The Commercial Court has considered the proper construction of the phrase "consequential or special losses, damages or expenses" in a ship-building contract, concluding that (in this specific contract) it meant any losses resulting from physical damage other than the cost of repair and replacement: Star Polaris LLC v HHIC-PHIL INC [2016] EWHC 2941 (Comm).

While this case does not establish new law, it is a useful illustration of the court's approach to construction of contractual terms and, in particular, that the court will construe limitations of liability in the context of the contract as a whole. It demonstrates in particular that, even if the court has previously decided on the construction of a similar (or even identical) term in a different contract, it may reach a different conclusion on its meaning in this different context. Here it was significant that the contract in question provided a complete code for dealing with liability, so it was not just a question of determining what liability was excluded, but ascertaining what liability was undertaken.

As a practical matter, the case illustrates that parties should take great care in ensuring that any terms defining or restricting their contractual liabilities are clear and unambiguous. Using precedent wording from a different contract that the court has already ruled upon is no guarantee that a similar approach will be taken in a different context.

James Baily and Martin Hevey, a partner and associate in our dispute resolution team, consider the decision further below. For more information on contractual limitation and exclusion clauses, see Defining your liability in advance: Liquidated damages, limitation and exclusion clauses from our contract disputes practical guides series.

Legal background

Traditionally, the courts have interpreted “indirect” or “consequential” loss to mean losses which fall within the second limb of the classic test for recoverable loss in contract, as set out in Hadley v Baxendale (1854) 9 Ex 341 – namely those losses which do not arise naturally from the breach of contract itself (which would fall within the first limb) but rather from some special circumstance that the defaulting party was aware of at the time of the contract.

So in other words, the traditional contrast is between those losses a reasonable person might expect would result from the breach in the ordinary course (direct losses), and those which would not be expected unless special circumstances are known (indirect or consequential losses).

Factual background

The Claimant (the Buyer) was the purchaser of the STAR POLARIS, a ship that was built by the Defendant (the Yard) under a contract which was in variance of the standard form ship-building contract (the Contract).

The Contract guaranteed the vessel for 12 months against all defects due to defective materials, design error, construction miscalculation and/or poor workmanship (but not various other causes including perils of the sea, normal wear and tear, mismanagement, negligence or wilful neglect). Following notification of any defects covered by the guarantee, the Yard would make the necessary repairs or replacements at its shipyard or, subject to certain conditions (including consent of the Yard) the repair work could be carried out elsewhere and the Yard would reimburse the cost. In any case, removal of the vessel to the place of repair was to be at the Buyer's risk and expense.

The Contract provided that Yard would have "no liability or responsibility whatsoever or howsoever arising for or in connection with any consequential or special losses, damages or expenses unless otherwise stated herein." The guarantee was expressed to "replace and exclude any other liability, guarantee, warranty and/or condition imposed or implied by statute, common law, custom or otherwise…".

Some months after taking delivery of the vessel, the vessel suffered a serious engine failure and was towed to a dockyard for repairs. The Buyer commenced arbitration against the Yard, contending that the engine failure was caused by the Yard's breaches of contract. In addition to the costs of repairs to the vessel, the Buyer made a claim for towage fees, agency fees, survey fees, and off-hire as well as for diminution in value of the vessel.

The Tribunal concluded that the Buyer's claims above and beyond the cost of repair of physical damage were excluded under the Contract because they were "consequential or special losses, damages or expenses". In doing so the Tribunal found that the word "consequential" was used by the parties in the agreement in its cause-and-effect sense, as meaning following a result or consequence. In essence it said the Yard undertook only to repair or replace defects falling within the guarantee and all other financial consequences were to fall on the Buyer.

The Buyer appealed against the Tribunal's award, arguing that "consequential or special losses" should be interpreted in accordance with its established meaning to refer to those losses falling within the second limb of the rule in Hadley v Baxendale as outlined above. Whilst the Buyer accepted that it was possible for parties to an agreement to have meant that the words be construed in a way other than the well-recognised meaning, it relied on the judgement of Teare J in Ferryways NV v Associated British Ports [2008] 1 CLC 117 to argue that it would require very clear words to indicate the parties had chosen such an approach.

The Buyer also argued that the fact that the term "consequential losses" was paired with "special losses" was indicative that the parties intended to refer to such losses referred to in the second limb of the Hadley v Baxendale test (which also uses the term "special losses"), and that the court should ascribe importance to the fact that the standard form contract had been amended to delete the exclusion of damages for loss of use.

Decision

The Commercial Court dismissed the appeal. It agreed with the Tribunal that the extent of the Yard's liability was not to be defined by looking at the exclusion of consequential / special losses in isolation, but rather it had to be considered in the light of the Contract as a whole, which included the guarantee in relation to defects.

The court found that the Contract included a deliberate distinction between defects and damage on the one hand (which, depending on their nature, may be compensable under the Contract), and consequential damage on the other. The fact that if the vessel was to be repaired at another yard, it was to be moved at the Buyer's risk, and that the Yard could forward replacement parts or send one of its representatives to that Yard, but only if that did not delay the operation of the vessel, showed that the guarantee did not cover any loss of time or loss of use of the vessel.

The court agreed with the Tribunal's findings that, given the only positive obligations assumed under the guarantee were for the repair and replacement of defects and physical damage caused by such defects, "consequential damage" had a wider meaning than in the second limb of the rule in Hadley v Baxendale. In those circumstances the word "consequential" had to mean that the parties had agreed to exclude liability for any damage which followed as a result of physical damage, namely additional financial loss other than the cost of repair and replacement.