The construction of exclusion clauses

Introduction

We look at two cases in the UK which emphasise the importance of clear and prescriptive exclusion clauses: Glencore Energy v Cirrus Oil Services and Polypearl Limited v E.ON Energy Solutions.

Any profit in your bargain?

The onward sale of commodities – whether oil, gas, copper, zinc, grain or anything in-between – even whilst in transit, is an everyday part of international trade. In rapidly changing markets, where complex chains of sales contracts are the norm, it is important for buyers and sellers alike to make sure that their liability is limited. In Glencore Energy v Cirrus Oil Services, the High Court clarified that a claim for damages under s50 of the Sale and Goods Act 1979 is not a claim for loss of profits but for the seller’s loss of bargain under the contract.

The buyer argued that the seller’s alleged loss amounted to a loss of profit, not a loss of bargain … The High Court rejected this argument

The facts

Glencore Energy UK Ltd v Cirrus Oil Services Ltd [2014] EWHC 87 (Comm)

The claimant, seller, entered into a contract with the defendant, buyer, for the sale of crude oil, with the buyer intending to sell the cargo on to a third party purchaser. The contract (between the parties) excluded liability for "loss of anticipated profits".

Before the seller could deliver the goods, the buyer discovered that the third party purchaser intended to refuse to accept the oil from the buyer as it came from a blend of oils from different wells. The buyer, in turn, refused delivery from the seller, thus repudiating the contract. The seller had initially bought the oil from a third party supplier and this transaction was cancelled, without cost to either party, following the seller’s acceptance of the buyer’s repudiation. The seller then sought to recover damages from the buyer, including for loss of bargain, relying on the Sale of Goods Act 1979 (sections 50(2) and (3)). The question before the court was whether the seller’s claim was excluded by the wording in the exclusion clause (excluding liability for loss of anticipated profits).

Sale of Goods Act, section 50

Where a buyer refuses to accept and pay for goods, the seller can bring an action for damages (sections 50(2) and (3)). The measure of damages is the estimated loss directly and naturally arising from the breach.

Where there is an available market for the goods (which, for any commonly traded commodity, there generally will be), the measure of damages is the difference between the contract price and the market price at the time when the goods should have been accepted. If no time was fixed for acceptance, then the measure of damages is the difference between the contract price and the market price at the time of the refusal to accept.

The defence

The buyer argued that the seller’s alleged loss amounted to a loss of profit, not a loss of bargain; and, since loss of profits was excluded under the contract, Glencore was not entitled to damages.

The judgment

The High Court rejected this argument and held that, on its proper construction, the exclusion clause did not exclude liability for damages under the Sale of Goods Act (section 50). The court differentiated ‘loss of bargain’ from "loss of profit" on the basis that loss of profit is ‘the difference between the total net cost to the seller of acquiring the goods and bringing them to the market on the one hand and the net sale price that would have been achieved on the other’. Loss of bargain is different, as it focuses on the difference between the value obtained for the goods under the contract against that price obtainable in the market at the time of the breach.

Cooke J stated that the assessment of loss involves calculating "how much worse off the seller would be if, at the time of the breach, he had sold the goods to a substitute buyer". Where there is an available market, the measure of damages will therefore be the amount by which the agreed contract price exceeded the price obtainable in the market at the time of the breach (i.e. the seller’s loss of bargain with the buyer).

Comment

The implications of the High Court’s decision, which continues a judicial trend of strict construction of exclusion clauses, are twofold.

First, it confirms that section 50 of the Sale of Goods Act does not provide for damages representing loss of profit: instead, it is a measure to compensate the seller for his loss of bargain. This means that even if the cost of goods to the seller is the same as the onward sale price, if the market price is lower and the onward buyer repudiates, the seller may recover the difference between the contract price and the market price.

The court was unwilling to adopt Cirrus’s argument that the claim was one of lost profits, even though Glencore had been able to cancel its contract with the third party supplier, thereby avoiding out-of-pocket losses. Had the court agreed that the claim was one of lost profits, Glencore would have recovered nothing following Cirrus’s repudiation of the contract. Cooke J felt that such an unlikely and uncommercial result would require extremely clear wording within the exclusion clause. As there was no wording clearly setting this out, the court ruled in favour of Glencore, allowing it to recover over US$2.5 million in loss-of-bargain damages, despite the fact that it had not suffered any out-of-pocket losses.

Where parties wish to exclude liability for both loss of profit and loss of bargain, specific wording to this effect should be included in the exclusion clause to ensure that unforeseen liabilities are not incurred. Glencore is the latest in a line of cases demonstrating the courts’ reluctance when interpreting exclusion clauses to give to them meaning that is not contained within the clause. Exclusion clauses should always be drafted with particular caution.

