Teaching Assistants: Victor Goldberg on Consequential Damages in the UK

This is the twelfth in our series of posts on Victor Goldberg's second volume of collected essays on contracts law, Rethinking the Law of Contract Damages (RLCD).  Links to previous posts on the first volume, Rethinking Contract Law and Contract Design (RCL), can be found here.  Today's post covers the eleventh chapter of RLCD, in which Professor Goldberg addresses consequential damages and exclusion clauses under UK law.

Immanuel Kant famously observed that two things fill the mind with ever-increasing wonder the more we contemplate them: the starry heavens above and the moral law within.  As far as I know, Kant never addressed consequential damages, but the more one contemplates them, the more the mind recoils in dread and confusion.

And so Professor Goldberg begins with a quotation from McGregor on Damages, in which the author reflects on court treatments of exclusions of consequential damages and concludes that the entire approach "is to be deprecated."  Professor Goldberg narrates the course of UK jurisprudence on consequential damages exclusion clauses.  That narrative seems to be heading back to the simplicity of McGregor's approach: the normal loss in contract is usually the contract-market differential; the rest is consequential damages. (RLCD, 199)

This material takes us back to themes we reviewed in our review of the Alien Vomit piece and in a discussion of a recent episode of the Unpacking Contract Law podcast.  As we noted in the latter post, the Australians have nicely summarized the UK approach exclusions: "the poms have got it wrong."

Like the podcast, Professor Goldberg speaks of Hadley v. Baxandale's two "limbs," the first of which is direct damages and the second consists of damages recoverable only because they were in the contemplation of the parties at the time of contracting.  It seems that courts have often read exclusion clauses as relating to categories of damages in the first limb (i.e. direct damages) when they really belonged  in the second limb (consequential). Courts have thus been reluctant to uphold such exclusions. (RLCD, 200-01) Professor Goldberg takes us through the history of court treatment of such exclusion clauses in three periods.

Early Cases

In Millar's Machinery v. David Way and Son, the court awarded direct damages and properly excluded consequential damages which had been contractually excluded. The case seems straightforward but is cited as authority for narrow readings of exclusions of consequential damages. (RCLD 201-02) In Saint Line Ltd. v. Richardsons, Westgarth, & Co., a case about a properly-rejected vessel, the court allowed the arbiter to determine damages, including lost profits when the vessel was not useable, expenses for wages, and superintendents' fees, notwithstanding a contractual exclusion of consequential damages. (RCLD 202-03) Finally, in Croudace Construction v. Cawoods Concrete Products, Croudace sued claiming various losses resulting from Cawoods' delayed delivery, notwithstanding an exclusion of consequential damages.  Both the trial and appellate court found, citing the Millar's case, that the damages sought were all direct and thus outside the scope of the exclusion. The courts explained this result, rather hard to square with parties' language or their reasonable expectations, based on the assumption that "commercial men" would not want to limit their liability. (RCLD, 203-05)

Turn of the Century Cases

Deepak Fertilisers v. Davy McKie involved the explosion of a methanol plant in India. Deepak sought ₤100 million in damages, including lost output, fixed costs, and overhead. There was a contractual exclusion of indirect or consequential damages. The trial court (per Judge Rix) excluded fixed costs and overhead, finding them indirect and thus excluded under the contractual provision.  The Court of Appeal reversed, finding the losses related to fixed costs and overhead to be "direct and natural," citing Croudace.  Lost profits were excluded because they were too remote. (RLCD, 205-06)

Judge Rix confronted the issue again in BHP Petroleum v. British Steel.  In that case, seller delivered ₤3 million of steel to a consortium of oil and gas companies for the construction of a pipeline.  When the pipeline failed, the consortium sued seller for ₤200 million, including lost profits. If Judge Rix could have just followed his instincts, he would have held that most of what was sought was unrecoverable due to a contractual exclusion of consequential damages.  Because the Court of Appeals' judgment in McKie foreclosed that correct application of the law, Judge Rix found that the matter turned on the parties' knowledge of the potential for special damages at the time the contract was formed.  The Court of Appeals approved of Judge Rix's disposition, while noting what a hardship it would be for seller if it had to assume the risk of liability so far exceeding the value of the contract. (RLCD 206-11) Indeed. That is why parties negotiate for exclusions of consequential damages.

In British Sugar Plc v. NEI Power Projects, British Sugar sought ₤5 million in damages that arose largely from production delays and lost profits caused by defects in  electric equipment that seller provided.  The court allowed the claim, notwithstanding a clause limiting recovery for consequential damages to the value of the contract.  The court found that the losses were direct, flowing naturally from the breach. (RLCD 211-12).  Hotel Services Ltd v. Hilton Int'l Hotels is similar.  The court allowed recovery of consequential damages, notwithstanding an exclusion, on the ground that "consequent loss of profit" was not consequential. (RLCD 212-13).

I wish I were making this up.

The Twenty-First Century

The first few cases that Professor Goldberg discusses seem pretty similar to the older cases. (RLCD 213-18) In two case, the courts opine that consequential damages must be recoverable.  Otherwise the non-breaching party would have no remedy for breach. Professor Goldberg shows why this is incorrect at least with respect to the first case. (RLCD 216-18)

Professor Goldberg next discusses a few cases that seem to come out right, but do not really address the confusion of direct and consequential damages. Both cases involved direct damages not subject to a contractual exclusion of consequential damages. (RLCD 218-20) The tide really begins to turn with Fujitsu Services v. IBM UK, in which the court gave effect to a contractual exclusion of consequential damages, including lost profits. (RLCD, 221-22)

But the more dramatic change comes with Transocean Drilling v. Providence Resources, in which the court rejected the "two limbs" approach to questions of exclusion of damages.  Rather the court distinguished between "loss of bargain damages" -- the contract/market differential, which are direct, and lost profits. (RLCD 222-24) Star Polis v. HHIC Phil then might go too far in the other direction.  A contract provided for an exclusive repair and replace remedy, and the court enforced that, but it neglected to consider that direct damages arise when a replacement is inferior to what was bargained for. (RLCD 224-25)

Professor Goldberg concludes with a short rumination on the fate of exclusion clauses in the U.S. and the UK (RLCD 225-27) It must be difficult for attorneys negotiating contracts involving UK and U.S. parties to draft the exclusion contracts. We are two legal traditions separated by a common language.

Below are links to previous posts on RLCD and the first post links to post posts on RCL:

Teaching Assistants: Victor Goldberg, Volume II, An Introduction
Teaching Assistants: Victor Goldberg on Valuation of the Contract as an Asset
Teaching Assistants: Victor Goldberg on The Golden Victory
Teaching Assistants: Victor Goldberg on Lost (Volume) in America
Teaching Assistants: Victor Goldberg on Lost Volume in the UK
Teaching Assistants: Victor Goldberg on Mitigation
Teaching Assistants: Victor Goldberg on the Middleman's Damages
Teaching Assistants: Victor Goldberg on Sub-Sales in the UK
Teaching Assistants: Victor Goldberg on Jacob and Youngs v. Kent
Teaching Assistants: Victor Goldberg on Victoria Laundry
Teaching Assistants: Victor Goldberg on Consequential Damages in the U.S.