06 Mar 2014

Interpreting exclusion clauses - general wording does not work

by Clive Luck, Kevin Zhou

Deciding whether a type of loss is an "indirect" or "consequential" loss must be done in the context of the contract in question.

The recent Western Australian Supreme Court decision in Regional Power Corporation v Pacific Hydro Group Two Pty Ltd (No 2) [2013] WASC 356 may have implications for the approach courts will take in determining whether a type of loss is an indirect or consequential loss for the purpose of an exclusion clause in a contract.

The Court indicated that it favours a more case-by-case approach, deciding whether a type of loss is an "indirect" or "consequential" loss in the context of the contract in question. This is a departure from the rigid application of the rules set out in Hadley v Baxendale (1854) 9 Ex 341 at 354, and the more recent judgment in Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd [2008] VSCA 26.

The Court also found that a contract cannot limit a party's right to the common law damages unless it explicitly says so.

The contract and the loss

Regional Power Corporation sought relief for breach of a Power Purchase Agreement entered into between its statutory predecessor (SECWA) and Pacific Hydro. Under the contract, Pacific Hydro agreed to construct and supply electricity from the Ord Hydro Power Station to SECWA.

SECWA had a statutory duty to provide and maintain supply of electricity to the public in the Kimberley region of Western Australia.

On 27 August 2006, the Power Station suffered an outage resulting from water damage which led to the Power Station becoming inoperative for a two-month period.

As a result, SECWA incurred expenses arising from arranging alternative power supply to meet its obligations.

Two issues for the court to consider

The Court had to decide, firstly, whether or not its contractual damages mechanism precluded Regional Power from pursuing damages available to it at common law.

If the answer to this issue was "yes", the second issue was whether or not the heads of loss and damage claimed by Regional Power were recoverable in the light of a clause excluding indirect or consequential loss under the agreement.

Common law rights to damages are not extinguished unless clearly excluded

Pacific Hydro argued that by express terms, the agreement set out an exclusive remedy mechanism for any breaches of it, through which the non-defaulting party was contractually entitled to limited liquidated damages and other closely confined remedies.

Regional Power contended that the relief regime in the agreement augmented its common law rights to damages for breach of contract.

On this point, the Court found that while there was a comprehensive relief regime within the document itself, a party's common law right to seek damages for breach of contract could only be excluded by clear words to that effect.

How should an exclusion clause be interpreted?

The exclusion clause at issue in the agreement provided that:

"Neither the Project Entity nor SECWA shall be liable to the other party in contract, tort, warranty, strict liability, or any other legal theory for any indirect, consequential, incidental, punitive or exemplary damages or loss of profits."

Regional Power argued that the additional economic outlays incurred by SECWA, which would be captured by the first limb of Hadley v Baxendale, or direct loss, were not "consequential loss", because at the time the agreement was entered into (1994), consequential loss was generally viewed as within the parameter of the second limb of Hadley v Baxendale and not recoverable.

Pacific Hydro disagreed and referred to a recent Australian decision in Environmental Systems, which considered a "'consequential loss' in a contract as everything beyond the normal measure of damages, such as profits lost or expenses incurred through breach" [emphasis added].

The Court considered that both approaches interpreted the term "consequential loss" from a narrow predisposition. It held that the correct approach is to examine the natural and ordinary meaning of the relevant presenting text, in context, as required by Darlington Futures Ltd v Delco Australia Pty Ltd [1986] HCA 82, and recently applied by the Western Australia Court of Appeal in Electricity Generation Corporation t/as Verve Energy v Woodside Energy Ltd [2013] WASCA 36.

The Court also noted that as the agreement was a commercial instrument it should be interpreted and assessed as a whole, taking into account the natural and ordinary meaning of the words in the clause itself. In applying this approach, the Court examined relevant terms of the agreement beyond the exclusion clause in question. It also considered that the parties were commercially sophisticated and understood that Regional Power had statutory obligations to provide a continuous electricity supply to the people in the Kimberley Region. After considering these significant factors and their effects on the relationship between the parties, the Court concluded that the SECWA's losses were "direct" in the context of the agreement.

Implications of this decision

This decision has not yet been followed in other jurisdictions of Australia, but best practice drafting tips to consider are common sense. Specifically, you should consider:

  • whether the parties intend for damages at common law to be restricted by contract; and
  • which losses are intended to be considered as "consequential loss" in a commercial contract.

It is recommended to use explicit language if you wish to exclude certain type of losses or limit a party's right to common law damages in general.

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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.