Facilities management: The meaning of consequential loss

Introduction

One of the main areas of debate when negotiating a facilities management contract is the extent of any limits on the liability of the facilities management contractor. The recent British Sugar case makes it clear that careful drafting of such limitation clauses is required to ensure that they reflect the intention of both parties to the contract.

Recovery of loss at common law

It is a common law principle, expressed in Hadley -v- Baxendale (1854) 9EX 341, that where a party to a contract suffers loss due to a breach of that contract, he can recover from the party in breach (1) all his losses flowing directly and naturally from the breach and also (2) such losses that were within the reasonable contemplation of both parties at the time the contract was made as would be likely to arise due to the breach. If for example, a facilities management contractor undertaking plant maintenance services was in breach of contract and this resulted in damage to the plant, ordinarily the employer would be entitled to recover not only the cost of repairing the plant but also other losses incurred such as loss of profit or the cost of additional rented accommodation, provided such losses fell within the types of loss described in Hadley -v- Baxendale.

Whilst in many facilities management contracts a facilities management contractor will be able to estimate and therefore price the risk of certain potential losses, such as the cost of repair, other potential losses, such as loss of profit, are far more vague and are therefore harder to estimate and price. If a tendering facilities management contractor is required to have unlimited exposure to such potential losses, the employer may find that the tender he receives is far higher than would be the case if the facilities management contractors' liability in relation to such losses was limited. Indeed, some facilities management contractors may refuse to enter into any contract which does not contain some cap on their liability.

Common Methods of Limiting Liability

Liability for loss can be limited in a number of ways:

• it can be capped to a specified agreed amount;
• it can be capped to the level of the facilities management contractor's insurance protection as of the date of the contract or to the level of insurance as the same may fluctuate over the duration of the contract;
• it can be capped to the amount of the facilities management contractor's fee.

Limits on liability can take the form of an overall cap on all liability, contractual or otherwise, or can limit only certain types of loss. For example, in some facilities management contracts, the facilities management contractor's liability for all non-repair losses is expressly excluded. The model form of facilities management contract currently being finalised by the Chartered Institute of Building includes a provision limiting the liability of the facilities management contractor for any breach of the contract or for claims outside the contract (for example in relation to claims in tort or for breach of statutory duty) to an amount to be agreed and to be recorded in the appendix to the contract. All losses, not just non-repair losses, are therefore capped.

The British Sugar Case

The recently reported Court of Appeal decision in British Sugar plc -v- NEI Power Projects Limited (1998) 87 BLR 42 concerned an attempt by NEI to limit their liability under a contract with British Sugar in respect of "consequential loss". NEI were engaged by British Sugar to design, supply, deliver, test and commission electrical equipment. They were to be paid a contract sum of approximately £106,585. British Sugar alleged that the equipment was poorly designed and badly installed and this resulted in breakdowns in the power supply. British Sugar claimed damages from NEI of more than £5m. The substantial part of British Sugar's claim was in respect of increased production costs and loss of profit attributable to the breakdowns.

Before the agreement of the contract, the parties discussed at some length limiting NEI's liability. NEI wanted to insert into the contract an overall cap on liability set at the level of the contract sum. British Sugar would not agree to this and instead proposed a limit of liability of £200,000 in respect of "consequential losses". NEI responded by saying they could agree to a limit on their liability in relation to "consequential loss" to the level of the contract sum. British Sugar agreed and the following was included in the contract:-

"The Seller's [NEI's] liability for consequential loss is limited to the value of the contract".

No attempt was made to define what "consequential loss" was, although it seems that those negotiating the point at NEI, and possibly also their counterparts at British Sugar, considered it meant all non-repair losses, including loss of profit. NEI sought to rely on the agreed limitation to defeat British Sugar's claim for increased production costs and loss of profits in excess of the value of the contract. The key question for the courts was what "consequential loss" actually meant.

The Meaning of "Consequential Loss"

NEI argued that consequential loss in the context of this contract should be widely interpreted to refer to all losses other than normal losses which might be suffered as a result of breach of contract. NEI argued that normal loss for this purpose meant the difference between the value of the goods and services transferred under the contract and the value of what would have been transferred but for their breach. This interpretation would clearly mean that British Sugar's loss of profit and increased production costs were not normal loss but were "consequential loss" and that therefore British Sugar could not recover more than the value of the contract in respect of such losses.

British Sugar argued that "consequential loss" should be narrowly interpreted as being only loss which did not flow directly from the breach of contract. They argued that as increased production costs and loss of profit did flow directly from the breach of contract they were not "consequential losses" and the limit on liability therefore did not apply.

The Judge in the first instance and the Court of Appeal both found in favour of British Sugar and concluded that both parties had agreed to limit NEI's liability for loss and damage to loss and damage not directly and naturally resulting from NEI's breach of contract. Lord Justice Waller stated that the effect of the limitation wording agreed was that:-

"an obligation was being placed on [NEI] to pay such damages as flowed naturally and directly from any supply by [NEI] of faulty goods or materials, with the limitation being imposed in relation to some other type of loss which did not flow so directly, for example, damage which might flow from special circumstances and come within the second limb in Hadley -v- Baxendale".

As British Sugar's loss of production costs and loss of profits were directly and naturally arising from NEI's breach, the limitation wording inserted into the contract was ineffective against British Sugar's claim.

The Court of Appeal effectively limited the definition of "consequential loss" to damage which did not flow directly from the breach of contract but which was in the reasonable contemplation of both parties at the time of the making the contract and which would, had they thought about it, have a very substantial likelihood of occurring. Such loss, in the context of the British Sugar case, would have occurred if, for example, British Sugar had intended to use the plant to complete a one-off exceptionally profitable contract which was outside their ordinary business activities. In the event of the failure of the plant and the loss of the contract profits, this would not be "normal" loss. Provided that NEI had been made aware of this special contract, and that the plant was to be used in relation to it, loss of these particular profits would have fallen into this definition of "consequential loss".

Consequences of the British Sugar Case

From the facts, at least one (if not both) of the parties at the time the contract was made envisaged that the limitation of NEI's liability in respect of "consequential loss" would limit claims for loss of profit and loss of production. Although the Courts construed the limitation clause by looking at the contract as a whole, they did so within the restraints imposed by a number of Court of Appeal decisions since 1935 which have dealt with or touched upon this issue. Lord Justice Waller pointed that the Courts now assume that businessmen using the term "consequential loss" use it in the sense given to it by the Court of Appeal, even where that may not be the case.

As a result, those agreeing to cap liability in contracts should define exactly what liabilities it is intended to cap. If they intend any cap on liability for "consequential loss" to cap liability for loss of profits or loss of production, this must be specifically stated. Alternatively, the liability of the contractor should be limited by stating what the contractor will be liable for, for example repair costs only. Careful drafting is required to ensure that the words of the contract give legal affect to the intentions of the parties.