Excluding Consequential Loss - Does It Matter If You've Been Naughty Or Nice?

Attempts to exclude or limit liability for consequential loss have given rise to considerable litigation, across industries. As two recent decisions in the energy sector have illustrated, adopting apparently wide-ranging and legalistic phraseology in such clauses may not have the desired result for the party seeking to limit its exposure.

It remains paramount to say clearly and precisely in the contract what losses are excluded. While English contract law generally allows the parties great freedom to allocate risk and liabilities, exclusion and limitation clauses are construed narrowly such that a more balanced, fairer result might be achieved.

In this article, we revisit the basic principles governing damages for breach of contract and liability for financial loss in particular, before reviewing Transocean v Providence (2014),a dispute under a contract for the hire of a drilling rig, and Scottish Power v BP Exploration Operating Company (2015), a case arising under a gas sales agreement relating to the Andrew Field in the North Sea.

A case of two limbs

When reviewing damages for breach of contract, one usually starts about 160 years ago with the famous decision in Hadley v Baxendale [1854] EWHC Exch J70. The general rule is that damages are meant to compensate the innocent party for the bargain it lost, by putting it into the position it would have been if the contract had been performed. Damages for breach of contract can be awarded for any loss that falls within the contemplation of the parties. Hadley v Baxendale hasdivided recoverable losses into two categories, or limbs: direct and indirect loss.

Direct losses

As a matter of law, all losses that occur as a direct, ordinary or natural consequence of the breach - or, to put it differently, which arise in the usual course of things - are deemed to be reasonably foreseeable, and within the contemplation of the parties. That means the parties are objectively taken to have foreseen that particular loss at the time of entering into the contract, whether or not they actually did. These 'direct losses' are often referred to as coming within the first limb of the rule in Hadley v Baxendale, and they generally have to be 'not unlikely' (and hence reasonably foreseeable) to be recoverable (see Koufos v C Czarnikow Ltd (The Heron II) [1969] 1 AC 350).

Special or indirect losses

But there may be other, more unusual and generally more extensive, losses that do not fall within the first limb, but for which damages are nevertheless recoverable because these losses are foreseeable in the particular circumstances of the case, and hence not 'too remote'. That, however, requires that the special circumstances which give rise to these losses were in fact brought within the contemplation of the parties, for instance by having been communicated, or otherwise become apparent, at the time of contracting.

The example that is often used to illustrate this 'second limb' of Hadley v Baxendale is found in Victoria Laundry (Windsor) v Newman Industries [1949] 2 K.B. 528. The defendant seriously delayed delivery of a new boiler for the claimant's laundry business. As a result, the claimant lost considerable business, including an especially lucrative Government contract. The Court of Appeal held that the loss of profit under the Government contract was not recoverable. The defendant had neither been told about this deal, nor could he reasonably have expected to have known about it, when signing the agreement. The other party has to be made aware of any special circumstances at the time of entering into the contract. That is the temporal cut off point (as reaffirmed, for instance, by the House of Lords in Jackson v Royal Bank of Scotland [2005] UKHL 3). So, things would have been different if Victoria Laundry had said 'You do realise we might lose the deal of the century if you are very late with this boiler' when signing the agreement - but not if they had only remembered to mention the profitable contract the following week.

Economic or financial loss can be within either limb

Economic or financial loss is often equated with the notion of 'consequential loss'. Over the years, there have been a number of decisions, including by the Court of Appeal, which have held that under English law 'consequential loss' however means 'indirect loss' falling within the second limb of Hadley v Baxendale (see for instance Croudace Construction v Cawoods 8 BLR 20, and British Sugar Plc v Nei Power Projects Ltd [1997] EWCA Civ 2438). Referring to 'consequential loss' in an exclusion clause does not, therefore, shed any light on what kind of economic or financial loss, or loss of profit or revenue, has been excluded. All these types of monetary losses can either be direct, or indirect ('consequential'). Taking the Victoria Laundry case as an example, damages would be recoverable for all loss of profit that would follow in the ordinary course of business, by the laundry not being able to serve customers without the delayed boiler. Certainly, loss of profit that could have been earned as a result of the performance of the contract itself is likely to be direct loss (see Hotel Services Ltd v Hilton International Hotels (UK) Ltd [1997] EWCA Civ 1822).

The decision in McCain Foods (GB) Ltd v Eco-Tec (Europe) Ltd [2011] EWHC 66 further illustrates that liability for direct financial loss (within the first limb) can be significant. McCain operated a waste water treatment system, which produced biogas. It then bought a system from Eco-Tec that was meant to generate electricity from biogas. The system was, however, unfit for its purpose and could not be installed and commissioned. The contract excluded any liability for "indirect, special, incidental and consequential damages". Nonetheless, the Court found that McCain could recover for all of the following financial loss as a direct consequence of the breach:

the cost of buying and installing a working replacement system to generate electricity from biogas; the cost of buying electricity instead of generating it from the time that the system should have been operational; loss of revenue from operating the system, in particular revenue that could have been earned by selling Certificates of Renewable Energy Production; the additional cost of employing contractors, site mangers and health and safety personnel while the system was being worked on; and the cost of personnel already employed whose time was taken up by the defects, the cost of expert analysis and testing, and the cost of additional equipment and further construction work purchased from Eco-Tec and others in an attempt to get the system to work. All of this was found to be loss that resulted in the ordinary course from the failure to provide a working system.

A new consideration: the 'assumption of responsibility' for particular losses

The law as to what damages were recoverable for breach of contract had changed little since Hadley v Baxendale until 2008, when the House of Lords decided Transfield Shipping Inc v Mercator Shipping Inc [2008] UKHL 48. In Transfield, their Lordships considered the policy reasons behind the law on damages, identifying an assumption of responsibility (by the contracting parties) as the basis on which liability for losses of a particular kind was imposed. Transfield concerned the late redelivery of a vessel by the charterers to the owners. The owners were forced to renegotiate the subsequent charter, since the vessel could not be tendered on the agreed date. The market was exceptionally volatile during that period, and the renegotiations led to a much lower rate than had previously been agreed, based on the prevailing market price at that time (which seemed to have fallen by 20 per cent over a few days).

An arbitral tribunal found that all the losses incurred by the owners as a consequence of having to renegotiate the subsequent fixture had been reasonably foreseeable. The House of Lords, however, disagreed, and in so doing reformulated the test for remoteness. Lord Hoffman in particular stressed that damages are awarded not purely based on what losses a reasonable person could foresee, but only for those losses for which the contracting parties would have 'assumed responsibility' (reflecting the consensual nature of contracts). A significant factor in this case was the very widespread acceptance or practice in the shipping industry that charterers did not assume the full risk of the owner losing out on subsequent fixtures if they delayed redelivery: charterers instead only expected to pay the difference between their charter rate and the market rate (if any) during the period of delay. It followed that the entire loss arising under the less favourable follow-on fixture was not loss for which the charterers could be deemed to have assumed responsibility at the time of contracting.

Transfield Shipping...

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