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.