Shipbuilding Contracts – Interpretation of “Consequential and Special Losses”

The Commercial Court has considered the meaning of the phrase “consequential and special losses, damages or expenses” in the context of a shipbuilding contract in the recent case of Star Polaris LLC v HHIC-Phil Inc [2016] EWHC 2941 (Comm).

A clause that excluded liability for “consequential and special losses, damages or expenses” was not construed as covering only those indirect losses that fell within the second limb of the well established case of Hadley v Baxendale [1954] EWHC J70. Instead, it was given the wider interpretation of including all financial losses above the cost of the repair of physical damage to the vessel. In the context of the contract, financial losses including diminution in value were held to be excluded.

Background

The parties entered into a shipbuilding contract that was largely based on the Shipbuilders Association of Japan standard form. Shortly after delivery, the vessel was found to have severe engine failure.

The claimant buyer commenced arbitration proceedings for breach of contract. It claimed the cost of the repairs to the vessel, certain fees and expenses caused by the engine failure and diminution in the value of the vessel. The defendant shipbuilder denied liability.

The arbitration tribunal found that the defendant breached its warranty of quality in the contract because the vessel was delivered with weld spatters in the pipe work causing the engine to fail. The claimant was therefore entitled to recover the cost of the repairs to the vessel that were causative of the defendant’s breach.

As to the other heads of loss claimed, the tribunal found that Article IX(4)(a) of the contract excluded liability for “consequential or special losses, damages or expenses”. The word ‘consequential’ was interpreted in its cause-and-effect sense as meaning “following as a result or consequence”. The costs and expenses and alleged diminution in value arising from the engine failure were construed to be consequential in this sense meaning that they were not recoverable.

The claimant appealed to the Commercial Court. The issues to be considered by the Court were as follows:

1) What was the correct interpretation of the phrase “consequential or special losses, damages or expenses” in context of the contract?

2) Did the diminution in the value of the vessel constitute a “consequential or special loss” on  proper construction of the contract?

Commercial Court ruling

The Commercial Court agreed with the arbitration tribunal that that the defendant’s responsibilities under the contract were limited to the repair of the physical damage caused by the engine defect. Any financial losses consequent on the physical damage were excluded.

The Court disagreed with the claimant’s argument that the parties contracted against the well recognised meaning of consequential loss and that liability was only excluded for losses falling within the second limb of Hadley v Baxendale, namely indirect losses that were reasonably in the contemplation of the parties at the time the contract was made. The claimant argued that the expenses and diminution in value incurred directly flowed from the defendant’s breach and should therefore be recoverable.

It was not disputed that the financial losses incurred would have been classed as direct losses for the purposes of Hadley v Baxendale. However, the court found that the provisions of the contract clearly intended the defendant’s liability for repairs to be exhaustive and that the parties did not have regard to the case law on recoverability of loss. The phrase “consequential or special losses, damages or expenses” was held to have the wider meaning of any financial losses above and beyond the cost of replacement or repair.

In the circumstances, the claim for diminution in value of the vessel was deemed to be a claim for “consequential and special losses” within the meaning of the contract and was therefore not recoverable.

Comments

The ruling in this case shows the court’s willingness to construe commercial contracts in line with the intention of the parties and give words and phrases their ordinary meaning.

It also warns that references to consequential loss in a contract may not simply be interpreted as referring to those indirect losses that fall within the second limb of Hadley v Baxendale. Depending on the context of the contract, a clause that excludes “consequential or special losses, damages or expenses” or similar may catch other losses that may otherwise be deemed to be direct such as costs, expenses, and other financial losses arising from a breach of contract.

Clauses similar to the one considered in this case will potentially allow shipbuilders to limit their exposure to breach of warranty claims and restrict their obligations after delivery.

The judgment demonstrates that the judicial rules laid down in well recognised cases such as Hadley v Baxendale are not capable of determining the recoverability of losses in all cases. The case shows the Court’s willingness to apply a flexible rather than fixed interpretation to contracts where appropriate. This emphasises the importance of ensuring that commercial contracts reflect the expectations and intentions of the parties to the extent possible.