Guidance on force majeure and consequential losses from the High Court

Background

The case concerned an agreement between 2 Entertain Video Ltd (2EV) and Sony DADC Europe Ltd (Sony) under which approximately £40 million of 2EV’s goods had been housed in storage facilities provided by Sony (the Storage Agreement).

The London riots of 2011 resulted in a break in and fire in the storage facilities operated by Sony, causing damage to 2EV’s property. 2EV claimed against Sony for loss of profits, business interruption and increased working costs stemming from this damage.

The High Court found that Sony had been negligent in failing to take reasonable care to secure the facility against break-in and fire, leaving Sony to rely on the force majeure and exclusion of loss provisions in the Storage Agreement to limit its liability.

Force majeure

Force majeure clauses are a common feature of commercial agreements which seek to excuse a party from complying with the obligations under a contract where an event falling within pre-agreed categories has interfered with performance.

The effectiveness of force majeure provisions depends on their drafting, and parties often seek to enhance them by, for example, including notification requirements, or requirements to mitigate the effect of the force majeure event.

The force majeure clause in the Storage Agreement excused a failure or delay in performance caused by “circumstances beyond the reasonable control of the party affected including but not limited to […] riot”.

It was common ground that the riots themselves were unforeseen and unprecedented. However, the High Court rejected Sony’s argument that the circumstances amounted to force majeure under the Storage Agreement. In particular, the High Court acknowledged that although the riots were unforeseen, the risk of intruders, the risk of arson and the risk of destruction of stock by fire were, or should have been foreseen. Further, Sony could have taken adequate security measures and fire precautions to significantly reduce any such risk and resulting damage. Therefore, the fire and resulting loss did not amount to circumstances “beyond the reasonable control” of Sony and did not fall within the force majeure clause.

Points to consider:

Not all force majeure clauses will require that events are unforeseeable, or outside the reasonable control of a party. However, many will have similar requirements and where they do, parties should take note of the Court’s findings. Specific points to bear in mind are:

• The Court rejected Sony’s argument that it was unaware of the relevant warehouse security guidance. Service providers should, therefore, ensure that they are aware of and properly consider accepted industry standards relevant to the subject matter of the agreement.
• Sony’s failure to act on deficiencies identified in audits and reports, and to refresh advice following changes made to the facilities, also weighed against it. So parties should ensure that any recommendations made are demonstrably considered at the relevant level.
• Sony’s argument that it had obtained advice from external consultants on site security and fire protection and that it was reasonable for it rely on this advice was rejected as it had not appointed the correct people to advise it. Parties should, therefore, ensure that any external consultants appointed to advise and make recommendations are suitably qualified and experienced.
• The fact that the riots themselves were unforeseen and beyond Sony’s reasonable control was insufficient. Parties must consider whether the resulting circumstances, and any loss flowing therefrom, fall within the terms of the clause.

Indirect and consequential losses

English law traditionally distinguishes between two categories of losses for breach of contract:

• losses that are considered to arise naturally from the breach of contract (direct losses); and
• losses that do not necessarily flow naturally from a breach but which may reasonably have been in the contemplation of the parties when entering into the contract (indirect losses).

Although it has been the subject of some controversy in the English courts, the generally accepted view is that exclusions of consequential losses will only exclude indirect losses. Various decisions have considered whether the relevant contractual context should be considered when categorising losses.

The Storage Agreement contained a clause excluding both parties’ liability for “any indirect or consequential loss or damage including […] but not limited to loss of profits, loss of sales, loss of revenue” (the Exclusion).

Sony argued that the loss of profits and business interruption losses being claimed by 2EV were consequential on the loss of the goods, and therefore excluded by the Exclusion. They also argued that the Exclusion should be read in the context of Sony’s liability cap.

Interestingly, the High Court accepted Sony’s argument that the general understanding of indirect or consequential loss should not override the meaning of that clause as read in the wider context of the contract. However, the court found that on the facts of this particular case, the loss of profits and business interruption were a direct and natural result of the fire and were therefore recoverable.

Points to consider:

In reaching its decision, the High Court made a comparison to another case in which ‘consequential losses’ were specifically drafted to include indirect losses and other types, such as loss of profits. It is possible that the Exclusion may have been upheld in the 2EV case had it been drafted in a similar way.

Therefore, parties to commercial agreements should consider in advance and clearly specify in the agreement which losses they consider to be direct and which ones are indirect or consequential in order to vary the standard position under English contract law. Any ambiguity in the drafting may result in exclusion clauses being held to be ineffective.