We see all too often, commercial contracts where parties exclude liability for “consequential loss” where the clause and that term are merely boilerplates that are not given enough consideration. Recent Australian cases have highlighted that the risk of failing to give the term more consideration in the context of the commercial transaction may result in parties giving away more than they intended. It is time to reconsider your exclusion clause boilerplates and remind your contract negotiating team to turn their minds to the exclusion clauses that refer to terms such “consequential loss”.
The traditional approach – why the term has become a boilerplate
The rule for determining the recoverability of damages for breach of contract was laid down in Hadley v Baxendale (1854) whereby damages are recoverable if they fall within one or both of two limbs:
- losses which arise according to the usual course of things or which directly and naturally flow from the breach (“the first limb”); and
- losses which may reasonably be supposed to have been in the contemplation of the parties at the time they made the contract, as a probable result of its breach (“the second limb”).
Terms such as “consequential loss”, “special loss” and “indirect loss” have sprouted in an attempt by parties to seek to exclude or limit their liability under the second limb. However, even where parties have excluded consequential loss from the liability clause in a contract, losses such as loss of profits and loss of revenue could still be found to be sufficiently proximate to the particular circumstances to fall within either limb and fall outside the exclusion clause.
A shift in waters in Australia
Recently, in Australia, the view started to diverge from this traditional view.
In the Victorian case of Environmental Systems v Peerless Holdings [2008] the court held that the true distinction is between “normal loss” which is loss that every plaintiff in a like situation will suffer, and losses which are “beyond the normal measure of damages, such as profits lost or expenses incurred through breach”, which are consequential losses. In other words, an exclusion of liability for consequential loss will exclude liability for loss of profits and expenses incurred through the breach; a significant expansion of the scope of “consequential loss”.
The Victorian approach was followed in New South Wales in Allianz v Waterbrook [2009]. It was further extended in the South Australian case of Alstom Ltd v Yokogawa Australia [2012] where the an exclusion clause using the term “indirect…or consequential loss” was held to exclude liability for any loss except the payment of liquidated damages or the reimbursement of performance guarantee payments, which had been expressly included in the contract.
A shift back to the traditional approach?
In the more recent decision of Regional Power Corporation v Pacific Hydro Group Two Pty Ltd [2013], in Western Australia, it was held that the approach in Environmental Systems was unlikely intended to have the effect of replacing the rigid rules of construction under Hadley v Baxendale with another rigid rule of construction of the Victorian court. Rather, the term “consequential loss” ought to be interpreted from a commercial perspective based on its ordinary and natural meaning in the context of the agreement.
Where does this leave us?
The effect of Regional Power is that, in Australia, there is still some uncertainty about which approach applies. It may well be that terms such as “consequential loss” will be given broad interpretation, but with such varying approaches coming from the courts, it is now more important than ever to think carefully about whether carve-outs for “consequential loss” are useful in your contracts, and to ensure that you have carefully set out what “consequential loss” means whenever it is used.
✓ Aspect Tip: Do not use your exclusion clause boilerplates without careful consideration and drafting of what you intend to carve out from liability with the use of terms such as “consequential loss”.
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