New judgment on consequential damages

The Court of Appeal has recently overturned the 2014 Commercial Court decision in Transocean Drilling UK Ltd v Providence Resources Plc concerning the construction of a consequential loss clause in a drilling contract. The potential impact of this decision goes beyond drilling contracts and may signify the beginning of a change in the interpretation of consequential losses.

Transocean Drilling UK Ltd (“Transocean”) entered into a contract for the drilling of an appraisal well with Providence Resources Plc (“Providence”). Disputes arose concerning the payment of hire during periods of downtime and whether Providence’s wasted “spread costs” (by which we mean the cost of 3rd party personnel, equipment and services incurred during downtimes) were recoverable under the contract.

Clause 20 of the contract provided that each party indemnified and held the other harmless against its own consequential losses, a form of “knock for knock” clause. Consequential loss was defined as being any indirect or consequential losses/damage under English law, i.e. the second limb of Hadley v Baxendale and to the extent not covered by the foregoing:

…loss of use (including, without limitation, loss of use or the cost of the use of property, equipment, materials and services including without limitation, those provided by contractors or subcontractors…)” (Clause 20(ii)).

The parties accepted that Clause 20(i) did not apply. The “spread costs” were not pure consequential losses as per the second limb of Hadley v Baxendale. However, Transocean sought to argue (amongst others) that the costs were excluded under Clause 20(ii), falling within the meaning of “loss of use”.

The Commercial Court found that (1) Providence were not liable to pay hire to Transocean for periods where the delay was caused by Transocean’s own breach of contract and (2) Providence were entitled to recover their “spread costs” during such downtimes. Justice Popplewell concluded that the “spread costs” did not fall within Clause 20(ii). Transocean appealed the recoverability of “spread costs”.

Court of Appeal Decision
The question before the Court of Appeal was confined to whether or not the “spread costs” fell within Clause 20(ii).

The Court of Appeal allowed the appeal, concluding that the “spread costs” were consequential losses within the meaning of Clause 20(ii). Their reasoning was underpinned by the principle of freedom to contract. They concluded that the parties were of equal bargaining power and as such, should be free to agree terms, which the courts are then obliged to uphold.

The effect of Clause 20 was that the parties had agreed to give up their right to claim consequential losses, which might have otherwise been recoverable. However, since Clause 20 was part of a wider scheme for apportionment of losses, its meaning had to be considered in the context of the contract as a whole.

The starting point was to look at the ordinary and natural meaning of the clause. The natural meaning of “loss of use” (Clause 20(ii)) would refer to the loss of the ability to make use of property/equipment. However, the parties had widened its meaning by reference to a non-exhaustive list of examples contained in the brackets that followed. These included “the cost of the use of property”. The Court of Appeal concluded that the intention was to give the phrase “loss of use” a broad meaning, which would clearly include “spread costs”.

The Court of Appeal disagreed with the Commercial Court’s application of the contra preferentum rule. They did not consider Clause 20 to be one-sided or ambiguous in its wording, which are the requirements for the principle to apply. They also disagreed with the Commercial’s Court’s approach that a party would be unlikely to give up their basic right to recover damages, instead taking the view that the language of Clause 20 was sufficiently clear to override any such assumption. Both parties had agreed to give up their right to claim consequential losses from the other.

It is not yet known whether Providence intend to appeal the Court of Appeal decision.

Impact of the Decision
The Court of Appeal decision gives support to the general principle of freedom of contract, which will come as a relief to a number of industries where contracts routinely exclude consequential losses and/or include “knock for knock” provisions.

The decision may also have wider reaching effect. The Court of Appeal questioned whether certain lines of authority on consequential loss would be decided in the same way if heard today, when courts are more willing to look at the context of a particular contract. Whether this is just a passing comment is yet to be seen. If, however, it signifies a general change in the courts’ attitude to the interpretation of consequential loss, we could see a development in this area of the law, taking a turn away from the long-established principles.

The Commercial Court decision also remains of significance to the drilling industry, to the extent that it has clarified that day rates will not be payable for periods of down time caused by the contractors own poor maintenance. This is contrary to the general view held previously across the industry, but will be a welcome change result for operators/oil & gas companies.