Consequential Loss Clauses In Contracts And How To Utilise Them

Consequential loss, which is also known as indirect loss, is any loss which may arise from the specific context of the case (e.g., if a part within a machine is not delivered on time and the company which owns the machine claims it cannot operate its whole factory, and therefore cannot pay its workers, as a result of the delay). Such losses are usually only recoverable if it can be said the defaulting party (e.g., the supplier of the part to the machine) was aware of the link and, therefore the likelihood of the resulting loss, due to their breach.

The concept of consequential loss, to some extent at least, is attributable to the case of 'Hadley v Baxendale' (1854). This case involved the claimant mill owner engaging the defendant to repair a crankshaft in the mill and return it. The defendant took longer than agreed, and the claimant could not operate the mill during the delay as a result. The claimant claimed for loss of profits. The Court held that the defendant was not liable for loss of profits as it was not informed the mill would be closed. The damages were not foreseeable/could not be said to be reasonably contemplatable by the defendant when it entered into the Contract.

This is compared to direct losses, which are easier to understand for the party that may be in default (e.g., if there are various defects in a building and the developer rectifies those defects, then the loss and expense is the cost incurred to rectify them).

Due to the ambiguity of consequential losses, some parties will seek to exclude liability for them in the contract. This is especially the case on large projects (such as oil and gas), where the loss that may be sustained could be very high.

A consequential loss clause may state that a party (usually the party who supplies or installs a product) is not responsible for 'any loss of profits, loss of production, loss of revenue, loss of use, loss of contract, loss of goodwill, loss of opportunity or wasted overheads or any other indirect or consequential losses'.

The purpose of such a clause is to ensure that (usually) the party with the better bargaining position (and the one who may be taking on more risk) is not exposing itself to potential claims for losses that could not have been reasonably foreseen. A building contractor, whose work on a building may have some defects, would not want to expose itself to being liable for the Employer losing its ability to rent the building as a result of the Employer not being able to carry out the rectification work.

The party who has to accept the exclusion clause may say the extent of these clauses is burdensome and potentially unreasonable. However, if the parties to a contract have reviewed and signed it, then the Courts are unlikely to revise the terms or deem a term in a contract void.

There have been a few instances where the Court has deemed some exclusion of liability for consequential losses clauses to be unreasonable and unenforceable, under the Unfair Contract Terms Act 1977. This may occur where the party that suffers consequential losses and has (on paper at least) agreed that the other party is not responsible for its consequential losses, is in a weaker bargaining position (e.g., a company whose yearly revenue is 50 times less than the other party to the contract). However, the default position of the Court is to avoid making such judgments.

If you are negotiating a contract, then how should you approach a consequential loss clause? If you are supplier (or building contractor/sub-contractor) then you will want to include a consequential loss clause which excludes your liability for any losses associated with your delay. If you are a customer (or developer on a building/engineer project) then you will not want to remove any consequential loss clause, or at least you will seek to amend it to allow you still to claim some consequential losses. The position may be more nuanced than this; for example, a building contractor whose work is delayed because of the Employer may want to claim loss of opportunity to work on other projects.

Any party that is contemplating including an exclusion of consequential losses will need to be conscious of the bargaining powers of the two parties. If the party seeking to exclude such losses is clearly a much larger company, then it will need to be careful not to have an 'unreasonable' exclusion clause. Consideration must be given to what losses may arise if a breach of contract does occur.

Ultimately, both parties should review and understand the terms of their contract. You should engage a solicitor who has the expertise to review such contracts or, at least, thoroughly review the contract yourself.

Consequential loss clauses were discussed in our webinar on 24 February 2022 with Mino Han, Peter & Kim, South Korea). Click here to view the webinar and detailed notes.