Finnish Supreme Court sets high bar for direct damage determination

The general rule under Nordic Sale of Goods Acts is that a seller of defective goods is liable to compensate the buyer for direct loss, but not for indirect loss. Unless otherwise agreed, liability for indirect loss requires that the seller has acted negligently or against an express warranty.

Where the line between direct and indirect loss should be drawn, is subject to interpretation. The Finnish Supreme Court took a surprisingly strict stand on the assessment of direct and indirect damage in its ruling KKO 2017:74 on 26 October 2017.

The case

The case concerned a claim for damages against an oil company. The claim was based on the Finnish Sale of Goods Act. The claimant had purchased fuel oil to be used in farming machinery and impurities in the fuel oil had caused damage to the machinery's engines.

The Supreme Court had three questions to consider, namely:

1. whether the damage to the engines was a direct or an indirect loss;
2. whether costs for laboratory tests were to be considered direct or indirect losses; and
3. whether the fact that the oil company knew that the fuel oil was to be used in farm machinery constituted an express warranty, which would mean that the oil company was liable also for indirect loss.

In contrast to the lower courts, the Supreme Court found that the damage to the engines was an indirect loss. The Supreme Court first stated that the position before the Sale of Goods Act entered into force was that damage to other property than the goods sold, even when the injured party was the buyer, fell outside the scope of the Sale of Goods Act. After the entry into force of the Sale of Goods Act, damage to other property than the goods sold may be subject to compensation under the damages regime in the Sale of Goods Act but loss pursuant to such damage is indirect loss.

The Supreme Court then stated that the fact that an engine will be damaged from using defective fuel is certainly predictable. This, however, only means that the damages regime in the Sale of Goods Act applies - not that it is to be considered a direct loss under the Sale of Goods Act. Instead, such damage is clearly indirect loss.

The Supreme Court then considered the costs for the laboratory tests. First, the court stated that costs for assessing a defect in the goods sold and the amount of damage are direct losses. In this case, however, the oil company had replaced the oil at its own cost, and the laboratory tests related to assessing the damage to the machinery, i.e. to an indirect loss. Hence, also the laboratory costs were to be considered indirect losses.

The final question related to whether the oil company should be considered to have given an express warranty regarding the quality of the oil. This was relevant because under the Sale of Goods Act, the buyer is always entitled to damages, including for indirect losses, if the goods did not, at the time of the conclusion of the contract, conform to an express warranty of the seller. It was common ground in this case that the seller was aware of the intended use of the fuel oil. The buyer argued that this constituted an express warranty.

The Supreme Court, however, found that such knowledge did not constitute an express warranty. Normally, an express warranty is something that the seller has expressly stated about the quality of the goods. In addition, the fact that the buyer has expressly stated some specific qualities to be required from the goods, and the seller has entered into the agreement with this knowledge, may constitute an express warranty. It should, nevertheless, be noted that any piece of information given by the seller about the quality of the goods is not considered an express warranty, but only such information upon which the buyer has specifically had a reason to rely due to the importance of the information or the way in which the information was given.

In this case, the court found that the fact that the fuel oil was to be used for machinery did not in any way deviate from what fuel oil is normally used for and there was no express warranty given by the oil company to provide pure and risk-free products to the buyer.

As all the claims concerned indirect loss and the seller was not liable for such loss, the claim was dismissed.

Implications

At first sight, the outcome of the case and the court's reasoning may seem somewhat surprising. The main purpose of the distinction between direct and indirect loss has been to limit the seller's liability to loss that is, at least to a certain extent, predictable. The purpose of the legislation has certainly not been to enable the seller to avoid liability for loss that is almost an inevitable consequence of delivering defective goods. The outcome in this particular case, however, was exactly that.

The court's reasoning is rather scarce and the court has in no way touched upon the purpose of the distinction between direct and indirect loss. It has only followed the statute in a very literal way. In our view, also another outcome would have been possible but it would have required more inventive reasoning by the court. Now, the court has decided to apply a very formalistic (and also minimalistic) reasoning. Be as it may, this ruling is a precedent and the lower courts will undoubtedly follow it.

The Finnish Sale of Goods Act is a result of a co-operation between the Nordic countries, and the Sale of Goods Acts in the other Nordic countries have identical provisions. Hence, this ruling may be used as an argument also in the other Nordic countries.

This ruling again stresses the fact that it is crucial for the buyer to ensure that it is expressly defined in the agreement what is intended with indirect damage and that the seller gives all relevant express warranties. On the other hand, it is in the interest of the seller to ensure that the seller is not responsible for totally unforeseeable losses. Consequently, sellers should be cautious about accepting liability for indirect loss.

In M&A transactions, it is market practice to expressly exclude the Sale of Goods Act. It should, however, be noted that regardless of this exclusion, it is likely that courts and arbitral tribunals will seek guidance as to the interpretation from case law regarding the Sale of Goods Act. This is most certainly the case if the wording of the agreement refers to "direct" and "indirect" loss. Hence, this ruling and its implications should be taken into account also when expressly excluding the Sale of Goods Act from an agreement.