Loss of profit - direct or indirect loss
POLYPEARL v E.ON ENERGY SOLUTIONS [2014]
In this case the Court confirmed that loss of profits can be a direct loss. The Court assumed that a direct loss of profits was not intended to fall within an exclusion of ‘indirect and consequential loss’.
Facts:
- Polypearl (P) brought an action against E.ON (E) for breach of a contractual obligation to buy a particular amount of insulation related products during the term of their agreement. P claimed approximately £2m for lost profits that it maintained it would have made had E purchased the committed quantities in accordance with the contract.
- E did not accept that it had any such obligation and denied that it was in breach of contract at all. E also submitted that even if it was required to purchase a set quantity of products, P’s liability for loss of profit was excluded under the terms of the contract.
- The wording of the relevant exclusion clause 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 (including as a result of negligence) under this Agreement, except in so far as it relates to personal injury or death caused by negligence".
- There was also a limitation of liability clause in the contract which provided for a cap of £1m for each party’s aggregate liability for direct losses.
- The Court had to decide in a preliminary trial on two issues:
- whether the exclusion clause excluded a claim for loss of profit; and
- if it did not, whether the claim would be capped by the limitation of £1m.
Decision:
General Principles
- In giving its decision, the Court reiterated the well-known general principles of construing contractual clauses which were summarised 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 by 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.
Exclusion and limitation of liability clauses
- The Court then went on to discuss the modern approach to exclusion and limitation of liability clauses. Generally it is for the party who wants to rely on the exclusion or limitation of liability clause to show that the clause, on its true construction, covers the obligation or liability which it is trying to restrict or exclude. However, the form of the exclusion is not conclusive and the matter is in every case a question of construction of the contract as a whole.
E’s argument
- E’s argument was that P’s losses were excluded under the contract as loss of profits. The Court rejected this and said the words of the exclusion clause were insufficient to exclude a claim for loss of profit directly following from the breach. There is a clear distinction in law between direct and indirect losses. Direct losses are losses that fall within what is described as the ‘first limb’ of the rule in Hadley v Baxendale [1854] (losses arising directly and naturally flowing from the breach).
- The judge said, “It will be a direct loss if, at the time the contract was entered into, it was likely to result from the breach in question ... [Polypearl] submits that the loss of profits claim in this case is a direct loss… and that the most obvious (and likely) loss from the breach of an obligation to purchase Product is loss of profit. I agree with that submission though it would be possible to conceive of other claims of loss of profit arising from other breaches which would be categorised as indirect.”
Conclusion
- The judge preferred P’s construction of the exclusion clause for the following reasons:
- by putting the wording in brackets, the only loss of profit that was excluded was that relating to indirect or consequential loss. The words in brackets were an explanation of the phrase ‘indirect or consequential loss’ and were not trying to place a direct loss in the indirect category;
- clear wording would be required to invalidate the presumption that neither party intends to abandon its remedies for breach of contract which arise by law; the exclusion clause did not clearly indicate this;
- P’s construction was more consistent with business common sense - the most likely (and often the only) damage that P would suffer from a failure to order would be a loss of profits. It seemed unlikely that a business person would wish to exclude this direct loss.
- As a result, P’s losses of profits were held to be direct losses and were not excluded by the exclusion clause. They were however limited to the £1m cap.
Points to note:
- This case is a further example of how the Courts tend to construe exclusion clauses strictly and narrowly.
- Loss of profit could be an indirect loss depending upon the circumstances.
- The decision is another demonstration that if contracting parties intend to exclude claims for a specific type of loss such as a loss of profit, then this should be very clearly and independently stated in the contract.
- The same conclusion in relation to very similar drafting was drawn by the Court in Markerstudy Insurance Co v Endsleigh Insurance Services [2010].
- The Courts will commonly try to find ways of ensuring that innocent parties are adequately compensated. Another example is the case of Glencore v Cirrus [2014], where the Court was asked to consider whether the loss suffered when a buyer refused to accept or pay for goods was a loss of profit. In the event it held it was not (it was held to be a ‘loss of bargain’) and was therefore not caught by an exclusion of liability for loss of profit set out in the contract.