Direct vs consequential loss: is there a difference anymore?

A contract is breached, and you've suffered loss. You look at the terms of the contract, and find the other party doesn't have to compensate you for any consequential loss. What does that even mean?

Consequential loss confuses business people and some recent cases have added to the confusion. The courts have adopted different approaches to clauses which seek to exclude or include consequential loss from the scope of damages that a party to an agreement can claim. What was once considered to be a consequential loss may now be a direct loss. If you are entering into a contract and want to exclude recovery for consequential loss, what should you do?

What is consequential loss?

Courts traditionally held that where one party breaches an agreement, the other party should receive damages:

• which fairly and reasonably arise naturally from the breach of contract (direct loss); and
• which were reasonably in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it (consequential or indirect loss) ^[1]. 

There is no longer a clear line between direct and consequential loss. In the 2008 decision of Peerless,^[2] the Victorian Court of Appeal distinguished between normal loss and consequential loss, finding that some consequential loss could still be direct loss. Courts in Western Australia and New South Wales have followed suit, looking at the circumstances and facts of a particular case as well as the bargaining power and nature of the parties.

If you want to exclude a category of loss, be specific

If you want to exclude recovery of damages such as loss of profits and additional expenditure caused by an initial breach, it is necessary to be specific. Consequential loss is now a term that is arguably cloaked in ambiguity which can make determining what is a consequential loss as opposed to a direct loss, a difficult task.

Although courts have taken different approaches, the key lesson from all recent cases is that if consequential loss is going to be carved out, it is not sufficient to merely state "consequential losses are excluded". The categories of loss being excluded now need to be expressly defined. It is necessary to be specific about the types of loss that are not recoverable and to avoid using broad catch-all expressions.

Breaches relating to non-payment

There may be circumstances where it is worth using the generic reference to consequential loss. For example, if your only obligation is to pay for services provided, then a mutual carve-out excluding "consequential or indirect losses" may benefit you if there is a breach and you can show that a loss of profit was, in fact, a direct loss which is recoverable.

In GEC Alsthom Australia Ltd v City of Sunshine ^[3], there was a breach of contract in relation to an agreement for gas supply. Under the agreement, the vendor had to indemnify the purchaser "in respect of any direct loss (other than consequential loss)." It was held that loss of revenue was not a consequential loss because consequential loss was restricted to loss which GEC incurred as a result of being unable to use its plant or capital investment for a purpose that was not directly contemplated by the contract. This means that excluding consequential loss will not necessarily avoid liability for damages such as loss of profits or revenue as the court may find these to be a direct loss.

Should you define consequential loss or not?

There is still uncertainty around consequential loss, and until the High Court rules one way or the other you should be careful.

If you want to exclude liability, it is necessary to be very specific and not rely on generic carve-outs. However, in light of the direction courts are now taking, where your only obligation under an agreement is limited to the payment of money, it may work to your advantage not to define consequential loss.

^[1] Hadley v Baxendale (1854) 9 Exch 341. ^{Back to article}

^[2] Peerless Holdings v Environmental Systems [2006] VSC 194; Environmental Systems v Peerless Holdings (2008) 227 FLR 1. ^{Back to article}

^[3] GEC Alsthom Australia Ltd v City of Sunshine (Federal Court, Ryan J, 20 February 1996, unreported). ^{Back to article}

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