Exclusions for loss of use, profit and production in construction contracts

A recent decision of the Commercial Court has considered the proper interpretation of contractual exclusion clauses for loss of use, profit and production. The case follows a similar decision of the Commercial Court late last year and provides guidance as to the approach to be taken to such clauses albeit in the context of a long term supply contract.

Scottish Power UK v BP Exploration Operating Co

Scottish Power entered into a long term agreement for the sale and purchase of natural gas (the "Sale and Purchase Agreement") from the owners of an oil and gas field known as the "Andrew Field" some 230km north east of Aberdeen in the North Sea (the "Sellers"). The Sellers were found by the court to have breached the Sale and Purchase Agreement by failing to produce gas from the Andrew Field during a period of shutdown. Scottish Power claimed to recover the additional costs it had incurred in sourcing replacement gas from third parties at a higher price than provided for by the Sale and Purchase Agreement.

Among other defences, the Sellers relied upon Article 4.6 of the Sale and Purchase Agreement which provided that:

"…neither Party shall be liable to the other Party for any loss of use, profits, contracts, production or revenue or for business interruption howsoever caused and even where the same is caused by the negligence or breach of duty of the other Party."

The Sellers argued that Scottish Power’s claim was one for "loss of use" or "loss of production" as it concerned Scottish Power’s inability to use gas produced from the Andrew Field or a lack of production of gas by the Sellers from the Andrew Field. Alternatively, the Sellers argued that the Scottish Power’s purchase of replacement gas at a higher price had mitigated the loss of profit and revenue it would have otherwise suffered had it been unable to source replacement gas. Previous case-law had suggested that a claim for costs incurred in mitigating or avoiding a loss was to be classified in the same way as the loss avoided for the purpose of an exclusion clause. The Sellers argued that Scottish Power’s claim could on this basis also be classified as a claim for loss of profit or revenue.

The normal measure of loss

Although the Sellers succeeded in relation to other defences raised in response to the claim, the court rejected both of the Seller's arguments in relation to Article 4.6. In interpreting the clause, the Court drew a distinction between three types of losses:

1. The normal or basic measure of loss for a failure to supply goods, being the difference between the contract price and the market price of the goods at the time or times when they ought to have been delivered.
2. Secondary losses which go beyond the normal or basic measure of loss, for example if replacement goods are unable to be found with the result that the purchaser’s ability to trade is affected.
3. More remote losses which would not in ordinary circumstances be expected to arise. These losses have in the past been referred to by the courts as "consequential" and "indirect" losses (falling within the second limb of the rule in Hadley v Baxendale) and require both parties to have specific knowledge as to the risk of such losses at the time of entering into the contract.

The court considered it clear that Article 4.6 did not intend to exclude the normal measure of loss for a failure to supply gas, but was aimed at secondary losses going beyond the usual measure. As the words "consequential" and "indirect" were not used in the clause, there was no need to limit the exclusion the third category of remoter types of loss mentioned above. Accordingly, the references to "loss of use" and "loss of production" were interpreted by the court as being directed to the future use by Scottish Power of gas to be supplied from the Andrew Field for its own business and the production of other products from it (such as electricity).

The court also applied this distinction to the mitigation case-law relied upon by the Sellers. The court noted that, strictly speaking, the normal measure of loss can always be said to be a mitigation of greater secondary losses (i.e. if a market for replacement gas were not available, then secondary losses would follow). However, only mitigation costs beyond the normal measure of loss were intended to be excluded by Article 4.6.

Conclusions and implications

In reaching its decision, the court followed a similar approach taken late last year to a "loss of use" exclusion by the Commercial Court in Transocean Drilling UK Ltd v Providence Resources Plc (click here for our Law-Now on this earlier decision). Taken together, these cases suggest that broader considerations as to the commercial losses intended to be excluded by such clauses are likely to prevail over linguistic arguments as to how particular phrases such as "loss of use" might be applied in varying circumstances.

The court’s distinction between the normal measure of loss and secondary losses appears to provide a helpful analytical tool, but may pose difficult questions in a construction context. For example, the FIDIC suite of contracts contains a similar exclusion for the "loss of use of any Works [and] loss of profit". Where works are left incomplete, the normal measure of loss would include the additional cost of completing the works with an alternative contractor but is also likely to include delay related losses, including for loss of profit, in respect of the additional time needed for a new contractor to be appointed, to mobilise and commence work. Such delays are often unavoidable even in a healthy construction market. However, delay related losses of this kind might also be said to be ordinarily expected to fall within an exclusion for loss of use and loss of profit. The distinction made in the present case between the normal measure of loss and the commercial intention of such exclusions may not therefore be as clear cut in other cases.

To register or adjust your preferences for our updated Law-Now service, please click here.

References:

Hadley v Baxendale (1854) 9 Ex 341;

Transocean Drilling UK Ltd v Providence Resources Plc [2014] EWHC 4260 (Comm);

Scottish Power UK Plc v BP Exploration Operating Company Ltd [2015] EWHC 2658 (Comm).