Consequential Loss - What Does This Exclude?

The courts continue to look at the meaning of "consequential loss" in limitation of liability clauses and at whether the traditional legal meaning or the ordinary language meaning should apply.

What's the issue?

Exclusion clauses in a contract aim to exclude a party's liability for certain types of losses. It is essential that these clauses are drafted clearly and without ambiguity if they are to be effective. Well drafted exclusion clauses are important in any contract, but we often see issues relating to these clauses in disputes arising from IT contracts. If an IT project fails, there is inevitably a dispute between the customer and supplier as to the nature of losses recoverable under the contract. These are likely to include both direct losses (e.g. the loss of the failed software system itself) and indirect losses (e.g. caused by business disruption although loss of profits can be both direct and indirect loss depending on the circumstances).

The risk of a badly drafted exclusion clause is that it is left to the courts to interpret its meaning, which can often result in a decision which leaves one party exposed to unanticipated liabilities.

What's the development?

Once again the interpretation of exclusion clauses limiting liability for "consequential losses" has come before the courts. The High Court's decision in Star Polaris LLC v HHIC-PHIL INC is an interesting reminder of the debate surrounding exclusion clauses and the interpretation of "consequential loss".

As with all cases on limitation of liability, this decision revolves around the exact wording of the clause but the Judge accepted that when read as a whole, it could be seen that the clause had the wider meaning of financial losses caused by guaranteed defects, above and beyond the cost of replacement and repair of physical damage. The relevant clause was intended to operate as a complete code under which all liability for losses over and above those specifically accepted by the defendant shipbuilder were excluded.

What does this mean for you?

The courts have, in the past, construed the phrase "consequential losses" narrowly, using the traditional interpretation set out in Hadley v Baxendale, often in an attempt to achieve what was perceived as a fair outcome. Now, the trend, reflected in the Star Polaris decision, is for the courts to give the words used their natural and ordinary meaning. This is particularly true for commercial contracts negotiated between sophisticated...