Stuart Pemble welcomes confirmation from the Court of Appeal that parties should be free to agree contractual limitations to, or exclusions of, indirect or consequential loss
Key points
- Consultants and contractors often ask for clauses limiting or excluding liability for indirect or consequential loss.
- The Court of Appeal has suggested that such clauses, if agreed, will be enforced.
Some cases are remembered by even the least-diligent of law students and practitioners. Hadley v Baxendale (1854) 9 Exch 341 is one such case. It is important because it established the traditional test for remoteness of damage for breach of contract. The test is trickier than might first appear. The loss will be recoverable only if it was in the contemplation of the parties when they entered into the contract as being not unlikely to occur should the contract be breached.
The knowledge that is taken into account when assessing what is in the contemplation of the parties comes under two limbs. Damages under the first limb flow from what happens “in the ordinary course of things”. That knowledge is imputed to the parties whether or not they know it. Damages under the second flow from actual knowledge of special circumstances (outside of the ordinary course) that was communicated to the defendant or otherwise known by the parties.
Loss under the first limb is known as direct loss; loss under the second limb is known as indirect or consequential loss (which are interchangeable terms). It was the concept of consequential loss – and, more importantly, the ability of the parties to limit or exclude its recovery by way of contractual agreement – which was the subject of the Court of Appeal’s decision in Transocean Drilling UK Ltd v Providence Resources plc [2016] EWCA Civ 372.
Limiting or excluding liability
Although Transocean was not a property or construction dispute (it concerned the hire of a semi-submersible drilling rig), the issue of the recoverability of consequential loss is a live one on property developments the length and breadth of the UK.
Imagine you are a property developer in dispute with your contractor because your new office block collapsed owing to the contractor’s poor design and workmanship one month before the scheduled date for practical completion. The direct loss you suffer is the cost of rebuilding the office. All other damage you incur – for example, lost rental income from the tenants you had lined up to take space in the new office or additional interest payments to the bank funding the development – will be consequential loss.
You are unlikely to be the only party suffering loss. Your prospective tenants and funders could well have claims under any collateral warranties given to them by the contractor. Nor will the contractor be the only party likely to be on the receiving end of a claim. You (as well as your tenants and any funder) will have claims against any consultants and sub-contractors who contributed to the collapse. A vast majority of those claims are likely to be for consequential loss.
It is this myriad of potential claims which means that contractors, sub-contractors and consultants involved in property developments often look to limit or exclude their liability for consequential loss. So, do those attempted exclusions or limitations work as a matter of law?
The case
Transocean entered into a contract with Providence to drill an appraisal well off the coast of Ireland. The contract was delayed and Providence sued Transocean for breach of contract. Clause 20 of the contract contained lengthy provisions under which both parties agreed to “save, indemnify and hold harmless” the other from consequential loss. The definition of consequential loss included the second limb of Hadley v Baxendale: “any indirect or consequential loss or damages under English law”.
Providence wanted to recover what were referred to as its spread costs from Transocean and these were categorised as “the costs of personnel, equipment and services contracted from third parties which were wasted as a result of the delay”. Transocean argued that these were caught by the contract’s own more-detailed definition of consequential loss in clause 20, as well as the second limb of Hadley v Baxendale, and were irrecoverable. Providence argued that, since it was an exclusion clause, clause 20 should be construed narrowly (relying on the contra proferentum principle) against Transocean as the party looking to rely on the clause.
At first instance, Popplewell J agreed with Providence. In addition to the contra proferentum point, he also held that the clause was “a specifically defined incursion” into the first (and not the second) limb of Hadley v Baxendale (because it applied to direct as well as consequential loss). This was another reason that the clause should be construed narrowly. Finally, he held that, if it was to be interpreted as Transocean argued, clause 20 meant that Transocean owed Providence no meaningful obligations. As such, it should be treated as an unenforceable declaration of intent.
Moore-Bick LJ, who gave the leading judgment on appeal, disagreed. He saw no reason why the courts should interfere with the bargain as made: the court’s task is “not to reshape the contract but to ascertain the parties’ intention, giving the words they have used their ordinary and natural meaning”. The clause did not need to be construed contra proferentum nor did it mean that Transocean owed no meaningful obligations.
He also felt that a detailed analysis of whether the clause included direct as well as consequential loss was irrelevant. The question was whether the clause prohibited the recoverability of the damages Providence was seeking. It did.
The decision means the courts are likely to uphold clauses limiting or excluding consequential loss, especially in contracts between two commercial parties. Requests for such clauses are likely to remain central to negotiations for property and construction projects for the foreseeable future.
Stuart Pemble is a partner at Mills & Reeve LLP
