One of the key clauses in any commercial contract is the limitation of liability clause. This seeks to protect the parties - often the supplier - from disproportionate and unbudgeted exposure to large losses if something goes wrong.

One key aspect of the clause is a limitation of liability - to limit the liability to a capped amount. Another is to exclude certain types of losses.

In the exclusion aspect of the clause, there is often an attempt to exclude certain losses that are "indirect or consequential" and also to exclude losses falling under stated heads of loss such as loss of profits, loss of revenue, loss of goodwill, etc.

"Indirect or consequential loss" has been interpreted by the English courts over many years as referring to the second limb in the Hadley v Baxendale case, i.e. not losses that would flow from a breach in the ordinary event (the first limb), but special types of losses that have been made known to the party in breach. The courts have said that financial losses such as loss of profits could be either direct losses (first limb) or indirect losses (second limb) and this depends on the context.

Some people have recently argued that this approach should be changed and does not reflect what many non-lawyers in business would understand by the phrase for "indirect or consequential loss" which they know as financial losses such as loss of profits.

The High Court has now considered the meaning of "consequential loss" again in the recent case of Star Polaris LLC v HHIC-Phil Inc.

The Facts

This case was about the building of a ship called the Star Polaris. The ship suffered serious engine failure eight months after it had been delivered and had to be repaired. The buyer of the ship claimed compensation for the repair costs and various other costs caused by the engine failure including towage fees, agency fees and survey fees, as well as diminution in value of the ship.

The contract contained a 12 month guarantee and it said the shipbuilder accepted certain obligations to remedy physical defects. One clause said the shipbuilder was to have no other liability in respect of the ship after delivery and expressly excluded "consequential or special losses, damages or expenses unless otherwise stated herein."

An argument arose over the interpretation of the phrase consequential loss. The arbitrators decided that the wording used suggested that all financial losses other than making repair or replacement would be excluded, and "consequential loss" was to be used in the sense of "cause and effect".

High Court Decision

The High Court has given effect to the same meaning as the arbitrators. It has ruled that "consequential loss" must be given the meaning according to the context of its use in the contract. In this context, it was clear that the parties had intended to limit the liability of the shipbuilder to the positive obligations of remedying the physical defects. The fact that "consequential loss" was referred to in the clause did not mean that it should only be read in light of previous cases, but it was about construing what the parties meant here. In this case, the parties had intended to use the phrase in the context of "cause and effect" rather than by reference to the specially known losses (i.e. the second limb of Hadley v Baxendale).

This case does not say that all uses of "indirect or consequential loss" must be interpreted in a particular way. That is actually the significance of the decision - that each case must now interpret that phrase based on the context in which it is used. It is important to have clear drafting that makes clear the context of use of that phrase.

When we draft an exclusion clause, we typically refer to indirect or consequential losses as separate from financial types of losses (such as loss of profits), to try to cover both bases. Going forward, we will continue to do that.

What is also important to recognise is that mere use of the phrase "indirect or consequential loss" can no longer be guaranteed to mean the special losses from the second limb in Hadley v Baxendale. It will depend on its context.