Key Point
- 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 effect.
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 contract.
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 breach".
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 Baxendale.
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.
