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Focus: Construction – March 2008

Exclusion clauses: court considers the meaning of consequential loss

In brief: The recent Victorian Court of Appeal decision in Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd examined the distinction between 'normal' and 'consequential' loss for a breach of contract and held that lost profit was a consequential loss. Partner Nick Rudge (view CV) and Articled Clerk John-Paul Santamaria report.

How does it affect you?

  • In interpreting exclusion clauses, consequential loss means all loss beyond the normal measure of damage, and the 'normal' measure of damages is the loss that every plaintiff in a like situation will suffer.
  • Consequential loss will include losses such as lost profit and expenses incurred as a result of the breach of contract, and does not exclusively equate to the second limb of the test in Hadley v Baxendale for the recoverability of losses.
  • Parties wanting certainty as to whether certain types of losses are excluded should specifically identify those losses in their exclusion clauses.
  • As the law is not settled, considerable care should be taken when negotiating and drafting clauses that exclude or limit liability for consequential loss.

The facts

In 1997, Environmental Systems Pty Ltd entered into a contract with Peerless Holdings Pty Ltd to provide Peerless with a Regenerative Thermal Oxidiser (RTO). The RTO did not perform as specified under the agreement and, as a result, Peerless had to acquire a replacement. Peerless then brought proceedings against Environmental Systems for breach of contract and for breach of the Trade Practices Act 1974 (Cth) and the Fair Trading Act 1985 (Vic).

Relevantly, the contract between the parties contained an exclusion clause relating to 'liquidated damages' and 'consequential loss'. The clause stated:

As a matter of policy, Environmental Systems does not accept liquidated damages or consequential loss.

  

Among other claims, Peerless claimed for damages relating to the cost of labour incurred attempting to fix the oxidiser and the extra gas costs required for the replacement oxidiser.

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At trial

The trial judge followed a series of English cases in holding that 'consequential loss' exclusively equated with the second limb of the test for recoverability of losses in Hadley v Baxendale1. That test states that losses can be recovered under two limbs:

  1. the losses that arise naturally, according to the usual course of things, as the result of the breach (first limb); or
  2. the losses contemplated by the parties, at the time that the parties made the contract, as being the probable result of the breach (second limb).

The trial judge held that the losses arose 'naturally and directly from the failure of the plaintiff to provide an RTO that could perform as intended under the terms of contract'.2 As a result, they fell under the first limb of the test in Hadley and thus were not 'consequential loss'. As such, the clause excluding liability for consequential loss did not apply to those claims. The trial judge awarded damages to Peerless for the labour costs incurred and the extra gas cost.

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Court of Appeal decision

On appeal3, this issue was unanimously overturned. Justice Nettle, with whom Justices Ashley and Dodds-Streeton agreed, held that the phrase 'consequential loss' should be given its 'ordinary and natural meaning'.

Justice Nettle held that 'normal' loss is the loss that every plaintiff in a like situation will suffer and that in the case of a contract for the sale of goods, the prima facie measure of damage is the difference between the contract price for the goods or services and their market value.

In relation to consequential loss, the court held that ordinary business people would naturally conceive of consequential loss in a contract as everything outside normal loss that is recoverable and not too remote, such as lost profits or expenses incurred as a result of breach.

As a result, the court held that because the labour costs and additional gas costs were beyond those considered normal losses, but did flow as a result of the breach, they were 'consequential losses'. As such, they fell within the ambit of the exclusion clause in the contract. The court overturned the award of damages on these claims.

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Practical considerations

The Court of Appeal's decision has highlighted that care needs to be taken in drafting exclusion clauses.

Although the court's decision was to give the term 'consequential loss' its ordinary and natural meaning, parties wanting certainty as to whether liability for certain types of loss are excluded should specifically identify those losses in their exclusion clauses.

This consideration particularly applies to loss of profit, as although the Court of Appeal held loss of profit claims would be a consequential loss the law in this area does not appear settled.

Footnotes

  1. (1854) 9 Ex 341.
  2. Peerless Holdings Pty Ltd v Environmental Solutions Pty Ltd [2006] VSC 194 [896].
  3. Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd [2008] VSCA 26.

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