Excluding liability for "indirect" losses

In Polypearl Limited v E.ON Energy Solutions, the court considered the meaning of terms such as ‘direct losses’, ‘indirect losses’ and ‘loss of profits’, within the context of an exclusion clause.

The facts

Polypearl Limited v E.ON Energy Solutions Limited [2014] EWHC 3045 (QB)

The claimant manufacturer brought a claim for damages against the defendant electricity supplier for alleged failure to purchase certain products under an agreement between the parties. The claimant argued that the defendant’s breach of contract resulted in, amongst other things, a loss of profits.

The agreement between the parties purported to limit liability for ‘direct losses’ to £1 million. A separate clause, however, stated:

Neither party will be liable to the other for any indirect or consequential loss (both of which include, without limitation, pure economic loss, loss of profit, loss of business, depletion of goodwill and like loss), howsoever caused …

The defendant argued that the sums claimed, including for loss of profits, were excluded because of the wording of this clause.

Contractual interpretation

The general principles around construction of contractual terms are well known. The judge in Polypearl summarised them as follows

• The ultimate aim of interpreting a contractual provision is to determine what the parties meant by the language used, which involves ascertaining what a reasonable person would have understood the parties to have meant.
• The reasonable person is one who has all the background knowledge which would reasonably be available to the parties in the situation they were at the time of the contract.
• Where a term of a contract is open to more than one interpretation, it is generally appropriate to adopt the interpretation which is most consistent with business common sense.
• Poorly drafted contracts do not attract a different approach, but the poorer the quality of the drafting, the less willing the court should be to be driven to semantic niceties to attribute to the parties an improbable or unbusinesslike intention.
• However, where the parties have used unambiguous language, the court must apply it.

Generally, a defendant which seeks to rely on a clause purporting to exclude its liability has to demonstrate that the clause covers the type of liability that the defendant is seeking to restrict or exclude.

Similarly, it is for the claimant to demonstrate that its claim falls within an exception to an exclusion clause.

Ultimately, in each case the question is one of general construction. The court in Polypearl reiterated the principle that the approach to construing exemption or limitation clauses should be the same as for construing any other contractual term.

The Polypearl problem

The problem identified in Polypearl is that ‘"oss of profit" can be both direct or indirect: "It will be a direct loss if, at the time the contract is entered into, it was likely to result from the breach in question … It will be indirect if there are special features known to the contractbreaker at the time of the contract such that a breach would be liable to cause more loss."

The question, therefore, was whether the clause applied to all loss of profit, i.e. including ‘direct’ losses within the so-called first limb of Hadley v Baxendale; or only to loss of profit that is ‘indirect’, i.e. losses within the socalled second limb.

The defendant contended that, on its proper construction, the clause excluded all losses of profit, whether direct or indirect.

The judgment

The court disagreed. HHJ Behrens, sitting as a judge of the High Court, found that the clause was ambiguous, but he concluded that it excluded only indirect loss of profit.

The judge found that the construction advocated by the defendant (that all loss of profit was excluded) would have resulted in the court construing a claim for direct loss of profits as, effectively, a claim for indirect loss of profits. In this regard, the words placed in brackets – including "loss of profit" – were subordinate to the opening phrase "indirect or consequential loss". The judge concluded that they were an explanation of it and not an attempt to include direct loss in the indirect category.

He noted that clear words are needed to rebut the presumption that parties do not intend to abandon remedies for breach of contract arising by operation of law (citing Lord Diplock in Modern Engineering (Bristol) Ltd v Gilbert-Ash (Northern) Ltd [1974] AC 689).

The judge concluded that the wording of the clause did not clearly indicate that the parties intended to abandon claims for "direct" loss of profits. Construing the clause so that it applied only to direct loss of profits was, he decided, more consistent with business common sense. In the circumstances of the case, loss of profits was the most likely loss to be suffered in the event of a breach and it would be unlikely for a party to agree to exclude this direct loss.

Comment

The discussion in this case of the meaning of contractual phrases such as "direct" and "indirect" loss and "loss of profits" is of general interest, particularly the reminder that loss of profits can comprise both direct and indirect losses. The court did point out that previous cases where differently worded clauses had been construed were of limited assistance. Every case will depend on the specific wording of the particular clause in issue; and every clause must be construed in its own right, having regard to the principles outlined above.

The moral is clear. Any exclusion clause should be drafted as fully and precisely as possible to minimise the risk that a court will construe it differently from the interpretation the parties had intended to apply. Any ambiguity or omissions will inevitably be seized on by an aggrieved party. If terms such as "loss of profits" or "indirect losses" are used, then the contract must spell out precisely what they are intended to mean.