The case of Regional Power Corporation v Pacific Hydro Group Two Pty Ltd (No.2)  WASC 356, a decision of the Supreme Court of Western Australia, has added a new layer of complexity to the interpretation of consequential loss clauses. In a contract which did not define consequential loss, the Court gave priority to finding a commercial interpretation based on the wording of the clause and reading the contract as a whole, rather than pigeonholing a consequential loss clause with reference to either Hadley v Baxendale or the Peerless Holdings decisions.
Why should I read this?
- The law on consequential loss is still not settled.
- Unless clearly defined terms are used, consequential loss clauses in your existing contracts may not operate as you expect them to.
- Using "catch-all" wording such as "any other losses that are special, indirect or consequential" in a definition of consequential loss may leave open the possibility that the Regional Power Corporation case could apply to interpreting that provision.
- There is now a greater need to be specific in drafting the types of loss that parties intend to limit or exclude liability for, and to ensure that your contract works together as a whole.
In 1994, Pacific Hydro Group Two Pty Ltd (Pacific) agreed to construct the Ord Hydro Power Station at Lake Argyle, near Kununurra in northern Western Australia. Pacific also agreed to sell the power station's electricity to the Regional Power Corporation (Corporation), pursuant to a power purchase agreement (PPA) between the parties.
Following a flooding incident in 2006, the power station was inoperative for two months. The Corporation claimed approximately $4 million in damages for breach of contract for costs it incurred in hiring diesel generators and purchasing fuel to generate replacement electricity.
Pacific Hydro argued that the Corporation's loss was consequential loss and was therefore excluded by clause 26.1 of the PPA, which stated 'Neither [party] 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.'
Pacific relied on the case of Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd  VSCA 26 to support its argument that the Corporation's losses were consequential losses. It submitted that ordinary reasonable parties in the positions of Pacific and the Corporation would surely have viewed the expenses that the Corporation incurred to obtain replacement generators, and fuel to operate them, as falling outside a range of any 'normal measure of damages'.
The Corporation argued that the losses it claimed fell within the first limb of the rule in Hadley v Baxendale (1854) 9 Exch 341 and were therefore recoverable under the PPA as being damages that 'may fairly and reasonably be considered' as 'arising naturally, ie according to the usual course of things, from such breach'. In other words, it claimed they were direct losses.
Justice Martin said that "It is trite law that a commercial instrument should be given a commercial interpretation". He referred with approval to the view of Professor Carter that approaching the construction of 'consequential' or 'indirect' loss by reference to the second limb of Hadley v Baxendale, or to the 'normal measure of damages' as set out in Peerless, is artificial. Justice Martin said that Professor Carter's view that both these approaches 'are wrong because they approach the expression 'consequential loss' from particular legal perspectives rather than a commercial perspective which will vary from case to case' was compelling.
Instead, Justice Martin approached the construction of clause 26.1 by referring to Darlington Futures Ltd v Delco Australia Pty Ltd  HCA 82. In that case, the High Court established that the meaning of an exclusion or limitation clause was to be 'determined by construing the clause according to its natural and ordinary meaning, read in light of the contract as a whole.'
In other words, in the court's view the proper approach to construing clause 26.1 was to start with the words of that clause, rather than with a fettering predisposition to construing 'consequential' or 'indirect' loss 'as only embracing a head of loss that falls under the second limb of the rule in Hadley v Baxendale'. His Honour also noted that it was inappropriate to adopt a predisposition to ascertaining the meaning of 'consequential' or 'indirect' loss by reference to the 'normal measure of damages' referred to in Peerless.
His Honour concluded that the losses the Corporation claimed were direct losses and therefore their recovery was not excluded by clause 26.1. This conclusion was based on several PPA clauses, including:
- clause 16, which made it clear that the PPA envisaged a long-term commercial relationship establishing a take and pay regime for electricity, founded on stated assumptions as to 'Reliable Operation'
- clause 16.3, which expressly recognised that the Corporation 'may need to generate its own electricity to make up [a] shortfall or obtain the shortfall from another source'
- clause 16.4, which showed that electricity supply was being provided in circumstances where the Corporation may have to maintain a 'reliable supply of electricity to its customers during the period that Reliable Operation is lost'.
Other provisions in the PPA also recognised the public character of the Corporation's statutory responsibilities to supply electricity to the community, rather than just making profits.
Justice Martin said that the PPA parties were sophisticated commercial entities which, against the background of the well understood requirement for the Corporation to continue to supply its customers with electricity if the power station failed, could be taken to have likely appreciated that such a failure would require the Corporation to take steps to replace the lost electrical supply.
What does it mean in practice?
In practice, many contracts already define consequential loss, although often they include "catch-all" wording such as "any other losses that are special, indirect or consequential".
Consequential loss clauses that do not include a carefully drafted definition of what is meant by "consequential loss" are likely to be determined by construing each clause according to its natural and ordinary meaning, read in light of the contract as a whole. Best practice would be to specify which losses are recoverable and which are not, ideally without using terms such as "consequential loss" or "indirect loss".
You should therefore consider:
- reviewing all of your existing contracts that contain consequential loss clauses to ascertain whether they will operate as intended if challenged
- for high risk or high value contracts in particular, being specific when drafting clauses that limit or exclude liability, so that it is clear what liabilities are being limited or excluded and how, and what is recoverable
- specifying the consequences of a particular breach of contract in the contract
- expressly recognising the particular nature of a party (eg a statutory body), or the particular purpose of the parties in entering into a contract (eg by including an objects clause), to assist in interpreting limitation and exclusion clauses as the parties intend.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.