The long-established principle of damages in English contract law is that the innocent party should be put in the same position as if the contract had been performed. The assessment of damages is often a complex exercise which involves a great degree of factual and contractual appreciation of each type of loss claimed on a case-by-case basis.
The general law on contractual damages makes a basic division between damages:
- Normal or direct, which follow as a natural and probable consequence of the breach; in other words, damages that every claimant would suffer; and
- Consequential or special damages which are particular to the claimant and include anything beyond the normal measure.
Use of exclusion clauses
The use of exclusion clauses is not uncommon in commercial contracts where the purpose is to exclude or limit a party’s responsibility for certain types of losses. The risk with these clauses lies in fully appreciating what is intended to be excluded by the words used and whether such commercial intention matches the English courts’ interpretation of the words used.
There have been cases where parties have found themselves ordered by the English courts to pay for what they thought they had specifically excluded or have been held unable to claim a type of loss which they had not appreciated had been excluded.
Exclusion clauses may vary from simple plain wording, ie “all indirect / consequential losses are excluded” to those with sophisticated, descriptive wording.
But what do consequential / indirect losses encompass?
From a drafting point of view, it is worth understanding what a consequential / indirect loss encompasses before seeking to exclude responsibility for it.
English courts (and tribunals applying English law) have decided on a number of occasions that damages recoverable under a contract must arise either:
- naturally from the breach of contract itself, i.e. from the ordinary course of things (the first limb of the Hadley v Baxendale test); or
- must have been within the reasonable contemplation of both parties at the time the contract was concluded (the second limb of the Hadley v Baxendale test). For a party to have contemplated certain types of losses, it should have had either imputed or actual knowledge of them.
A significant number of English authorities, when construing the exclusion clauses which exclude consequential loss or damage in certain contracts, have decided that consequential / indirect losses are the same as losses that, despite not flowing naturally from the breach (being the first limb of the Hadley v Baxendale test), were within the reasonable contemplation of the parties at the time of the conclusion of the contract (being the second limb of the Hadley v Baxendale test). Other decisions have questioned this approach by stating that each case needs to be examined in the context of its own facts and according to the specific contractual terms, when deciding whether losses occur naturally in the ordinary course of things and are direct or indirect / consequential.
It is submitted (in line with the preeminent text on damages law) that recoverable consequential / indirect loss in contract is not necessarily identical to loss that was within the reasonable contemplation of the parties at the time the contract was entered into (falling within the second limb of the Hadley v Baxendale test). This narrow interpretation of consequential losses:
- is not consistent with the plain and ordinary meaning of the words “consequential” or “indirect”;
- creates confusion to the market and lay people as against the established position in respect of normal (direct) and consequential (special) damages as outlined in the “Introduction” section above; and
- confines types of recoverable losses to a particular meaning, without taking into account business common sense and the intention of the parties in a particular contractual context.
The Star Polaris LLC v HHIC-PHIL Inc, is an example of a case where the English Court did not treat the exclusion clause in the specific contractual context narrowly, but rather decided that the parties intended it to apply to “the wider meaning of financial losses caused by guaranteed defects, above and beyond the cost of replacement and repair of physical damage” and thus did not allow claimants to claim anything else in damages against the ship-builders other than the costs of repairing the defective engine of the vessel. The particularity in this case was that the shipbuilding contract went into detail to set out which losses were to be recoverable, which was seen by the English Court as a complete code for liability.
Therefore, it is clear that English law is not explicit as to what direct and indirect/consequential losses encompass in any given situation.
The English courts’ approach in charterparty cases
Exclusion clauses are not such a common feature of traditional charterparty proforma contracts. In fact, there are only a few standard proforma charterparties that incorporate exclusion clauses (e.g., Towcon, Supplytime, Heavycon, Wreckstage), which are used in particular sectors (towage, off-shore support vessels or super heavy lift cargoes etc). There are also certain BIMCO standard clauses that incorporate exclusion clauses.
However, in the recent years, we have come across the inclusion of sophisticated exclusion clauses mainly in tanker / LNG charters (where potential losses can be vast) as well as other simpler and less detailed clauses in dry-cargo charters.
Both on a time-charter and voyage-charter basis and in the absence of exclusion clauses, losses within the reasonable contemplation of the parties when the contract was entered into, have generally been awarded to claimants in their true amounts, subject to remoteness. In other words, losses that would fall under the second limb of the test in Hadley v Baxendale (for example losses from the owner’s subsequent employment which the charterer does not have any specific knowledge of or from a charterer’s sub-contract which the owner does not have any specific knowledge of) have been awarded because the party in breach is deemed to know of the type of loss for which damages are being awarded (imputed knowledge). In the MTM Hong Kong, the Court awarded damages for repudiation of a voyage charterparty for the consequence of the vessel's delay in repositioning to the North Atlantic market in addition to the loss of the profit which would have been earned from performing the contract voyage. It was held that these damages were “related to a different kind of loss, ie something different from loss of the profit which would have been obtained from performance of the repudiated charter, [and] there was no reason why such loss should not be recoverable in damages in addition to damages for loss of the profit from performing the charter, subject to the principles of causation, mitigation and remoteness”.
