ‘personally’ to do work for Pimlico Plumbers and under which they could not be regarded as a client or customer of his own business undertaking.
In reaching the conclusion that Mr Smith did indeed meet this test (which made him a ‘worker’ under the Working Time Regulations 1998 and an ‘employee’ under the Equality Act 2010) the tribunal found that there was an on-going obligation on Mr Smith to provide his services personally – indeed it was expected that he would do so on a full-time basis. He was not able to compete freely with Pimlico Plumbers by doing work for other firms or customers and that indicated that he was not ‘in business on his own account’.
On appeal to the Court of Appeal, Pimlico Plumbers argued that there was no real obligation on Mr Smith to do his work ‘personally’ and that he could have engaged someone else to do it on his behalf. The Court rejected this. The most that could be said was that Mr Smith could arrange for other operatives to cover his work if he had another job to go to. That fell far short of a ‘right of substitution’ that would indicate that there was no obligation on Mr Smith to provide personal service.
Pimlico Plumbers also argued that Mr Smith was actually engaged under a series of individual assignments rather than under one continuous contract under which he worked full-time. They argued that the tribunal had therefore been wrong to find that Mr Smith was not in business on his own account. The Court of Appeal rejected this line of argument as well. A number of fixed expenses were deducted from Mr Smith’s pay and so Mr Smith had to work a certain number of hours to make the work worthwhile for both parties. The tribunal had been entitled to find that there was a continuing obligation on Mr Smith to work for Pimlico Plumbers. The appeal was dismissed.