16 Feb 2006

Did You Know - What exactly is consequential loss?

By _Gone

The phrase "consequential loss" is likely to be found buried in an exclusion clause in most contracts in the energy and resources sector. However, although it might be a well-used phrase, it is greatly misunderstood.

The basics of contract law provide that damages for breach of contract may be recoverable:

  1. if the loss arises naturally from the breach ("direct loss"); or
  2. if the loss is actually contemplated as a probable result of the breach ("indirect loss").

Indirect loss normally arises where a party loses a unique opportunity as a result of breach of contract by the other party. The other party will only be expected to compensate for the indirect loss when he/she has knowledge of that special circumstance.

Consequential loss is most often associated with "indirect loss" or the second limb of the Hadley v Baxendale test for damages (the leading case in this area which held that, if you are in breach of a contract, you must pay damages for that breach). That is, it is normally assumed to be loss that is actually contemplated as a probable result of the breach, but not necessarily naturally arising from the breach.

This mistaken interpretation has led many contract drafters to assume a reference to consequential loss in an exclusion clause will avoid damages for loss of profits or loss of opportunity (ie. losses that are assumed to be losses consequent on or arising as a secondary loss to the immediate and direct loss suffered), but case law attests that this assumption is unwise.

Significant is the Federal Court decision of Justice Ryan in GEC Alsthom Australia Ltd v City of Sunshine which involved a breach of contract in relation to an agreement for gas supply. A clause in the gas supply agreement stated "the Vendor shall in its absolute discretion… indemnify the Purchaser in respect of any direct loss (other than any consequential loss)". There was a mirror clause in a Deed of Indemnity requiring the Council to indemnify GEC Alsthom Australia Ltd.

Justice Ryan held that loss of revenue was not consequential loss. Rather, consequential loss "connotes a loss at a step removed from the transaction and its immediate effects." In this case, Justice Ryan held that "consequential loss" was confined to that which GEC might incur as a result of being unable to use its plant or capital investment for a purpose extraneous to that directly contemplated by the contract documents.

Lessons to be learnt for contract drafting:

  • excluding "consequential loss" will not necessarily avoid liability for damages for loss of profits, loss of revenue or loss of opportunity (the court may interpret any of these as a direct loss)
  • be specific when drafting contractual clauses. It is preferable to state specifically the areas where damages are limited or excluded eg. loss of profits, loss of revenue or any other specific loss intended to be excluded.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.