The recent case of Star Polaris LLC v HHIC-Phil Inc in the High Court is a reminder to accountants and auditors that clauses in their letter of engagement seeking to limit liability towards their clients or disclaim liability to third parties need to be kept under review to ensure that they comply with the latest caselaw and meet their intended objective.
The finding by the High Court in Star Polaris is evidence of a departure from the previous authorities which provide a well-recognised meaning for the phrase "consequential loss" in any exclusion of liability. Now, instead of relying on the legalistic meaning of these words, the courts are focusing on the context of the contract and the intention of the parties.
This decision is not limited in impact to the specific phrase "consequential loss" but it shows that over- reliance on previously well-settled legalistic language may be dangerous. The courts have an appetite for contextual analysis which may mean that the same words can have a different meaning in different situations. Clear drafting using plain English should help overcome these difficulties.
In Star Polaris LLC v HHIC-Phil Inc, the High Court considered the meaning of "consequential or special loss" and whether, in the context of limitation of liability clauses, this means losses that fall within the second limb of Hadley v Baxendale.
Hadley v Baxendale is the leading case on assessing contractual damages and the first limb is taken to referring to direct losses whilst the second limb refers to consequential losses – those that are only recoverable if the special circumstances from which they flow are known to both parties.
The claimant buyer bought the ship, Star Polaris, from the defendant shipbuilder under the terms of a contract. Eight months after delivery the ship suffered catastrophic engine failure, which the claimant argued resulted in financial loss, lost profit and diminution in value to the claimant.
The shipbuilding contract included a limitation of liability clause excluding responsibility for consequential losses. Liabilities which were accepted included a guarantee for the defendant to replace or repair any physical defect covered by the guarantee within the first 12 months after delivery. However the defendant argued that "consequential or special loss" in the clause did not mean those which fell under the second limb of Hadley v Baxendale, but had a wider meaning of "cause and effect", meaning any losses caused as a result of a physical defect.
The High Court found in favour of the defendant and ruled that "consequential or special loss" in this context should have a wider meaning than previous caselaw has provided. After a careful textual analysis, Sir Jeremy Cooke accepted the defendant's argument that the well-recognised meaning of "consequential loss" was not the meaning intended by the contracting parties, and as such the line of authorities was not conclusive.
Key points for auditors and accountants
Auditors and accountants may incorporate limitation clauses in their client engagement letters in relation to non-statutory audit work carried out for their clients or rely on disclaimers where they seek to limit their liability in relation to third parties (the latter is commonly known as a "Bannerman" clause). Sections 534-538 of the Companies Act 2006 also permit auditors to limit liability in relation to statutory audits provided the limitation is set out in a Liability Limitation Agreement (LLA) that is approved by the shareholders annually, the LLA specifies the financial year that it relates to, and the limitation is ‘fair and reasonable’.
Star Polaris is a helpful reminder that auditors and accountants need to take care when drafting such limitation clauses – a well drafted clause could materially affect overall liability.
In our experience, the following points may help avoid disputes in relation to limitation clauses and disclaimers.
For auditors retainers:-
- the limitation or exclusion clause in the engagement letter should be approved by a shareholder's agreement;
- the engagement letter should specify the financial year it relates to and be for one year only, with new engagement letters being issued for subsequent years; and
- the limitation clause should only relate to the auditor's role and auditors should be wary of lumping different types of work together under one cap which will undermine its reasonableness.
For all retainers:-
- clear and unambiguous wording should be used in the engagement letter which expressly states what liability is being excluded or limited;
- where certain phrases such as "consequential losses" or "indirect losses" are used, care needs to be taken to ensure that they reflect the proper intentions of the parties as to what is and is not excluded. These should be reviewed in light of Star Polaris;
- check for any inconsistencies between the limitation/exclusion clause and the agreement as a whole because the courts will look at the entire agreement in the event of any dispute, and not just the exclusion clause when determining the parties' intentions; and
- check for any ambiguity because the exclusion may be construed against the accountant/ auditor (the contra proferentem rule). This is particularly likely where the professional is dealing with a less sophisticated client.
It is sensible for accountants and auditors to ensure their engagement letters are up-to-date with current practice, law and legislative requirements.