Contractual Limitation: High Court narrows “consequential loss”


In Star Polaris LLC v HHIC-Phil INC [2016] EWHC 2941 the High Court considered the correct construction of the phrase

consequential or special losses, damages or expenses

in a shipbuilding contract which contained a limitation of liability clause.

Overview

The case is of wider interest as lessons can be drawn generally regarding contractual terms and conditions, and letters of engagement, it

  • shows a clear departure from traditional interpretations of “consequential loss” in contract clauses seeking to limit or exclude loss
  • introduces a new approach in considering the meaning of the phrase by taking into account the context of the contract as a whole and the intention of the parties at the time of entering into the contract.
  • demonstrates that a limitation of liability clause setting out an exclusive code of damages may be effective if drafted in clear language

Background

The Claimant, Star Polaris LLC (the “Buyer”) entered into a shipbuilding contract with the Defendant, HHIC-PHIL INC (the “Builder”) for the purchase of a bulk carrier vessel named the POLARIS STAR (the “Vessel”).

Article.XI of the contract made detailed provision for the Builder’s liability for any defects in the ship. Article.XI.1 of the contract imposed an obligation on the Builder to guarantee the Vessel for a period of 12 months against

all defects due to defective materials, design error, construction miscalculation and/or poor workmanship

Following written notification of any defects covered by the guarantee, Article.XI.3 required the Builder to make the necessary repairs or replacements at its shipyard or reimburse the cost thereof.

Most importantly, Article.IX.4(a) of the shipbuilding contract contained a limitation of liability clause which specifically excluded the Builder’s liability for “consequential or special losses, damages or expenses”.

The Vessel was delivered to the Buyer on 14 November 2011; however, on 29 June 2012 the Vessel suffered from a serious engine failure and had to be towed to STX Gosung in South Korea for repairs.

The Builder denied all liability for the incident and as a result the Buyer commenced arbitration proceedings against the Builder for breach of contract. The buyer’s claim included:

a) the cost of repairs to the Vessel; and

b) towage fees, agency fees, service fees, off-hire and off-hire bunkers caused by the engine failure.

During the hearing, the Buyer also indicated that it wished to claim for diminution in the value of the Vessel.

In summary, the tribunal ordered an Interim Final Award on 12 November 2015 on the basis that there had been a causative breach of the Builder’s express warranty of quality. However, the Tribunal found that the Buyer’s chief engineer had failed to react to various warnings to reduce the speed of the Vessel and had failed to stop the Vessel’s main engine in sufficient time. It was held that these omissions contributed to the Vessel’s damage and amounted to a break in the chain of causation and therefore not all the repair costs were recoverable by the Buyer.

When assessing the remainder of the Buyer’s claim, the Tribunal considered Article.IX.4(a) of the shipbuilding contract which contained the limitation of liability clause.

Article.IX.4(a) – “Except as expressly provided in this Paragraph, in no circumstances and on no grounds whatsoever shall the Builder have any responsibility or liability whatsoever or however arising in respect of or in connection with the Vessel or this contract after the delivery of the Vessel. Further, but without in any way limiting the generality of the foregoing, the Builder shall have no liability or responsibility whatsoever or howsoever arising for or in connection with any consequential or special losses, damage or expenses unless otherwise stated herein”.

The Tribunal’s interpretation was that the word “consequential” was intended to be used by the parties in its “cause-and-effect sense”, as meaning “following as a result or consequence”. Accordingly, the losses set out at section (b) above were not recoverable by the Buyer.

It followed that any claim for diminution in value of the Vessel would also be a claim for consequential loss and as such, would be excluded from the Builder’s liability.

High Court Appeal

The Buyer appealed against the Tribunal’s decision on the basis that the phrase

“consequential or special losses”

should be interpreted in accordance with the second limb of the classic test for recoverable loss established in the leading case of Hadley v Baxendale [1854] EWHC 9 Exch 341.

In Hardley v Baxendale it was held that damages available for breach of contract could be pursued under two separate limbs:

  1. Direct loss – those which may fairly and reasonably be considered arising naturally from the breach of contract.
  2. Consequential loss – such damages as may reasonably be supposed to have been in the contemplation of both the parties at the time the contract was made.

The Buyer maintained that at the time the parties entered into the contract, the phrase “consequential or special losses” had a very well-recognised meaning as a matter of law. Furthermore, as other authorities suggest, the fact that both the words “consequential” and “special losses” where paired together in Article.IX.4(a) was a strong indicator that the parties intended the meaning of consequential loss as set out in the second limb of Hardley v Baxendale to apply to the contract.

High Court Judgment

Sir Jeremy Cooke, sitting as a High Court Judge decided in favour of the Builder, that Article.IX of the contract provided a comprehensive code for the determination of liability. He was therefore of the view that the limitation of liability clause should be construed in the context of Article.IX as a whole, including the guarantee in relation to defects.

On an analysis of Article.IX, the judge agreed with the Tribunal that on entering into the contract, the parties did not intend the Builder’s liability to extend beyond the obligation to remedy any defect by making all necessary repairs and replacements. “In short, the parties had agreed objectively that financial loss consequent upon physical damage was excluded”.

