Consequential loss – what is it and is my business liable for it?

Commercial Directions

When entering into commercial contracts, businesses generally want to know ‘how much will I have to pay if this goes wrong?’. Like most aspects of law, the answer is not straightforward.

If there is a breach of contract, the general principle when assessing damages for that breach is to put the innocent party in the position it would have been in had the contract been performed according to its terms. However, damages are generally not recoverable if they are ‘too remote’ from the relevant breach.

As it is largely impossible to predict all of the types of loss that may arise from a breach of contract, and there is no definitive list of what types of damages are ‘too remote’, many businesses seek more certainty in defining and limiting their liability for breach of contract.

One of the more common ways to limit liability in commercial contracts is to include a clause that expressly excludes ‘consequential loss’. For example, a contract may state ‘neither party is liable for indirect, consequential and special losses, however arising’.

What does this mean? Is it just legal ‘mumbo jumbo’ or standard terminology best left to the lawyers to sort out?

The short answers are:

  1. The term ‘consequential loss’ has no fixed meaning[1] and is open to legal interpretation.
  2. No, it is not best just left to lawyers!

Understanding consequential loss and being clear about what you mean by it could be the difference between being liable for a multimillion dollar claim or not (or being able to claim against another party for a multimillion dollar claim or not).

A hypothetical example

Assume you own a company, Applegrowers Pty Ltd, and you grow the sweetest apples in the country. You enter into a contract with Piemakers Pty Ltd to supply them with apples which Piemakers will use to make apple pies. The contract states that
‘…despite any other provision of the contract, Applegrowers Pty Ltd is not liable for any consequential loss incurred by Piemakers Pty Ltd’.

Piemakers has contracts to sell apple pies to various small grocers around the country and is currently in negotiation with a major supermarket chain for a lucrative contract.

Applegrowers fails to provide the apples to Piemakers in accordance with the contract. Piemakers can only source alternative, less sweet apples, to supply half of its current clients with apple pie. The supermarket chain pulls out of negotiations with Piemakers due to concerns over supply.

Piemakers sues Applegrowers for breach of contract and claims the following costs and losses incurred by Piemakers as a result of that breach:

  1. Costs incurred in sourcing apples from another supplier
  2. Costs of extra sugar required in the recipe to compensate for the different (less sweet) flavour of the alternative apples
  3. Loss of opportunity to do business with the major supermarket chain
  4. Loss of profits under the existing arrangements with the small grocers
  5. Cost of making six employees redundant due to insufficient work.

Applegrowers argues that it is not liable for any of these costs pursuant to the clause in the contract that says it ‘is not liable for any consequential loss incurred by Piemakers Pty Ltd’.

Are all of Piemakers’ costs within the meaning of ‘consequential loss’ and therefore excluded under the contract?

What is consequential loss?

Because the term ‘consequential loss’ has no fixed meaning, we look to the courts to assist us in interpreting what it means.

In the high profile English decision of Hadley v Baxendale (1854) 156 ER 145, the court described the type of loss that may be recoverable for a breach of contract by reference to the following two limbs:

  1. losses such as may fairly and reasonably be considered as arising naturally (that is, according to the usual course of things) from such breach of contract itself; and
  2. losses such as may reasonably be supposed to have been in the contemplation of the parties at the time they made the contract as the probable result of its breach.

Broadly, losses within the first limb were described as ‘direct loss’ and losses within the second limb were described as ‘consequential loss’. All other types of loss were considered ‘too remote.’

This was the generally accepted position for a number of years and contracts that expressly excluded consequential loss were generally understood to mean that the types of losses within the second limb were excluded.

However, Australian law (at least at state level) has been moving away from the approach in Hadley v Baxendale for some time.

In the case of Environmental Systems v Peerless Holdings (2008) 227 FLR 1, the Victorian Court of Appeal said that consequential loss should not be limited to the second limb of Hadley v Baxendale. The Court said that consequential loss was to be accorded the ordinary meaning given by ordinary reasonable business persons as everything ‘beyond the normal measure of damages.’

Later, in the case of Regional Power Corp v Pacific Hydro Group Two Pty Ltd (No.2) [2013] WASC 356, the Supreme Court of Western Australia said that a clause excluding consequential loss should be interpreted by looking at the contract as a whole.

Which approach is correct? The short answer is, the position under Australian law is open to judicial interpretation. We can use the cases of Peerless and Regional Power Corp as a guide, but the underlying uncertainty means that we cannot easily define what ‘consequential loss’ means and determine whether the costs and losses claimed by Piemakers in the example above are in fact ‘consequential loss’ within the meaning of the contract.

What does that mean?

To limit any uncertainty as to the meaning of the term ‘consequential loss’, businesses need to consider the consequences of a breach of contract and the types of losses that may arise due to that breach. It is best be as prescriptive as possible and identify each of the types of loss that you consider to be ‘consequential’. Only these losses will be excluded from the claims that can be brought by a party.

For example, it would be easier for Applegrowers to argue that it is not liable for Piemakers’ loss of opportunity to do business with the major supermarket chain if the contract between Applegrowers and Piemakers expressly excluded loss of opportunity ‘despite any other provision of the contract Applegrowers Pty Ltd is not liable for any consequential loss, including loss of opportunity, incurred by Piemakers Pty Ltd’.

What next?

If your company wants to limit its contractual liability for consequential loss, or wants to ensure the parties with whom it contracts will be liable for certain consequential loss, it is necessary to be very specific as to what you mean by that term. Moray & Agnew can assist you in drafting an appropriate consequential loss clause.

Further information / assistance regarding the issues raised in this article is available from the authors, Tina van Epen, Partner or Stacey Noonan, Senior Associate or your usual contact at Moray & Agnew.

[1] Master Sanderson in Valentine Falls Estate Pty Ltd v SMEC Australia Pty Ltd [2010] WASC 319 explained that the phrase, ‘indirect, consequential and special loss’ is not a term of art. It has no fixed meaning.

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