Consequential loss - a state of confusion

Posted by Paul Jeffreys and Paul Kallenbach

Contracts are used to allocate risk between the contracting parties.  One mechanism for doing so in a contract is by using limitation and exclusion of liability clauses.  These clauses have the effect of:

• in the case of a limitation of liability provision - limiting the requirement for one party to compensate another party to losses up to a specified amount; and
• in the case of an exclusion of liability provision - completely excluding the requirement for one party to compensate another party for particular types of loss.

A common type of loss that is often completely excluded in technology contracts is 'consequential' loss (sometimes also referred to as 'indirect' loss).  Until recently, a rather ancient line of English cases had been followed by Australian courts in interpreting the meaning of 'consequential loss'.   Unfortunately, more recent Australian authority has lent varying interpretations to this phrase, giving rise to uncertainty in the interpretation of exclusion clauses in commercial contracts.

The purpose of this blog post is to briefly summarise the varying interpretations of 'consequential loss' in those Australian jurisdictions that have considered the issue.

The traditional English (and, until recently, Australian) approach

Under English law (which Australian courts have followed until recently), 'consequential loss' has been interpreted as losses that satisfy the following two elements:^[1]

• the loss does not arise naturally as a result of a breach; and
• the loss was in the contemplation of the parties at the time of the contract and results as a probable result of a breach.

One difficulty with this approach is that, if the parties dispute whether a particular loss happens to be a 'consequential loss', the party seeking damages will have to prove that the particular loss was in the contemplation of the parties at the time of entering into the contract. 

Victoria, New South Wales and South Australia

The Australian re-interpretation of 'consequential loss' began with the 2008 decision of the Victorian Court of Appeal in Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd ^[2] (Peerless). The approach in this decision was subsequently approved by the New South Wales Court of Appeal ^[3] and the South Australian Supreme Court.^[4]

The Court in Peerless created a distinction between:^[5]

• normal losses - being a 'loss that every plaintiff in a like situation will suffer'; and
• consequential losses - being 'anything beyond the normal measure … incurred through breach'.

Consequential losses were deemed by the Court to include loss of profits or additional expenses incurred as a result of the breach.

 

Unfortunately, the precise scope of what constitutes a 'normal loss' remains open.   Minter Ellison Partner Cameron Ross, in considering Peerless, has observed:^[6]

While it is clear that "normal loss" is different from "natural loss" [a key concept under the English interpretation] ... the judgment in Peerless does not provide guidance on what constitutes this measure of damages and when a party is in a similar situation.  The question whether a loss is categorised as a "normal loss" ... will inevitably be determined by the context and nature of the contract and the breach.

Despite these ambiguities, it can probably be said that the interpretation of 'consequential loss' in Victoria, New South Wales and South Australia is now somewhat broader than the original English position.  As a consequence, where a contract excludes liability for 'consequential loss, losses that may previously have been considered 'open game' may now be covered by the exclusion clause, and accordingly no longer be recoverable from the party in breach.^[7]

Western Australia

The Western Australian Supreme Court has recently rejected both the English and Peerless approach, instead adopting yet another method of interpreting 'consequential loss'.^[8]

In Regional Power Corporation v Pacific Hydro Group Two Pty Ltd [No 2]^[9] (Regional Power), Justice Kenneth Martin expressed his approval for the opinion of Professor J W Carter that both the English and Peerless approaches were 'artificial' and that they approached 'the expression 'consequential loss' from particular legal perspectives rather than a commercial perspective which will vary from case to case'.^[10]

The Court instead preferred an approach based on principles set out by the High Court in Darlington Futures v Delco Australia Pty Ltd^[11] (Delco), in particular, the principle that the meaning of an exclusion or limitation clause must be 'determined by construing the clause according to its natural and ordinary meaning, read in light of the contract as a whole'.^[12]

This principle does not, by itself, provide much guidance as to the meaning of 'consequential loss' in any particular circumstance  However, the factors considered on the facts of Regional Power may provide some guidance as to the practical application of this approach.  More specifically, in deciding whether the loss in Regional Power was a 'consequential loss', the Court considered the following factors:

• the wording of the exclusion clause;
• other clauses in the contract that deal with, or contemplate, the breach event;
• any references in the contract to the maintenance and operation of the relationship between the parties; and
• the character and responsibilities of the parties (in Regional Power, one of the parties was the State Energy Commission of Western Australia), including the commercial sophistication of the parties.

