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New Zealand Engineering 1999 June Law Indirect Meanings for Indirect Words Alice in Wonderland said that words said what
they meant and meant what they said. If only life were that simple in the real world. As
an example I ask you to read the clause set out immediately below. Don’t read the
rest of the article yet. Now having read that clause, do you think that under a contract where a contractor is engaged to repair equipment in an industrial plant and the repairs are done badly and have to be redone that the contractor will have to pay the owner its revenue losses or its wasted overheads during the plant’s down time if that clause was in the contract? Well, that will turn on your view of what the parties meant by indirect or consequential losses. To most people, perhaps even most lawyers, the whole purpose of the clause is to take off from the contractor the exposure for losses of profit and other non-physical losses. The reason that owners often include such limitations of liability is not just because they are reasonable organisations who wish to protect the contractor. No, it is usually because the price for the work would be very much higher if the contractor was exposed to the full range of possible losses that the owner might suffer as a result of breach of contract. As an example, if a small to medium size contractor enters into an agreement to carry out some power station maintenance, and under that agreement the contractor is liable for all lost electricity generation caused by it doing the work too slowly or badly then the contractor will only do the work for a very large price. The power station owner on the other hand is normally a big company which would rather carry the risk of lost production itself rather than put it onto the contractor. This is similar reasoning to that applied to situations where liquidated damages are set at substantially less than the genuine pre-estimate of loss that the employer will suffer as a result of delay. So, if you want to exclude consequential loss liability, how do you go about it? The standard NZS 3910 does not include any clause dealing with this. FIDIC (E&M) does have a clause1 which excludes liability in both directions for "any loss of profit, loss of use, loss of production, loss of contracts or for any other indirect or consequential damage". No doubt as you are reading this list you are mentally criticising lawyers for long lists of what seem to be similar terms. Why not just exclude liability for indirect or consequential damage and be done with it? Why have the first list at all? Well, there have been two recent English Court of Appeal cases which show you the pitfalls of assuming that words like "consequential loss" or "indirect" loss have an obvious meaning. To the commercial world an exclusion of consequential loss liability is assumed to be intended to cover all loss of profits claims. But judges do not operate solely in the commercial arena. The first case was between British Sugar and NEI Power Projects2.. Here there was a contract to design and install electrical equipment to a value of just over one hundred thousand pounds sterling. When the equipment was installed British Sugar was unhappy and brought a claim alleging that the equipment was poorly designed and badly installed. They said that this resulted in interruptions to the power supply. They claimed more than five million pounds. A substantial part of that claim was for increased production costs and loss of profits because of the power supply interruptions. The supplier, NEI, said that it should not be liable for any consequential loss over and above the value of the contracts because of an exclusions clause which said that "the Seller’s liability for consequential loss is limited to the value of the contracts". They argued that loss of profits was consequential loss and was caught by the clause. The Court at first instance and then the Court of Appeal threw this argument out. They decided that consequential loss meant loss which was over and above that which arose as a direct result of the breach of contract. That is, because the power supply interruptions directly caused the loss of profit it was not consequential. So consequential loss was said to be loss which did not flow naturally from the breach of contract in the usual course of things. This decision would be a surprise to most business people. Almost invariably their view would be the losses of profits are consequential. The second case was between Deepak Fertilisers, Davy McKee and ICI Chemicals3 . Here Davy McKee was to provide services in relation to the design construction and operation of a methanol plant in India. The plant had been operating for a year when it exploded and as a result had to be rebuilt. Claims in excess of one hundred million pounds were brought. A very substantial amount indeed. One of the many issues that arose in the case was whether the loss of profits and wasted overheads incurred during the reconstruction of the plant were indirect or consequential damages. If they had been indirect or consequential then they would not have been able to be recovered because of an exclusion clause. The clause in that case excluded liability "for loss of anticipated profits, catalyst, raw-material and products or for indirect or consequential damages". The Court of Appeal looked at the overheads claimed. They said that they were fixed costs and overheads referable to the plant during the period from the explosion to the resumption of commercial production and loss arising from the fact that the rebuilt plant used more catalyst than the original. They felt that these losses arose directly and naturally from the breaches of contract and therefore couldn’t be said to be indirect or consequential. The court said: "The direct and natural result of the destruction of the plant was that Deepak was left without a methanol plant, the reconstruction of which would cost money and take time, losing for Deepak any methanol production in the meantime. Wasted overheads incurred during the reconstruction of the plant, as well as profits lost during that period, are no more remote as losses than the cost of reconstruction. Lost profits cannot be recovered because they are excluded in terms, not because they are too remote." So if the clause had not explicitly excluded loss of profits, they would not have been taken to be indirect or consequential damages but would have been recoverable in addition to the wasted overheads. Why do judges interpret this sort of provision so strictly? Well, it is because it is treated as a limitation of liability clause included for the benefit of the contractor. So when the contractor seeks to rely on it, it is interpreted as narrowly as the words will allow. It is sort of like giving the batsman the benefit of the doubt in an lbw decision. In this case it is the owner who gets the benefit of the doubt. The contractor is the bowler and unless the contractor can show that the losses fall directly within the words in the limitation of liability clause the contractor will be liable. The Federal Court of Australia has also considered the issue of whether loss of profits are consequential damages in terms of an exclusion clause4. In this case the contract in question was an agreement to supply a certain amount of gas. A claim was made for loss of revenue associated with the contractor’s failure to provide the specified flow of gas. There was a clause excluding liability for consequential loss. The contractor had contracted to supply gas. The generation of electricity by the owner and deriving revenue as a result was a consequence of the sale of gas rather than being what the contractor had directly promised. But the judge still held that the loss of revenue was not consequential. While the derivation of revenue from the supply of gas was a consequence of the sale of the gas, in his view the complicated contractual relationships between the parties showed that each had a high degree of knowledge as to the revenue implications of the agreement. So what did the judge think might be consequential? He was prepared to give a view that loss which the owner might incur as a result of using or being unable to use its capital investment for a purpose outside that directly contemplated by the agreement. On that sort of reasoning any loss will be direct rather than consequential if the contractor has either a direct or an obvious implied knowledge of the likelihood of that loss. So what do you do to avoid this sort of problem? Well, you can now see why it is important to specify more fully what losses are excluded and not just rely on generic terms such as "indirect and consequential losses". You need at least the level of detail of the FIDIC clause and probably in many instances even more detail. Don’t just exclude liability for consequential or indirect losses. This will not protect parties much, if at all, since the types of losses the courts are now saying are consequential are usually the sorts of losses that would not be recoverable under general legal rules as to damages in any event. Carole Durbin is a partner of Simpson Grierson. This article is not intended as legal advice. References |
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