Australia: WA Supreme Court says BOO to non commercial interpretations of consequential loss

The Western Australian Supreme Court has bucked the recent trend of Australian courts expanding the meaning of consequential loss in exclusion clauses. In Regional Power Corporation v Pacific Hydro Group Two Pty Ltd, the Court adopted a commercial analysis of the clause and rejected the approach of the traditional English authorities and most of the Australian decisions since Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd. The decision highlights the uncertainty surrounding this commonly used term, and reinforces the importance of expressly drafting the types of loss the parties intend to exclude.

Background to the decision

Pacific Hydro (Supplier) entered into a Power Purchase Agreement (PPA) with the Regional Power Corporation (Purchaser) to build, own and operate (BOO) the Ord River Hydro Power Station and supply the Purchaser with power.

As a result of flooding, the power station was inoperative for two months, and the Purchaser spent $4 million sourcing alternative power to supply its customers. The Purchaser then claimed these costs from the Supplier as damages for breach of the PPA.

The Supplier argued that the damages claimed were indirect or consequential losses and fell within the exclusion clause, which stated:

"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."

The construction of the term "consequential loss" before the decision

Until recently, the term "consequential loss" was widely understood in Australia and England. In both jurisdictions the term reflected the 1854 decision of Hadley v Baxendale, which stated that the two limbs of recoverable damages are:

• losses that arise naturally, that is, according to the usual course of things, and
• losses that 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葉hat is, losses sustained as a result of the special circumstances of the plaintiff in question.

Consequential losses were regarded as the losses falling within the second limb.

However, the position in Australia was changed by Peerless, where it was held that it was incorrect to construe consequential loss as being limited to the second limb. Instead, the Court stated that the expression should be given its ordinary and natural meaning and, as a result, it held that consequential loss meant everything beyond the normal measure of damages, such as profits lost or expenses incurred through the breach.

Since the Peerless decision, a number of Australian decisions have further expanded the meaning of consequential loss. For example, the recent South Australian case of Alstom Ltd v Yokogawa Australia Pty Ltd & Anor (No 7) held that the term, unless otherwise qualified, would extend to all damages suffered as a consequence of a breach of contract (see our article Contractual good faith strengthened and consequential loss expanded again).

The WA Supreme Court rejects both approaches

In Regional Power Corporation, the Court rejected the approaches adopted in both Hadley v Baxendale and Peerless. Justice Martin argued that in both these cases the courts wrongly approached the question of construction from "particular legal perspectives" rather than from a "commercial perspective that will vary from case to case".

His Honour held that the proper approach to construction is set out in the High Court decision in Darlington Futures Ltd v Delco Australia Pty Ltd, which required the natural and ordinary meaning of the clause to be determined by beginning with the words themselves and assessing them within the context of the PPA as a whole.

The Court considered that both parties were commercially astute companies and accordingly, weight should be given to the commercial terms of their agreement. His Honour stated the Hadley v Baxendale approach was entirely unhelpful and inconsistent with Darlington Futures Ltd v Delco Australia Pty Ltd. Likewise, his Honour also rejected the approach taken in Peerless stating that it was inappropriate to interpret consequential loss by reference to a concept of "normal measure of damages", rather than determining the natural and ordinary meaning of the clause.

Applying the Darlington principles to this case, his Honour held that:

• the failure by the Supplier to deliver the promised levels of electricity to the Purchaser was not simply a case of the Purchaser suffering some bare loss of profit (by not being able to on-sell at profit to customers)
• the failure meant that the Purchaser was unable to meet its wider public energy supply obligations to Kimberley consumers, and
• this well-understood, ongoing public responsibility to supply energy to consumers could not be categorised as an indirect outcome of a breach of the PPA.

Accordingly, it was held that the Purchaser suffered direct loss (and not "indirect" or "consequential") due to the Supplier's breach, as a result of being exposed to well-understood supply replacement obligations.

Implications

The decision departs from the line of authorities that, following the Peerless decision, have continued to expand the meaning of consequential loss. The requirement that each clause be interpreted from a commercial perspective on a case-by-case basis has created further uncertainty about the scope of the term consequential loss.

In light of these developments, to ensure that your consequential loss exclusions only cover the losses that you intend to exclude, and no others, any exclusion clause should clearly identify which losses are to be subject to the exclusion rather than using terms such as "consequential" or "indirect" losses.

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.