Consequential Loss in Commercial Contracts:

Exclusion clauses for 'consequential loss'

The recent NSW Court of Appeal decision in Allianz v Waterbrook [2009] NSWCA 224 ('Allianz') considered the meaning of 'consequential loss' when that legal phrase is not further defined in an exclusion clause. Although this case has given some jurisdictional consistency to this area of law in Australia, it has not changed the need for a precise definition of 'consequential losses' when drafting such an exclusion clause.

No definitive meaning

An exclusion clause for consequential loss is commonly found in commercial contracts. Yet many parties to a contract treat 'consequential loss' as shorthand for a broad category of losses, including loss of profit, loss of revenue, loss of a business opportunity, loss of production or a loss of goodwill. Indeed many of these types of losses may fall into the category of consequential loss.

The problem with this shorthand approach is that in Australia (and in many other common law jurisdictions) there is no definitive definition of 'consequential loss'. As there is no definitive definition of 'consequential loss' it means using the shorthand approach leaves uncertainty as to the precise meaning of the exclusion clause.

In a dispute involving an exclusion clause that simply refers to 'consequential loss' a court may come to a different conclusion as to what a party or both parties intended to mean when they agreed to exclude liability for 'consequential losses'. Alternatively, it may exercise its judicial discretion to find against the party seeking to rely on the exclusion clause because of that uncertainty of meaning.

Normal loss or consequential loss

To understand this issue in its full legal context it is useful to understand the broad categories of losses that contractual parties often claim when there is a breach of contract and resulting losses.

In Australia, the courts have traditionally allowed two broad categories of losses to be recovered against a party who has breached a contract and where loss has been suffered as a result, subject to what the contract states on the matter. The first is 'normal losses', which are those losses which flow naturally from the breach. The second is 'consequential losses', which are those losses which are, at the time of entering into the contract, contemplated by the parties as being a probable result of a breach of contract. These broad categories emanate from the leading case of

Hadley v Baxendale

(an English case – (1854) 9 Ex 341) and have been applied over the 150+ years in many common law jurisdictions like Australia.

Although on its face the two broad categories appear to be quite distinct, whether a particular loss suffered by a party to a breach of contract falls into one category or the other depends on the facts of that particular case. For instance, the courts have found that a loss of profit can be categorised a 'normal loss' as well as the more usual finding that it is a 'consequential loss'.

The leading Australian cases

In Australia, the courts have followed Hadley v Baxendale and applied the two broad categories of loss depending on the facts of the particular case. This includes the leading Australian case of Peerless (Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd [2008] VSCA 26).

In Peerless the question of what is meant by 'consequential loss' was considered in the Victorian Court of Appeal. Peerless held that 'consequential loss' should be given its "ordinary and natural" meaning as used by "ordinary and reasonable business persons". It went on to describe 'consequential losses' as losses which are "anything beyond the normal measure, such as profits lost or expenses incurred through breach". However, Peerless also conceded that some so called 'consequential losses' may well fall within the broad category of 'normal losses' as described in Hadley v Baxendale.

There were a number of legal commentators, particularly in New South Wales, who questioned whether Peerless would be followed. This created the potential for legal uncertainty in terms of how the courts would interpret and apply the meaning or scope of consequential loss exclusion clauses in disputes where a precise definition had not been used in the contract. Just over 18 months after the Peerless judgment was handed down, the NSW Court of Appeal did indeed follow Peerless in the Allianz case.

Allianz involved an insurance dispute. The insured had acquired a retirement village which had defects in its construction. The insurance company sought to rely on an exclusion clause for consequential losses. The insured claimed it had a statutory indemnity entitlement to be recompensed for the defects that rendered the exclusion clause ineffective. Both the first instance and Court of Appeal judgments agreed with the insured. In doing so, both courts as part of their judgments applied the principles laid down in Peerless.

Drafting implications

Although Allianz has given a measure of jurisdictional consistency on the issue of what is meant by 'consequential loss', there still remains no definitive definition for this legal phrase. Ultimately, the approach in Peerless will be applied in New South Wales and each case will be decided on its particular facts.

Therefore, it is still crucial for a draftsman seeking to insert an exclusion clause for consequential loss in a contract to precisely define exactly what is meant when purporting to exclude any liability for 'consequential loss'.

Equally for a party receiving a set of draft terms to be agreed that contains an exclusion clause for 'consequential loss', it is crucial to ensure that the extent of the clause is not too widely drawn. If it is, then that party may well find that losses which it could have claimed as 'normal losses' have been unnecessarily excluded to its detriment when a breach of contract claim arises.

Warren Davis is a Senior Associate of Gadens Lawyers, Sydney. Paul Brown is a Partner of Gadens Lawyers, Sydney. Warren and Paul specialise in commercial law and contracts.
This report does not comprise legal advice and neither Gadens Lawyers nor the authors accept any responsibility for it.

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