In a recently reported London arbitration award it was held that a clause in a time charterparty excluding liability for “consequential damages [including] but not limited to, loss of use, loss of profits, shut-in loss or loss of production and costs of insurance, whether or not foreseeable at the date of this Charter Party” was enough to debar the charterer from claiming for (a) loss of hire under the sub-time charter; (b) loss of right to a demobilisation fee; and (c) loss of the profit they would have made under a proposed renewal of the sub-time charter. In another London arbitration award, an owner’s contractual responsibility only for “extra directly-related costs/expense/time” arising from the owner’s breach of warranty in respect of the holds’ condition on arrival at the loading port, was not enough to exonerate the owner from liability for delay in berthing following the rejection of the holds. In other words, this type of loss was classified as a direct rather than indirect loss.
The English courts’ approach in bills of lading cases
The Hague and Hague-Visby Rules do not contain a provision on exclusion of certain types of losses. They include, however, the following provision:
“The total amount recoverable shall be calculated by reference to the value of the said goods at the place and time at which the goods are discharged from the ship in accordance with the contract or should have been so discharged […].”
One could read this provision as covering all types of losses arising from a breach of the Hague-Visby obligations in which case claims for other losses, beyond this normal measure, would be excluded. However, one of the purposes behind the introduction of the Hague-Visby Rules was not to exclude carrier’s liability for losses beyond the normal measure for loss or damage to goods but rather to put a maximum monetary limit on their liability for this particular type of loss.
Indeed, English case law has not restricted compensation under contracts of carriage for losses beyond the measure identified in Article IV(5)(b) of the Hague-Visby Rules. In The Subro Valour,damages were awarded in respect of losses incurred under a bill of lading that was subject to the Hague-Visby Rules due to fluctuation in an EEC relief levy on the cargo during the period of delay which was held to be within the imputed knowledge of the owner. In The Pegase, there was a delay of 65 days in the claimants obtaining their cargo of chromite sand and, in consequence, they claimed loss of profits on sales that would otherwise have been made to customers in addition to claims for having to purchase replacement material. The court held that there was no rule of policy excluding or limiting the recovery of that type of damages against a carrier. However, the court rejected the claimants’ additional claim for loss of goodwill as this did not fall within the “contemplation” test. In The Ardennes (not a Hague-Visby case), a claimant recovered the additional import duty that had become payable on the goods due to the delay. Finally, in The Ocean Dynamicthe court upheld a claim for consequential loss (over and above the claim for loss of the cargo of cherries in containers) in the form of compensation paid to the cherry pie producers to whom the cargo owner claimants had sold the cherries.
From the above, it appears that, in the context of most shipping cases – which do not often involve the presence of exclusion clauses – the English courts have awarded damages on a case-by-case basis and without being forced into restrictive interpretations of consequential / indirect losses.
Intention vs result
It appears that the English courts and the commercial people negotiating contracts are not always on the same page when it comes to interpreting terminology used in commercial contracts and that will also be the case in charterparty contracts.
For example, there is often a misconception that if a party takes responsibility only for direct losses (or liability for indirect / consequential losses is excluded), that party is sufficiently protected against loss of profit and/or other financial losses of their counterparty. However, loss of profit will normally be categorised as a direct loss by the English courts and the exclusion of liability for indirect or consequential losses will not operate to protect the party from a claim for loss of profit.
The importance of using clear and express language
The starting point for an English court (or tribunal) in interpreting an exclusion clause will be the language of the clause itself. Given the complicated exercise of determining in advance and in the abstract what direct as against indirect or consequential losses encompass, the best approach in drafting a clause will be to spell out in clear and express language what types of losses are accepted and exclude all other losses; alternatively, to exclude named types of losses.
It will always be preferable that the named excluded types of losses be not characterised generically as “indirect or consequential losses” as this may be interpreted by the courts (and has so been interpreted in the past) as showing an intention to exclude the named excluded losses, only where they are of an indirect / consequential nature but not where they are of a direct nature.
It appears that the English courts are prepared to uphold a clause’s specific language if it is seen as a complete code for the allocation of risks and its consequences between two commercial parties of equal bargaining power. However, a simple exclusion stating, for example, “any and all indirect losses whatsoever”, may be interpreted by the English courts as having the same meaning as, those losses which fall under the second limb of the rule in Hadley v. Baxendale, i.e. those losses within the reasonable contemplation of the parties at the time the contract was entered into. Such generic words are probably to be avoided if certainty of meaning is to be produced.
The lesson to be learned is that parties must be very cautious when drafting exclusion clauses and ideally seek legal advice in this regard. There is uncertainty in English law and in the courts (and tribunals) applying English law as to the precise meaning of direct / indirect / consequential losses. A decision from the Supreme Court could help to promote certainty and provide clarity, but matters may still be fact sensitive. A well drafted clause should help to remove the need to rely on uncertain principles.