Exclusion clause may now operate to exclude losses that
the parties did not intend to exclude, so they now need to be
meticulously drafted and negotiated.
The Victorian Court of Appeal judgment in Environmental
Systems v Peerless Holdings changes the way in which the term
"consequential loss" is likely to be interpreted in
Australian contract law. Although the decision is not binding
on courts in other jurisdictions, it will no doubt be taken
into consideration by all State courts in future decisions. As
a result, current contracts containing an exclusion for
consequential loss may operate to exclude losses that the
parties did not intend to exclude, and exclusion clauses in any
new contracts must be drafted carefully so as not to have this
Peerless operated an animal rendering plant which was
situated close to a residential area. Peerless used an
afterburner to alleviate odour emanating from the plant. When
seeking a replacement afterburner, Environmental Systems
persuaded Peerless that a " Regenerative Thermal
Oxidiser" would be more efficient and cost effective. When
it did not work to specification, Peerless sued Environmental
Systems for breach of contract.
The contract contained an exclusion clause in relation to
consequential loss which read, "as a matter of policy,
Environmental Systems does not accept liquidated damages or
consequential loss". Contrary to previous English and
Australian authority, the Court of Appeal held that the term
"consequential loss", does not refer to second limb
losses under the well-established and widely accepted
classifications of loss under v Baxendale. v Baxendale divides
loss into first and second limb losses:
First limb losses are those which arise naturally,
according to the usual course of things following a breach,
regardless of whether the parties considered the effect of
the breach at the time they entered the contract.
Second limb losses cover indirect or special losses
which, at the time they made the contract, the parties
contemplated as being the probable result of a breach of
Instead of adhering to these classifications, the Court of
Appeal found that the correct distinction should be between
"normal loss", which every plaintiff in a like
situation will suffer, and "consequential loss",
which is everything else including lost profits or expenses
incurred. Court stated that "ordinary reasonable business
persons would naturally conceive of "consequential
loss" in contract as everything beyond the normal measure
of damages, such as profits lost or expenses incurred through
Previously, a clause which excluded "consequential
loss" (without further definition of what that might
entail) would not have been found by the courts to exclude
things such as loss of profits and loss of production provided
that those losses fell within the first limb of Hadley v
Now, it is more likely that an exclusion of
"consequential loss" will exclude all losses which
are not "normal losses", in particular lost profits,
lost revenue, lost production, third party claims etc, whether
or not these heads of claim are listed in the exclusion clause
or not. A clause that excludes "consequential loss"
may in fact now be effective to exclude all loss except the
difference between the contract price and the market price for
the goods or services provided under the contract.
As a "standard" exclusion clause may now operate
to exclude losses that the parties did not intend to exclude,
these clauses now need to be meticulously drafted and
negotiated, taking into account the effect of this decision.
The most sensible and prudent course of action is to precisely
identify the types of damages the parties wish to exclude (eg.
loss of profit) without relying on terms such as
"direct", "indirect" or
"consequential". The meanings of these terms have
become less clear at law as a result of this decision, and
their use in contracts may have unintended results unless they
are defined in the contract itself.
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.
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