A contract is simply a way for parties to record how they agree to assign risk in a commercial transaction. Commercial contracts often contain clauses where a party (usually the supplier) seeks to:
- limit its liability to compensate another party for losses up to a specified amount; and/or
- exclude any requirement for a party to compensate another party for a certain losses.
For example, in an IT contract the supplier will often state that it excludes or limits its liability for consequential loss, otherwise known as indirect loss.
Scope of consequential loss uncertain in Australia
While there is a lot of UK case law providing guidance on the interpretation of the terms consequential loss and indirect loss, the meaning of these terms is currently unsettled in Australian law. Courts in Australian states have recently adopted differing interpretations of the terms consequential loss and indirect loss. It has not helped that the highest court in Australia, the High Court in Canberra, has not yet ruled definitively on the issue.
That’s all very well, but as Steve Jobs would say to his lawyers: “Awesome information guys, but why does it matter to me?”
Why consequential loss is important
The upshot for entities entering into a contract governed by Australian law is that if the standard ‘catch-all’ consequential loss clause “Party X excludes liability for any consequential loss arising from its breach of contract” is used, and the specific types of losses that are recoverable or excluded are not set out in the contract, the operation of the ‘catch-all’ phrase and the losses that it applies to will vary from state to state. This makes it particularly tricky for a party to determine its potential liability and exposure before it signs a contract as the losses a party intends to be limit or exclude may not actually be excluded in a future claim.
1. Foreseeability based approach: Hadley v Baxendale – England
Let me take you back 150 years. In 1854 a crank shaft in Mr Hadley’s mill in Gloucester, England broke down. He asked Mr Baxendale to transport it to Greenwich for repair by a certain date. Baxendale failed to deliver on time. Hadley lost business and brought a claim against Baxendale for lost profits. The subsequent decision has informed how lawyers in England and Australia construe different types of damages resulting from breach of contract. In the Hadley v Baxendale case the court found that Hadley could not recover his lost profits as they were not reasonably foreseeable as a result of Baxendale’s breach.
Generations of lawyers have read this case and understood it and subseqent English case law as meaning that consequential loss is those losses falling within the second limb of Hadley v Baxendale. That is, consequential loss is any loss which does not arise naturally as a result of the breach and may reasonably be supposed to have been in the contemplation of the parties at the time of formation of the contract as the probable result of the breach of it.
2. Damages based approach: Peerless case – Victoria, NSW and South Australia
In a series of Australian cases from 2008 onwards, judges are redefining the interpretation of consequential loss. In the Peerless case, direct loss was interpreted to mean ‘normal’ loss, that is loss that every claimant in a similar situation will suffer. This case held that consequential loss is therefore anything beyond the normal measure of damages.
If a court uses the Peerless test, the ‘catch-all’ term consequential loss will be construed in a broad manner and will include losses that fall under both the first and second limb of Hadley v Baxendale. Going back to Mr Jobs point, in simple language this means if a court adopts the Peerless test, and the contract states that the supplier excludes consequential loss, the supplier will not be not liable for the customer’s loss of profits and additional expenses incurred as a result of the supplier’s contractual breach.
3. Context based approach: Regional Power case – Western Australia
Another approach was adopted in Western Australia in 2013. Regional Power v Pacific Hydro takes Australian case law from the 1980s in respect of the interpretation of contractual drafting and applies it to exclusion clauses and consequential loss. In Regional Power the court rejected the previous tests in Hadley v Baxendale and Peerless as not appropriate and instead took a commercially focused approach.
The court held that no special meaning should be given to the words consequential loss and essentially there is no correct or standard measure of what will constitute consequential loss that applies to every situation. If a court follows the Regional Power test, a clause excluding consequential loss will be interpreted according to its natural and ordinary meaning, read in the context of the contract as a whole.
It should be noted that this decision is not binding on courts in other jurisdictions and, although the ruling is persuasive, the general feeling of Australian legal commentators is that until courts in other jurisdictions start adopting the Regional Power test, this decision may be an anomaly.
Consequential loss advice for EU entities contracting in Australia
If your contract will be subject to the laws of an Australian state, it is imperative that both the direct loss and consequential loss that the parties wish to exclude or limit are definitively and exhaustively specified in in the contract. You should avoid using short hand or ‘catch-all’ terminology in the contract and instead define the term consequential loss by reference the specific types of losses that are recoverable or excluded, for example, loss of profit, loss of revenue, loss of business opportunity and loss of savings. Even if you adopt this approach there is still the problem that terms such as loss of profit and loss of business opportunity are relatively broad in scope and the use of such high level terminology may only slightly clarify the types of loss that are covered.
Another potential approach, although not used in Australian contracts today, is to work with your lawyers to prepare a detailed list of losses that the parties intend to include or exclude in the event of a claim. This list should be drafted in the context of the proposed transaction, including with reference to the goods and services the supplier is providing and the relationship between the parties. Undoubtedly, it would be a time consuming exercise to construct bespoke contractual wording that suitably addresses both the types of losses in your list and the operation of the drafting in the event of a future claim. Nevertheless, I firmly believe that as long as we are on this uncertain road, this is the best way for EU companies to avoid being caught out by the subtle differences in the judicial interpretation of the terms consequential loss and indirect loss in Australia.
Selected further reading
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