By Humphrey Lloyd QC and Jennifer Jones, Atkin Chambers
Contracts often limit the losses recoverable for a default, for example saying that those which are “indirect” or “consequential” are not recoverable. Where is the line to be drawn? If the contract is governed by the law of England and Wales, a court or arbitral tribunal will probably get some help from seeing what might be allowed in law in a comparable situation for damages for breach of contract.
In English law, as in many other jurisdictions, an award of damages is to compensate the party not in default for the loss that has been suffered. In a contractual claim, it is often said that damages should put that party in the position it would have been in had the contract been properly performed. This may be contrasted with a claim in tort, where the purpose of the award is to put the claimant in the position it would have been in had the wrong complained of not been suffered.
However, English law has a judge-made rule of policy that limits what is recoverable in a contractual claim. The principle has been followed widely in common law jurisdictions. The concept does not exist as such in civil law jurisdictions, but in practice the results may be similar. The English principle was formulated in Hadley v Baxendale (1854) 9 Exch 341, in which it was decided that damages are recoverable in respect of a breach of contract either when they arise naturally (ie, according to the usual course of things) from the breach of contract, or when they may reasonably be supposed to have been in the contemplation of the parties at the time they made the contract as the probable result of the breach of it. These two elements are traditionally known as the first and second limbs of the rule in Hadley v Baxendale and create the “remoteness rule”. Assessing whether or not a loss is thus sufficiently connected to (or legally remote from) the breach of contract is very fact-sensitive. Indeed, whether the loss falls within the first or the second limb may only become clear at a hearing. Obviously the principle still applies whether: the claim is by a contractor against an employer; by an employer against a contractor; by a sub-contractor against a contractor; or vice versa.
The rule has been refined since 1854. For example, the manner in which the loss arose need not be contemplated by the defaulting party. For the purposes of the first limb, it is sufficient if loss of the kind which occurred would reasonably have been considered a natural consequence of the breach. Under the second limb, there may be liability only if the defaulter was specifically made aware that the consequences that might result, or if it ought to have been so aware given its knowledge of the circumstances of the contract. The relevant time is when the contract is made, and not later. Applied to contracts “consequential” losses will not usually be taken to include the natural consequences of breach, but may cover items which would otherwise be recoverable under the second limb of Hadley v Baxendale. So although, literally, losses of profit are a consequence of a breach of contract they might not in English law be classified as “consequential losses” for the purposes of a contractual clause exempting liability for them – see McCain Foods GB Ltd v Eco-Tec (Europe) Ltd  EWHC 66 (TCC) for a recent helpful discussion and application in which, for instance, costs of repair, replacement, mitigation and associated losses were recoverable.
Not long ago the UK House of Lords looked again at the principle – not in a case involving a construction contract, but one about the charter of a ship. The Achilleas  UKHL 48 considered the extent to which assumption of responsibility has a role to play in considering remoteness of damage, which is particularly relevant given the opportunity that parties have to allocate risks and rewards between themselves when negotiating their contracts. What effect might this decision have on contractual claims? This short article can only provide a non-authoritative outline to that question. For a fuller treatment up-to-date text books should be consulted (such as Hudson’s Building and Engineering Contracts, 13th edition, 2015). In relation to a particular claim or actual or potential contract provision, advice on English law should be obtained.
In The Achilleas, the question was whether the owners of the ship that had been chartered could recover losses that they incurred when the ship was returned late. The owners claimed that they would have got advantageous rates from a follow on charter had the ship been returned on time but had to accept market rates which were lower due to market movement. The charterers were not informed about the higher rates. The owners claimed for the duration of the new charter but the charterers said that they could only claim for the actual period of delay on the basis that the loss of profit with the higher rates would only have been recoverable if the risk of losing high rates on a new charter had been brought to the charterers’ attention.
The arbitral tribunal concluded that the owners’ entire loss was not too remote. However the issue was considered to be of general importance to permit an appeal under section 69 of the English Arbitration Act 1996. That ultimately reached the House of Lords which decided that damages were only recoverable for the period of delay in returning the ship. The reasoning was not unanimous but the consensus of the majority was that the charterers had not assumed responsibility for more than the period of the over-run.