At paragraph 39 of his judgment, the judge held that

“consequential or special losses, damages or expenses does not mean such losses, damages or expenses as fall within the second limb or Hadley v Baxendale but does have the wide meaning of financial losses caused by guaranteed defects, above and beyond the costs of replacement and repair of physical damage”

Comment

The Judge decided that the construction of the Article showed the Builders had guaranteed to repair defective items for 12 months, but excluded all other financial consequences, which were the responsibility of the Buyer.

This decision highlights the importance of ensuring that caution is taken when entering into or negotiating a contract and that the contractual terms reflect the true intention of the parties, particularly when one party is attempting to limit or exclude its potential liability.

This case suggests a move towards a more flexible approach when interpreting the meaning of limitation/exclusion clauses, rather than being bound by traditional interpretations. Courts may now be more inclined to consider such clauses on a case-by-case basis, taking into account the whole of the contract that the clause appears in and the intentions of the parties at the time that the contract was entered into. For this reason, contracting parties should also check for any inconsistencies between the limitation/exclusion clause and the contract as a whole.

The decision indicates the conventional Hadley v Baxendale approach is secondary to the wording and construction actually used by the parties.

Action Points

  • Businesses providing goods or services, including professional services, should regularly review their Terms and Conditions and Letters of Engagement to ensure they accord with current practice, law and legislative requirements.
  • Limitation clauses can be included in retainer letters or disclaimers to limit liability, including regarding third parties. A properly drafted clause could substantially affect overall liability.
  • Parties should carefully identify the type of loss that may arise from their contract, and describe clearly what liability the party accepts, and excludes.
  • The court will review the whole agreement in the event of a dispute, to decide on what the parties intended.
  • Consider reviewing your Contracts, Agreements, Terms and Conditions and Letters of Engagement (especially limitation clauses) in light of the trend highlighted in the Star Polaris judgment

Previously published at http://social.luptonfawcett.com/blog/contact-limitation-clause-high-court-limits-consequential-loss

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Freezing Injunction: Full & Frank Disclosure – Reflective Loss

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  • For a Freezing injunction, does a Claimant need “much the better of the argument”?
  • On Reflective Loss, what is a “good arguable case”?

Case

Kazakhstan Kagazy and others -v- Arip [2014 EWCA CIV 381]

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Key Points

  1. On a Freezing injunction, a “good arguable case” is more than barely capable of serious argument, but not necessarily better than 50% prospects of success.
  2. The parent company’s alleged loss was the same as those of its subsidiaries. Under the reflective loss principles the parent company had no good and arguable loss of its own.

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Background

The Court of Appeal has unanimously upheld a freezing injunction in a case involving alleged inter company frauds exceeding $150M.

The Court considered issues relating to limitation, reflective loss, and the obligation on the Claimants to give full and frank disclosure on without notice applications.

The Court of Appeal held that the “good arguable case” was the appropriate test, approving the traditional test laid down by Mustill J in Ninemia Maritime Corporation -v- Trave (The Neidersachsen) [1983] 2 Lloyd’s Rep 600;

“…in the sense of a case which is more than barley capable of serious argument, and yet not necessarily which the Judge believes to have a better than 50% chance of success…

The injunction had been granted by Judge Mackie QC in the Commercial Court adopting a somewhat higher test requiring the Claimants to show they had “much the better of the argument“.

The Court of Appeal emphasised the wide discretion of the lower Court, including all matters of alleged non-disclosure, and the Judge’s decision was well within the margins of discretion.

The Defendants deny any wrong doing. No defence had yet been required from the Defendants, and Jackson LJ commented that “… it is only by a narrow margin that (the Claimant’s) case is strong enough to support their entitlement to a freezing injunction…“. He referred to “a very real possibility that the Defendants’ limitation defence will prevail at trial on the basis of Kazakh law“. That stipulated a three year limitation period.

Elias LJ said in relation to the alleged non-disclosure and the date of knowledge from when limitation runs

… nobody should allege dishonestly lightly. The Court should not readily conclude that fraud ought to have been apparent unless it is satisfied that the evidence would plainly justify the allegations. That is all  a high hurdle…

It was also pointed our that it is inherently unattractive for the Defendant to submit that the fraud should have been manifestly obvious, and yet at the same time to assert that he had a complete defence to the allegation (on the basis of the proceedings having been issued too late).

Avoid Mini Trial

The Court of Appeal emphasised that applications to discharge freezing injunctions should not turn into mini trials. The High Court had considerable discretion regarding allegations of non-disclosure.

Any failures to give full and frank disclosure were unintentional and ultimately not material. The Court of Appeal commented that the question of when the Claimants had the relevant knowledge, which determines when the limitation period starts should not be usually be decided on an interlocutory basis unless the facts and circumstances were very clear.

Reflective Loss

Although the injunction was upheld for £72M and this stays until the trial, the Defendant was successful in the cross appeal. According to the “reflective loss” principle, a  shareholder cannot recover damages simply on the basis that the company in which the shareholder has an interest has suffered loss. Applying Johnson -v- Gore Wood [2000 UKHL65] Longmoor LJ found that it was well arguable that the claims were not time barred, but if they are, the subsidiaries ought to have been aware that their rights had been violated. In those circumstances the subsidiaries could not say that the inability to sue was no fault of their own. Accordingly, the parent company had no loss independant of the subsidiaries (the other Claimant companies).

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