How can the parties ensure that what their contract says about lost profits is what they really intend when using FIDIC Contracts?

Clause 17.6 of the FIDIC 1999 suite of contracts states that “Neither Party shall be liable to the other Party for loss of use of any Works, loss of profit, loss of any contract or for any indirect or consequential loss or damage which may be suffered by the other Party in connection with the Contract….”.

The equivalent wording in the 2008 Design, Build, Operate (“DBO”) form (the Gold Book) is in Clause 17.8 and differs by two words : “Neither Party shall be liable to the other Party for loss of use of any Works, loss of profit, loss of any contract or for any other indirect loss or damage which may be suffered….”.

What is the difference?

The Hadley v Baxendale test

Ask most common lawyers about the difference between direct and indirect/consequential losses and they are most likely to refer to Hadley v Baxendale [1849]. The contract was simple: the defendants agreed to transport a broken crankshaft, a component of the plaintiff’s mill, to its original engineers’ workshop and then back after its repair. The carrier took longer than agreed, and the mill stood idle for several days. The plaintiff claimed its loss of profit.

The court found that the plaintiff’s loss of profit did not flow naturally from the defendant’s breach of contract (the so-called “first limb”), nor was it a loss that could be supposed to have been in the parties’ reasonable contemplation as a result of the breach. The plaintiff would need to have communicated special circumstances for those lost profits to be recoverable (“the second limb”). In the event, the plaintiff recovered nothing.

Hadley is an odd decision to modern eyes because it seems obvious that the absence of a vital component would lead the mill to stand idle and therefore the mill owner to lose profit.

Nonetheless the two limbs of Hadley have become etched into the legal psyche, and contracts commonly distinguish between “direct” damages and “indirect” or“consequential” damages. As a way of mitigating exposure to potentially large claims, indirect or consequential damages are often excluded. This is unnecessary given what Hadley says (that, absent communication of special circumstances, such damages are irrecoverable anyway).

The current position

It is now well settled, particularly in the commercial sphere, that ordinary lost profit is a direct loss (although there may be certain categories of lost profits that are indirect: Victoria Laundries v Newman [1949]).

The House of Lords decision in The Achilleas [2008] introduced a further consideration: even if the loss in question was within the parties’ reasonable contemplation, was it a type of loss for which the contract breaker had assumed responsibility? More recently, in Sylvia Shipping v Progress Bulk Carriers [2010] andJohn Grimes v Gubbins [2013] the Court of Appeal has confirmed that Hadley remains the correct test, except in those rare cases where its application leads to a result that is contrary to market expectations. Ironically, it could be argued that this was the case in Hadley itself.

Civil law systems, such as those in the Gulf states, reach the same result by a slightly different route, recognising that lost profit is generally a direct loss and is therefore recoverable, but applying a foreseeability test to exclude losses that are too remote, which could include certain types of lost profit.

FIDIC

Which leads us back to FIDIC drafting.

As a matter of clear drafting, it may well be better to identify the actual heads of losses you intend to exclude as a category, and let the governing law do its work for everything else. It would be perfectly clear to draft an exclusion clause that did not use the words “direct”, “indirect” or “consequential”, but people like catch-all wording, as used in the FIDIC 1999 contracts, which specifically exclude loss of profit (apparently both direct and indirect) and then exclude indirect or consequential losses separately.

The FIDIC 2008 DBO form omits the word “consequential” which, as shown above, is quite (with apologies) inconsequential.

Of greater significance is the additional word “other”; a word which projects both backwards and forwards in the sentence, forming a link. The implication is that loss of profit is always an indirect loss, but we know that is not correct. It could be argued that, as a result of the word “other”, the blanket exclusion of loss of profits does not extend to those which are direct – but would a DAB or arbitral tribunal agree?

FIDIC’s guidance on Clause 17.8 of the DBO says that “it is in neither Party’s, nor the Project’s, best interests if a Party is forced into bankruptcy or an unacceptable financial situation by carrying unlimited liability”. It is also in the parties’ interests to have clarity over which losses will be recoverable, and to avoid ambiguity in the drafting, in order to avoid a long, expensive, time-consuming and unpredictable dispute resolution process.

The drafting solution

If the parties truly want to render all lost profits irrecoverable, the solution, if using the Gold Book, is to use the Particular Conditions to delete the word “other” in Clause 17.8. Alternatively, if the parties wish to permit claims for lost profits, whether in the Gold Book or the 1999 suite, it might be best to replace the clause altogether.

Despite these clauses, the FIDIC forms are peppered with clauses which allow the contractor to recover profit. But that’s an issue for another day.