The construction of exclusion clauses: 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 "loss 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).

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.