A new meaning of consequential loss in technology contracts

By Amy Noble.

Key Points:
Parties should not use the term "consequential loss'" in a technology contract without dedicated thought as to the purpose of the contract and the potential losses that a particular party might suffer from a breach of the contract.

It is now customary for suppliers of software products and technology platform systems to attempt to disclaim their liability for consequential loss in technology contracts. The recent decision of the Victorian Court of Appeal in Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd [2008] VSCA 26 changed the concept of the term 'consequential loss' as it is often used in limitation of liability clauses and may have a significant impact on suppliers and customers with active technology contracts.

This case considered an exclusion clause which said that one party "does not accept liquidated damages or consequential loss".

Decision

The Court of Appeal held, in determining that a particular loss was not recoverable as damages, that the correct distinction is between:

• Normal loss which is loss that every plaintiff in a like situation will suffer and can be generally stated as the market value of the property, money or services that the plaintiff should have received under the contract, less either the market value of what he does receive, or the market value of what he would have transferred, but for the breach; and
• Consequential loss is that loss which is special to the circumstances of the plaintiff, and is anything beyond the normal measure, such as profits lost or expenses incurred through the breach, and is recoverable if not too remote.

Previous position

Prior to this decision, it had become generally accepted that a clause excluding consequential loss was sufficient only to exclude losses falling under the second limb of the rule in Hadley v Baxendale (1854) 9 Ex 341.

These limbs provide that, to be recoverable in contract (subject to the contract terms), damages:

1. must be fairly and reasonably considered as arising naturally from the breach or as may reasonably be supposed to have been in the contemplation of the parties, at the time of entering into the contract, as the probable result of the breach; or
2. if the contract was made in special circumstances which are known to both parties, would ordinarily follow from a breach of contract under those special circumstances.

The upshot of those tests was that losses, although "consequential", might still be recoverable if they fell within the wider first limb. Examples of recoverable, consequential losses have included:

• increased production costs and lost profits;
• wasted overheads incurred during reconstruction of a plant following its destruction;
• cost of removal and loss of profit associated with defective minibars in a hotel; and
• loss of sales, loss of opportunity to increase margins, loss of opportunity to make staff cost savings and wasted management from breaches of a computer hardware and software contract.

What does this mean for active technology contracts?

Until the High Court of Australia is asked to consider how "consequential loss'" should be interpreted in exclusion clauses, it is likely that a clause excluding "consequential loss'" will, without more, be interpreted as excluding all losses that are not normal, including lost profits, lost revenue and loss of production.

Contracts with a bare exclusion of consequential loss will be susceptible to a wider interpretation and may leave customers without recourse for certain losses, such as loss of profits, in circumstances where they may have been recovered if assessed under the Hadley v Baxendale interpretation.

It may not be necessary to panic. In reaching its decision, the Court of Appeal held that there was no evidence that the parties had used the term "consequential" advisedly. So, it seems that an exclusion clause will still be interpreted in light of the contract as a whole and in view of the surrounding circumstances. Accordingly, if you were able to demonstrate (for example, by a statement of issues or notes from a negotiation) an intention to adopt the term "consequential loss'" in the context of the Hadley v Baxendale distinction, there could be a different result.

There might be little difference under either distinction for parties who use more detailed exclusion clauses than was seen in this case. Parties whose clauses specifically exclude the losses that have been held in the cases to fall outside the second limb and/or reflect language from the first limb to try to cover unspecified consequential losses which might be recoverable, are unlikely to be in for any surprises. Practically, there may be little difference in the interpretation of a detailed exclusion clause and interpretation of consequential loss under the normal vs consequential distinction favoured by the Court of Appeal.

What to do now?

• Review template technology contracts and all active major contracts against this decision.
• Identify any unintended exclusions of liability and get legal advice if necessary.
• Amend or insert practice notes in template technology contracts with bare exclusions of consequential loss provisions.
• Advise your contract negotiating teams about the change in the law.
• Remember an exclusion of consequential loss alone will exclude loss of profit and costs associated with the breach, not the opposite.

Going forward

Parties should not use the term "consequential loss'" in a technology contract without dedicated thought as to the purpose of the contract and the potential losses that a particular party might suffer from a breach of the contract.

It will be beneficial for a supplier to pursue a bare exclusion of consequential loss, as it will now be the most extensive exclusion and exclude liability for loss of profits etc., where previously it may not have been sufficient.

There is no longer a need to include language referring to the first limb of Hadley v Baxendale to ensure all unspecified consequential losses are excluded.

Customers should avoid, if possible, a reference to "consequential loss'" if conceding exclusions of liability, and rather be very specific about the types of loss for which an exclusion of liability is being accepted.

For further information, please contact Jeremy Charlston.