Who does this affect?

All corporate legal advisors drafting or negotiating provisions relating to consequential loss.

What do you need to do?

Conduct a review of consequential loss provisions in your contracts to assess the impact of the new meaning of "consequential loss".

Author
Hazell Honour  
Senior Associate (Not Australia Qualified)

Cheng Lim  
Partner
T +61 3 9643 4193

Melbourne
Cheng Lim  
Conduct a review of consequential loss provisions in your contracts to assess the impact of the new meaning of "consequential loss". Mark Weber  
Conduct a review of consequential loss provisions in your contracts to assess the impact of the new meaning of "consequential loss". Stephen Neenan   Conduct a review of consequential loss provisions in your contracts to assess the impact of the new meaning of "consequential loss".


03 March 2008

Consequential loss - a new definition - 3 March 2008

A recent decision1 by the Court of Appeal in Victoria has clarified the definition of “consequential loss” under Australian law. This decision appears to mean that, in general, an exclusion of consequential loss will be interpreted to exclude lost profits and other pure economic losses unless the contract or circumstances indicate that the parties intended the economic loss to be a “normal loss”.

The judgment by the Court of Appeal asserts that the term “consequential loss” should be given its “ordinary and natural meaning” and that the true distinction is between:

  • “normal loss” which is the loss that every plaintiff in a like situation will suffer, and
  • “consequential loss” which is anything beyond the normal measure, such as profits lost or expenses incurred through the breach.

Comment

Until this issue is considered by the High Court, it would be prudent to specifically identify the types of losses that the parties wish to be excluded as consequential losses (for example loss of profits, loss of revenue, loss of business opportunities, loss of anticipated savings and damage to goodwill).

However, it is important to be clear about the extent of the exclusion. For example, if the identified losses are listed as examples of consequential loss, the exclusion will only apply to the extent that each loss is “beyond the normal measure”.

Background - facts of the case

Peerless Holdings Pty Ltd (Peerless) purchased a system from Environmental Systems Pty Ltd (Environmental Systems) for reducing odour emissions at Peerless’ organic recycling (animal rendering) plant.

The system did not function as expected and Peerless claimed against Environmental Systems for (amongst other things) damages for breach of contract. The contract between Peerless and Environmental Systems contained the following clause:

“8.9 LIQUIDATED DAMAGES AND/OR CONSEQUENTIAL LOSS
As a matter of policy, Environmental Systems does not accept liquidated damages or consequential loss…”

In order to assess Peerless’ claim for damages the judge had to consider the meaning of “consequential loss” and therefore which losses were excluded by the contract.

Traditional meaning of consequential loss - the Court of first instance

The judge followed precedents in Australia and applied the test established in the English case of Hadley v Baxendale2. This test identifies the following two types of losses for which contractual damages are (subject to the contract terms) recoverable:

  • losses which flow naturally from the breach, and
  • losses which are, at the time of entering into the contract, contemplated by the parties as being a probable result of a breach of the contract.

The first limb of the test is often referred to as describing “general losses” and the second limb as describing “special” or “consequential” losses.

The judge held that consequential loss is limited to losses recoverable under the second limb. The decision on this point was appealed by both parties and was unanimously overturned by the Court of Appeal.

Read the full judgment here (particularly paragraphs 85 to 94).

Read Hadley v Baxendale here.

Footnotes

1. Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd, unreported judgment in Victoria handed down 26 February 2008
2.
(1854) 9 Ex 341 at 354-355