Consequential Loss

What is consequential loss? For many years the simple answer to this question has been considered to be those losses falling within limb 2 of Hadley v Baxendale, however, a recent decision of the Commercial Court has cast doubt upon this.

In Star Polaris LLC v HHIC-PHIL INC [2016] EWHC 2941 (Comm), a different interpretation as to what is meant by “consequential loss” was adopted which was a departure from the traditional approach, and may signal a new approach to be followed in future cases.

The Fact of the Case

Star Polaris LLC (“Star Polaris”) entered into a contract with HHIC-PHIL INC (“Defendant”), a shipyard, to purchase the “Star Polaris” vessel, which was delivered to Star Polaris on 14 November 2011. On 29 June 2012, the vessel suffered a serious engine failure and had to be towed to South Korea for repair.

Star Polaris sought to claim damages, through arbitration, for the cost of:

The Defendant denied all liability.

Under Hadley v Baxendale it has long been established that the classification of recoverable losses for breach of contract can be split into two:

  1. limb 1 – losses which occur in the ordinary course of things, which are referred to as direct losses and are recoverable; and
  2. limb 2 – loses which arise due to special circumstances outside of the ordinary course of things and which are only recoverable if they were reasonably foreseeable at the time the parties entered into the contract. These are known as indirect or consequential losses and generally are excluded from a contract.

The arbitral tribunal held that certain repair costs were recoverable (being a direct loss), but that “consequential or special losses, damages or expenses” were excluded from the contract as being recoverable which included the Fees and the claim for diminution in value.

Unsurprisingly, Star Polaris appealed the decision. A key question for the court was in relation to the correct interpretation of the phrase “consequential or special losses, damages or expenses” contained in the contract. The court had to consider whether such wording fell within limb 2 of Hadley v Baxendale.

Star Polaris argued that “consequential or special losses” should be construed in the context of limb 2. The Defendant, on the other hand, argued that the phrase should be construed within the context of the contract itself which contained express obligations on the Defendant to make any necessary repairs or replacement to any defects directly caused by any defective materials or poor workmanship and to compensate Star Polaris for any costs associated with this, but expressly excluded any liability for consequential or special losses.

The Commercial Court held that the phrase should be construed in the context of the contract as a whole, meaning that Star Polaris could only claim for the cost of the repair works, not the Fees and diminution in value of the vessel. The court found that the exclusion clause set out a code which excluded other liabilities imposed by statute, common law, custom or otherwise, and the remaining losses fell within the exclusion of consequential loss.

As the Defendant’s guarantee and obligations were expressly limited under the contract to repair or replacement of defective items, the Fees and other financial consequences were to be borne solely by Star Polaris.

The Commercial Court made it clear that “consequential and special losses” did not necessarily mean losses within limb 2 of Hadley v Baxendale but rather had a wider meaning in the context of the contract as whole.

Paris Smith Comment

Whether the decision in this case is a good thing or a bad thing will depend on which side of the argument you sit, but it has certainly only served to increase the uncertainty as to which losses will be considered consequential losses. It is also likely that we will see an increase in disputes being referred to the courts for determination as the parties seek to argue the point as to whether a specific loss is recoverable or not.