Queensland, Tasmania, the Australian Capital Territory and the Northern Territory

 

No courts in the remaining Australian states and territories have had an opportunity since Peerless to consider their jurisdiction's preferred approach to interpreting 'consequential loss', with one minor exception.

 

In Queensland, Justice Douglas distinguished the Peerless interpretation of 'consequential loss' in MGC Properties Pty Ltd v Tang^[13] (Tang).  His Honour did so because the relevant clause in Tang was an indemnification clause in a guarantee and indemnity deed, rather than a contractual exemption clause.  In the context of the indemnity, 'consequential loss' meant losses flowing from a default by the indemnifier.^[14]  The judgment shows that '[t]he natural meaning of "consequential loss" may alter depending on the context and the nature of the document'.^[15] However, as the context in Tang is distinguishable from the usual contractual exclusion clause, there remains uncertainty in Queensland as to what approach a first instance court might take.

 

We would assume that trial judges in Queensland, Tasmania, the Australian Capital Territory and the Northern Territory will, in accordance with the High Court's position on judicial precedent, follow the decisions of the intermediate appellate courts in Victoria and New South Wales, unless the trial judge is 'convinced that the interpretation is plainly wrong'.^[16]  Having said that, it didn't take much for Justice Kenneth Martin to divert from the Peerless approach in Regional Power.

 

Application in practice

 

Until the High Court renders a decision on the meaning of 'consequential loss', the issue will remain unsettled in Australian law.  It therefore remains prudent for parties in their contracts to expressly set out the types of loss that they wish to exclude (for example, loss of profits, loss of revenue, loss of goodwill or loss of business opportunity), as well as those losses that the parties agree should be recoverable from each other. 

The rather unsavoury alternative is for the parties to leave it to the courts to divine the meaning of this term - and therefore the contractual allocation of risk between them - from the contradictory patchwork of Australian jurisprudence in this area.

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[1] Hadley v Baxendale (1854) 9 Ex 341; 156 ER 145. Also see Croudace Construction Limited v Cawoods Concrete Products Limited [1978] 2 Lloyd's Rep 55. ↩
[2] (2008) 19 VR 358 (Peerless). The Peerless decision has been applied subsequently in Victoria in Papadopoulos v MC Labour Hire Services Pty Ltd (No 4) (2009) 24 VR 665 and Rod Investments (Vic) Pty Ltd v Abeyratne (No 2) [2009] VSC 278. ↩
[3] Allianz v Waterbrook [2009] NSWCA 224. ↩
[4] Alstom Ltd v Yokogawa Australia Pty Ltd (No 7) [2012] SASC 49 at [286]-[289] per Bleby J. ↩
[5] Peerless at 386-387 [87] per Nettle JA (Ashley and Dodds-Streeton JJA concurring). ↩
[6] Cameron Ross, 'A loss of no consequence' (2010) 84(4) Law Institute Journal 27 (Ross), 28. ↩
[7] Ross, 27. ↩
[8] The most notable decision is Regional Power Corporation v Pacific Hydro Group Two Pty Ltd [No 2] [2013] WASC 356 (Regional Power), as discussed in the body of this article. However, Peerless was doubted in an earlier Western Australian decision: Valentine Falls Estate Pty Ltd v Smec Australia Pty Ltd [2010] WASC 319 at [6] per Sanderson M. ↩
[9] [2013] WASC 356. ↩
[10] Regional Power at [94] per Kenneth Martin J quoting Carter J W, 'Exclusion of Liability for Consequential Loss' (2009) 25 Journal of Contract Law 118, 133. ↩
[11] (1986) 161 CLR 500 (Delco). ↩
[12] Delco at 510 per Mason, Wilson, Brennan, Deane and Dawson JJ. ↩
[13][2009] QSC 322 (Tang). ↩
[14] Tang at [21]-[25] per Douglas J. ↩
[15] Ross, 29. ↩
[16] Farah Constructions v Say Dee Pty Ltd (2007) 230 CLR 89 at 151-152 [135] per Gleeson CJ, Gummow, Callinan, Heydon and Crennan JJ. ↩