It is common to see contracts, especially IT contracts, that exclude ‘consequential loss’. But do you know what loss you are excluding if you agree to such a clause?
In this article we will explore what constitutes ‘consequential loss’ and how you should apply these principles to your contracts.
Traditional position
The principles for what damages are recoverable for breach of contract came from the seminal case of Hadley v Baxendale (1854) 9 Ex 341 (Hadley v Baxendale). In Hadley v Baxendale, Baron Sir Edward Hall Alderson outlined that damages are recoverable if:
‘[T]he damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered either arising naturally ie, according to the usual course of things, from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it‘.
This is just an old fashioned way of saying that damages are recoverable if:
- they arise naturally in the usual course of things (first limb); or
- the loss was contemplated by both parties at the time the contract was signed (second limb).
Traditionally, consequential loss was any loss that fell under the second limb outlined above. This differs substantially from the common commercial understanding of ‘consequential loss’ which is focused on the whether the loss is beyond the normal measure of loss.
Modern position
Australia has arguably departed from the traditional position in a series of state supreme court decisions, which have been cited with approval by the Federal Court of Australia in Sherrin Hire Pty Ltd v Tidd Ross Todd Ltd (No 2) [2016] FCA 891.
Peerless
This process began in 2008 with the Victorian Supreme Court of Appeal decision in Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd [2008] VSCA 26 (Peerless). In Peerless Nettle JA held that ‘the true distinction’ is not the limbs in Hadley v Baxendale but:
‘between ‘normal loss’, which is loss that every plaintiff in a like situation will suffer, and ‘consequential losses’, which are anything beyond the normal measure, such as profits lost or expenses incurred through breach.‘
Under this principle, consequential loss is loss that is beyond the normal measure and aligns closer to the common understanding of consequential loss than the second limb.
Post-peerless
Australia has continued to uphold this principle in the Supreme Court of Western Australia’s decisions in Regional Power Corporation v Pacific Hydro Group Pty Ltd [No 2] [2013] WASC 356 (Pacific Hydro) and Patersons Securities Ltd v Financial Ombudsman Service Ltd [2015] WASC 321 (Patersons).
In Pacific Hydro the court found that what constitutes consequential loss depends on the context of the contract. This case concerned a contract to supply of electricity to help a party meet statutory obligations, which required the plaintiff to ensure it had a supply of electricity. In this context, where ‘the plaintiff was effectively required to‘ move to an alternative supplier and this decision was not discretionary, the expenses for moving to an alternative supplier was not a consequential loss.
Paterson concerned an action brought by investors against a securities advisor who had an obligation to invest monies in a certain manner and failed to do so. In this case, the court held that:
‘[T]he breach found was a failure to act in accordance with a contract which required an investment to be made in a particular way… an appropriate measure of damages would have been the difference in the value of the investment portfolio… and the value which the portfolio would have had at that date if the contract had been performed according to its terms.‘
In plain English, this means that the investors loss of profits is not a consequential loss when a contract outlines a specific situation that the investor failed to meet specific contractual requirements for how monies were to be invested.
Lessons
The High Court of Australia has yet to endorse the above principles and there are still some questions on if Australia has truly departed from the traditional position. We will not get an answer to this question until the High Court of Australia gives its opinion, however it does appear that these principles are binding on any lower court and therefore should be considered when making any commercial decision.
Interestingly, in both Pacific Hydro and Patersons, the courts adopted the principle from Peerless so that damages that may traditionally be consequential loss were not considered consequential loss. This highlights the importance of the specific contract and situation in interpreting what constitutes consequential loss. We have seen that losses that cannot be avoided are likely not to be consequential loss, so it is vital to expressly call out any losses that you want to be excluded when you exclude consequential loss.
HWL Ebsworth’s IT and IP team has extensive experience in advising businesses regarding commercial IT contracts and common law. If you are concerned about consequential damages, please contact us for further information on how we can assist you.
This article was written by Luke Dale, Partner and Max Soulsby, Solicitor.
