Australia: Exclusion or limitation clauses in contracts must be clearly drafted

In brief - Cost of interruption to power supply held to be a direct loss, not a consequential loss

The Supreme Court of WA has found that expenses incurred by an electricity supplier in generating replacement power to supply its customers, following a two month outage at a power station, amounted to a direct loss which was not excluded under the terms of the contract as a consequential loss.

What constitutes "indirect" or "consequential" loss or damage?

It is not uncommon for parties to more sophisticated commercial contracts to agree to limit or exclude claims against each other for certain types of loss or damage. In such contracts, claims for "indirect" or "consequential" losses or damage are frequently sought to be excluded. The meaning of "indirect" or "consequential" loss or damage, however, continues to be a topic of much debate.

A recent decision of the Supreme Court of Western Australia considered the operation of a contractual clause that sought to limit or exclude, amongst other things, "indirect" or "consequential" damage or loss.

Power station inoperative for two months following outage and flooding

The case Regional Power Corporation v Pacific Hydro Group Two Pty Ltd [No 2] [2013] WASC 356 concerned energy company Pacific Hydro, which entered into a Power Purchase Agreement (PPA) in 1994 with SECWA, a statutory corporation, which later became Regional Power. Pursuant to the PPA, Pacific Hydro agreed to construct the Ord Hydro Power Station ("the power station") and then supply power to Regional Power.

Following an outage and flooding incident on 27 August 2006, the power station was inoperative for two months. Regional Power incurred expenses as a result of the need to generate replacement power in the aftermath to meet its supply obligations to its customers.

Contract excludes liability for indirect or consequential loss

Regional Power sought damages for breach of contract from Pacific Hydro. The key issue was whether the losses claimed by Regional Power were recoverable in light of the exclusion in the contract of certain types of losses and damages.

Clause 26.1 of the PPA provided:

Neither the Project Entity nor SECWA 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.

In construing clause 26.1, the court examined the meaning of "indirect" and "consequential" damage or loss.

Regional Power argues that losses not caught by consequential loss exclusion in contract

Regional Power argued that in 1994, the well-understood and well-accepted meaning of "indirect" or "consequential" loss was understood by reference to Hadley v Baxendale (1854) 9 Exch 341.

The two limbs of Hadley v Baxendale outlined the damages available for loss. Specifically:

  • the first limb allowed recovery of damages arising in the ordinary course of things, that is, direct loss;
  • the second limb allowed recovery of damages for 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, that is, consequential loss.

Regional Power submitted that although the law may have altered since 1994, it was more appropriate to apply the case law as understood by Australian lawyers in 1994 in construing clause 26.1 and determining the meaning of consequential loss.

Regional Power argued that in 1994, a person in the position of Pacific Hydro would surely have contemplated that, in the ordinary course of things, there would be a need for Regional Power to implement backup electricity generation measures and thereby incur expense, should Pacific Hydro fail to supply power in accordance with the PPA.

Hence, Regional Power argued that this fell within the first limb of Hadley v Baxendale, constituting direct loss and thus, was not caught by the consequential loss exclusion in clause 26.1.

Energy company argues that cost of replacement power outside "normal measure of damages"

Pacific Hydro contended, however, that the meaning of "indirect" or "consequential" damage or loss should be correctly construed having regard to the decision Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd [2008] VSCA 26 which stated (at [389]):

... ordinary reasonable business persons would naturally conceive of "consequential loss" in a contract as everything beyond the normal measure of damages.

Pacific Hydro argued that any reasonable person in the position of Regional Power and Pacific Hydro would have viewed the economic expenses of Regional Power in implementing backup electricity generation measures as falling outside the "normal measure of damages". Hence, it constituted indirect or consequential damages or loss and would thus fall within the consequential loss exclusion in clause 26.1 of the PPA.

No universal meaning of consequential loss

The WA Supreme Court rejected both constructions of the meaning of consequential loss.

The Judge opined that the correct approach in construing a limitation or exclusion clause commences with the natural and ordinary meaning of the words of the clause itself, assessed in the context of the contract as a whole, as required by Darlington Futures Ltd v Delco Australia Pty Ltd [1986] HCA 82.

The Judge then held that:

  • it was well understood by the parties to the PPA that Regional Power had an ongoing public responsibility to supply energy to consumers;
  • thus, it was well understood by the parties to the PPA that there would be a need for Regional Power to incur expenses in implementing backup electricity generation measures following a failure by Pacific Hydro to supply power pursuant to the PPA;
  • hence, Regional Power suffered "direct" loss.

Accordingly, Regional Power's losses were not excluded by clause 26.1 of the PPA.

Draft your contracts properly - identify what losses are excluded

While it remains to be seen whether this decision of the Supreme Court of Western Australia will be applied in other Australian jurisdictions, the judgment clearly signals that courts may construe a limitation or exclusion clause in a way that one or both of the parties to the contract do not contend.

It is essential therefore that limitation or exclusion clauses are clearly and succinctly drafted, to ensure that the result is what the parties envisaged when entering the contract.

Karen Lo Brad Kermond
Construction and engineering
CBP Lawyers

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