In Star-Polaris v HHIC-PHIL, the UK High Court was asked to rule on the meaning of ‘consequential loss’ – a phrase commonly used in exclusion and limitation clauses in commercial contracts. The High Court chose to depart from existing precedent to rule that these words should no longer be given a fixed meaning but the meaning that the parties themselves intended the words to have at the time the contract was made.

Traditionally, the courts have interpreted ‘consequential loss’ as referring to losses falling within the second limb of the rule in Hadley v Baxendale; that is, losses resulting from special circumstances around the contract that the party in breach was aware of. Judges have said that this fixed meaning should always be given to the words consequential loss. However, this fixed meaning has been criticised as not reflecting the general understanding of business people that consequential loss means unusual losses which would not normally flow directly from a breach of contract.

In this case, the Defendant (D) challenged the fixed meaning given to consequential loss.

D contracted to build a ship (the Star-Polaris) for the Claimant (C).  The contract contained Article IX by which D agreed to repair any defects which arose within 12 months of delivery of the ship but otherwise excluded any other liability, in particular liability for any consequential loss.  Eight months after delivery, the ship suffered an engine failure and had to be repaired by D under its Article IX guarantee.  C issued proceedings for breach of contract looking to recover compensation for its ‘knock-on’ financial losses resulting from the defects, including towage, agency and survey fees. C argued these losses did not result from special circumstances and so were not excluded as consequential loss.

The High Court said that, when construing the words consequential loss, the starting point should always be that the words be given the fixed meaning of second limb losses. However, unless the particular exclusion clause in issue had been interpreted by a court before, judges were free to construe the words in the context of the particular contract and, unconstrained by precedent, give them the meaning intended by the contracting parties.  In this case, Article IX was a complete code setting out the full extent of D’s liability under the contract.  It was clear that D’s only obligation was to repair defects, with all other financial losses falling on C.  In light of that, it was clear that the parties intended consequential loss to have a wider meaning, referring to all financial losses caused by the guaranteed defects over and above the cost of repair.  This interpretation meant that D’s liability for the losses claimed by C had been excluded.

Arguably, the courts will always interpret a contract as they think justice demands, even if that requires the deployment of complex intellectual means to sidestep conflicting precedent.  This is the first ruling in which the courts have endorsed a more flexible interpretation of consequential loss, giving judges more discretion around the interpretation of exclusion clauses without the need for intellectual gymnastics.  The ruling is consistent with the more modern approach to contractual interpretation advocated by the courts in the last couple of years and treats the intention of the contracting parties as king.  The perhaps undesirable result of this ruling is the uncertainty it creates around the meaning to be given to consequential loss.  It is perhaps unnecessary to unpick existing contracts in light of this ruling.  However, anyone drafting new agreements should bear it in mind.  To the extent that bargaining power permits, it will still be preferable for a party to be specific about, and allocate responsibility for, losses likely to result from a breach of contract rather than to rely only on general words, such as consequential loss.