'Consequential Losses' – What Does This Exclude?

Once again the interpretation of exclusion clauses limiting liability for "consequential losses" has come before the court. Star Polaris LLC v HHIC-PHIL INC is an interesting reminder of the debate surrounding exclusion clauses and the interpretation of "consequential loss".

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 engagement letters. If a dispute arises from the engagement the effect of the exclusion clause in the engagement letter is often called into question as well as those losses recoverable under the contract.

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

Case law has established the traditional interpretation of the meaning of "consequential loss" in exclusion clauses. The principles under contract law are described under two limbs.

The first limb relates to direct losses - "losses arising in the ordinary course of things" those claimable losses which arise naturally as a result of the breach. In more exceptional circumstances, and under the second limb, are "indirect" losses or "consequential losses" - "losses likely to arise from special circumstances of the case". These are particular losses recoverable only if the other parties know of those circumstances and if it was in the reasonable contemplation of the parties at the time the contract was made as being a probable result of the breach. The court has in the past construed the phrase "consequential losses" narrowly, often in an attempt to achieve what was perceived as a fair outcome. Now, the court tends to give the words used their natural and ordinary meaning. This is particularly for commercial contracts negotiated between sophisticated parties.

In Star Polaris the vessel built by the defendant shipyard suffered a serious engine failure. The ship owner claimed compensation against the shipbuilder for repair costs and expenses caused by the engine failure (such as towage fees). The ship owner also claimed the loss of value in the vessel following the incident. On the question of breach, the tribunal found that while the...