Australia: Consequential loss - another fork in the road?

A Western Australian Supreme Court decision has turned the meaning of consequential loss on its head...again.

The Judge decided that there is no universal definition of 'consequential loss', and that its meaning will depend on the circumstances of each case. Extraordinary care must now be taken when using the term.

REGIONAL POWER V PACIFIC HYDRO

The case in question concerned an agreement between Pacific Hydro Group Two Pty Ltd and a statutory corporation which later became Regional Power Corporation.

Pacific Hydro agreed to construct the Ord Hydro Power Station and then supply electricity from that power station to Regional Power.

The agreement contained a typical exclusion of liability for 'consequential loss' clause, which excluded both parties'' liability to each other for "indirect, consequential, incidental, punitive or exemplary damages or loss of profits." The term 'consequential loss' was not otherwise defined in the agreement.

In 2006, the Ord Hydro Power Station was inoperable for 2 months due to flooding. During that time Regional Power had to find alternative power sources to meet its supply obligations.

Regional Power claimed Pacific Hydro's failure to operate the power station was a breach of the agreement and sought damages for the costs of sourcing alternate power. In response Pacific Hydro argued the claimed losses were "indirect" or "consequential" and therefore it was not liable for them under the agreement.

CONSEQUENTIAL LOSS

For a long time it was accepted in Australia that 'consequential loss' referred to the second limb of the 1854 English Case, Hadley v Baxendale. In that case, the Court ruled there were two categories (or limbs) of damages for breach of contract.

The first limb was direct loss, meaning any loss that may fairly and reasonably be considered either arising naturally, that is, according to the usual course of things, from a breach of contract.

The second limb was indirect or consequential loss which meant a loss which 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.

In 2008, Victoria's Court of Appeal in Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd rejected this long held approach, instead drawing a distinction between:

• 'normal loss', which is loss that every plaintiff in a like situation will suffer; and
• 'consequential loss', which is anything beyond the normal measure, such as lost profits and expenses incurred through breach.

Although this new approach to 'consequential loss' was generally accepted by other Australian Courts,¹ it remained a rather nebulous concept. What exactly did 'loss beyond the normal measure' mean?

REGIONAL POWER – HAS ALL MEANING BEEN LOST?

In the Regional Power v Pacific Hydro case, Regional Power argued that because the agreement pre-dated the Peerless decision, 'consequential loss' should be confined to the second limb of Hadley v Baxendale.

In contrast, Pacific Hydro argued that the definition favoured by the Victorian Court of Appeal in Peerless should be applied.

Ultimately, the competing definitions were of no real practical significance because the Court rejected both approaches!

Instead, the Judge relied on the High Court's statement that the meaning of an exclusion clause is to be "determined by construing the clause according to its natural and ordinary meaning, read in light of the contract as a whole" (see Darlington Futures Ltd v Delco Australia Pty Ltd).

The Judge thought it wrong to start with any predisposition about the meaning of 'consequential loss'. Rather his Honour thought the term should be given its natural and ordinary meaning in light of the contract as a whole.

On that basis, the Judge held that the losses were 'direct losses'. His Honour reasoned Regional Power's ongoing public responsibility to supply electricity was well known and was a direct result of the power station's failure.

Therefore, at the time of entering the contract, the parties could not have meant for 'indirect losses' to cover such a loss. These losses were clearly 'direct losses'.

Importantly, the Court did not reject the approach in Peerless, but instead found the common assumption that Peerless redefined the meaning of 'consequential loss' is wrong.

The Judge concluded that what the Court of Appeal meant in Peerless was that the terms of a limitation of liability clause must always be given their plain and ordinary meaning and that the Court of Appeal's definition of 'consequential loss' was not intended to establish 'a rigid new construction principle for limitation clauses'.

That reasoning is significant. In confining the definition of 'consequential loss' in Peerless to the facts of that case, the Court effectively found the meaning of 'consequential loss' must be determined on a case by case basis.

While we wait to see if the approach of a single judge in Western Australia is accepted by others; other State Supreme Courts, perhaps including Victoria, may now feel comfortable in rejecting the definition applied in Peerless and instead define 'consequential loss' on a case by case basis.

WHAT THIS MEANS FOR YOU

The implications of the Regional Power case are not limited to contracts governed by Western Australian law. Regional Power potentially redefines, or more correctly robs of definition, the meaning of 'consequential loss' across all Australian jurisdictions.

Now, more than ever, when seeking to exclude 'consequential loss' from contracts, it is important to define exactly what losses are excluded. Prudence dictates that parties should not rely on pre-defined legal meanings. Failing to define what is meant leaves the contracting parties open to the risk that a court will determine that the 'plain and ordinary meaning' of the term in their contract is different to what they envisaged at the time of contracting.

Footnote

¹For example by the NSWCA in Allianz v Waterbrook [2009] NSWCA 224.

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