Lord Hoffman considered the rule in Hadley v Baxendale should give effect to the intentions of the parties and not contradict them. He thought that the parties would reasonably have considered that liability would be limited to the period of late delivery and that losses during the entire period of the follow-on charter was a type or kind of loss for which the charters were not assuming liability. Lord Hope thought that in the law of contract assumption of responsibility formed the basis of what was and what was not remote. It was determined by what at the time of the contract was reasonably foreseeable since the parties could then have taken account of any unusual risks or responsibilities in their negotiations of and pricing for the contract.
Will the decision make a significant practical difference? From subsequent decisions it seems the answer is no. However, the resolution of most disputes under construction contracts, like other commercial contracts, requires analyses of the relevant risks and responsibilities, and decisions as to how the contract allocated them. So it will now also be prudent to test whether a loss was or was not remote in terms of assumption of risk and responsibility.
Since the decision in The Achilleas, the courts have not shown a willingness to move away from the traditional analysis. However, one of the first cases in the construction field was quite similar. In Mayhaven Heathcare Ltd v Bothma  EWHC 2634 (TCC) an arbitrator had made an award rejecting an employer’s claim for delay in completion based on higher rates that would have been obtained for certain residents of a nursing home as compared to those paid for ordinary residents. On an appeal the court held that the arbitrator had not erred:
“... in this case the arbitrator held that the damage [claimed] was outside the first limb, not that it was within the first limb but excluded because it was loss for which a party had not assumed responsibility”.
Shortly afterwards, in Siemens Building Technologies FE Ltd v Supershield Ltd  EWHC 7, the Court of Appeal had to consider The Achilleas. The appeal concerned the recovery of loss caused by a nut and bolt connection not having been made correctly. The Court said that its effect was that examining the contract and the commercial background may show that “the standard approach would not reflect the expectation or intention reasonably to be imputed to the parties”. However, it pointed out that this might lead to the contract breaker being held not liable for loss which resulted from its breach, although some loss of the kind was not unlikely, but it might also lead to the conclusion that the loss was within the scope of the duty and would not be remote, even if that would not have occurred in ordinary circumstances. On that basis of fairness to both parties, it therefore appears that, if remoteness is in question, the contract and its commercial background ought always to be examined.
However, some judges consider that there must be special circumstances. In Sylvia Shipping Co Ltd v Progress Bulk Carriers Ltd  EWHC 542 (Comm) (another shipping case), the Commercial Court stated that “the orthodox approach remains the general test of remoteness applicable in the great majority of cases. However, there may be “unusual” cases, such as The Achilleas itself, in which the context, surrounding circumstances or general understanding in the relevant market make it necessary specifically to consider whether there has been an assumption of responsibility.” In Harrison v Technical Sign Co  EWHC 2887 (a construction case) it was also said there had to be exceptional circumstances for assumption of risk to be considered. It is not clear why this should be so.
A more recent decision of the Court of Appeal in the construction field is instructive: John Grimes Partnership Ltd v Gubbins  EWCA Civ 37. A developer claimed from engineers loss in the value of a development caused by a drop in the market during a period of delay caused by engineers. The engineering company relied on The Achilleas to avoid the consequences of a fall in the market. It argued that it ought not to be taken to have assumed responsibility for the risk of a drop in the market, bearing in mind its relatively modest fees compared with the potential scale of losses through market movement, and the fact that it had no control over such movement. Its appeal was rejected. The Court applied Siemens Building Technologies FE Ltd v Supershield Ltd, but reframed the position:
It seems … to be right to bear in mind, as Lord Hoffmann emphasised in The Achilleas, that one is dealing with the law of contract, where the situation is governed by what has been agreed between the parties. If there is no express term dealing with what types of losses a party is accepting potential liability for if he breaks the contract, then the law in effect implies a term to determine the answer. Normally, there is an implied term accepting responsibility for the types of losses which can reasonably be foreseen at the time of contract to be not unlikely to result if the contract is broken. But if there is evidence in a particular case that the nature of the contract and the commercial background, or indeed other relevant special circumstances, render that implied assumption of responsibility inappropriate for a type of loss, then the contract-breaker escapes liability. Such was the case in The Achilleas.
So where are we now? The principles stemming from Hadley v Baxendale are still applicable. Remoteness, like causation, still depends on the facts. Nonetheless, what was said in The Achilleas appears to reinforce the need for an examination of the contract and its background. In order to see where the line to be drawn it may be better to analyse the contract in terms of assumption of risk and responsibility for the loss at stake. This approach is even more appropriate if the contract is governed by English law and the issue is whether loss or damage is excluded or included by the contract’s provisions.