19/09/2017
The capital and investment required to see a major construction or engineering project through to completion is considerable, meaning a breach of contract can result in the loss of thousands (and sometimes millions) of pounds.
It may seem simple in theory to identify loss caused by a construction contract breach, but any law student will tell you that the topic of ‘remoteness of damage’ in tort and contract law is one of the most difficult to decipher. However, for businesses facing substantial delays to a project following a breach, ensuring they recover maximum damages can make a difference to the organisation’s professional reputation for moving projects towards completion and, in some cases, their financial survival.
Hadley v Baxendale – the remoteness test
To recover a loss caused by a breach of contact (this applies to all contracts, not just construction agreements) the two-limbed test set out in Hadley v Baxendale 1854 EWHC Exch J70 must be satisfied.
Although Hadley v Baxendale is 163 years old, its facts are quickly recognisable to any business awaiting delivery of an essential piece of equipment.
The crank shaft of the steam engine used by H in their mills had broken, rendering the mill unworkable. H contracted with B for B to deliver the broken shaft to an engineering firm to be used as the model for a new one. H told B that the shaft had to be sent immediately and B promised to deliver it the next day. B was unaware that the mill was unworkable without a new shaft.
The shaft was delivered seven days after B received it. H claimed B’s negligence caused the mill to be inoperable for an additional five days, and sought damages covering the resulting loss of profits and payment of wages. B argued that the damages sought were too remote.
The court held that damages for breach of contract:
‘should be such as may be fairly and reasonably considered either arising naturally, that is according to the usual course of things, from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it’.
Thus, if A enters into a contract with B and subsequently breaches that contract, the loss B suffers will be deemed too remote to recover damages unless at the time the contract was agreed A could have been reasonably been expected to foresee that a breach was likely to result in B suffering that type of loss, because either:
a) it would have been quite normal or natural for B to suffer that type of loss because of the breach; or
b) A knew, or could reasonably have been supposed to have known, at the time of the contract, the loss B suffered was likely to flow from a breach.
As a general, but not strict rule, where the phrase indirect or consequential loss is used in a commercial contract, it is referring to the second limb of the Hadley v Baxendale test.
Clauses in construction contracts excluding and limiting liability for consequential loss
Because the scope of indirect loss can be wide, leading to generous damages in some cases, parties to construction contracts commonly include clauses excluding or limiting liability for consequential losses. When drafting such terms, it is imperative to ensure the scope of the clause encapsulates everything the party intends to exclude or limit. For example, it is risky to assume that ‘loss of profits’ is automatically excluded or limited; an expert drafter will state this specifically in the relevant clause/s.
Many standard form construction contracts contain limits and/or exclusions on certain types of loss. For example:
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in the JCT Standard Building Contract With Quantities 2011/2016, the contractor's liability for 'loss of use, loss of profit or other consequential loss' arising in respect of any design carried out by it is limited to the amount stated in the contract particulars (clause 2.19.3)
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in the FIDIC Red Book 1999, save for some exceptions, neither party is liable for 'loss of use of any Works, loss of profit, loss of any contract or for any indirect or consequential loss or damage' arising under the contract
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option X18 of NEC4 (and NEC3) allows the parties to agree separate caps on the contractor's liability for indirect/consequential loss, damage to the employer's property and its design (as well as an overall cap on liability)
When drafting a clause excluding or limiting liability for consequential loss, it is important not to inadvertently affect the recovery of loss under specific heads. For example, in Pegler v Wang (2000) 70 ConLR 68, an exclusion clause excluded 'indirect, special or consequential loss, howsoever arising (including but not limited to loss of anticipated profits or data)'. The court held that 'loss of anticipated profits' was only intended to cover such loss of profits as would fall under 'indirect, special or consequential loss’.
Best practice is for parties to the construction contract to agree what will constitute consequential loss and include this definition in the agreement.
In summary
Setting out definitions and the scope of any exclusion or limited liability for consequential loss can provide certainty to all parties to a construction contract in the event of a breach. Definitions should be drafted to clarify if specified types of loss are to be regarded as consequential losses under the contract, even if they would otherwise be considered direct losses under the test in Hadley v Baxendale.
The best way to ensure such intricacies are included in a construction contract is to instruct an experienced solicitor to draft or view the agreement and advise on any gaps which could cause disputes as the project moves forward.
Fisher Scoggins Waters is a London based law firm who are experts in construction, manufacturing, and engineering law. If you would like more information on construction contract disputes, please phone us on 0207 993 6960.