Consequential Loss

A recent Victorian Court of Appeal decision and a New South Wales Supreme Court decision significantly expanded the scope of loss that is covered by a consequential loss clause in a contract.

Determining the extent of consequential damages.

The basic rule to determine the extent of consequential damages that can arise from a breach of contract was laid down in Hadley v Baxendale.

Damages for breach of contract that can be recovered under two limbs:

  1. those which flow directly and naturally from the breach; and
  2. all losses that the parties reasonably ought to have contemplated as a result of the breach.

In this case the plaintiff, Mr. Hadley, was a miller whose crankshaft was sent for repair to the defendant, Baxendale. Baxendale did not deliver the repaired crankshaft on the date specified in the contract and as a result Hadley lost business and profit. He then sued for the profits he lost due to Baxendale’s late delivery.

The main issue was whether a defendant in breach of a contract could be held liable for damages that he was not aware would be incurred from a breach of the contract.

It was determined that a party in breach of a contract can only be held liable for losses that were generally foreseeable, or if any exceptional circumstances were mentioned by the contracting parties in advance. Where there are special circumstances, the parties can voluntarily make provisions in the contract entered into to impose particular terms as to the damages for breach. It would be unjust to constrict freedom of contract and deprive contracting parties of such a right.

Baron Sir Edward Hall Alderson stated:
“Now we think the proper rule in such a case as the present is this: Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered either arising naturally, ie, according to the usual course of things, from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it.”

Foreseeability

A party in breach of a contract is liable for the foreseeable consequences of that breach. The test of foreseeability is determined by what is foreseeable to a ‘reasonable person’ and subject to the hypothetical person who is doing the foreseeing. Exactly what is forseeable to a reasonable person has been determined by a gradual process of judicial inclusion and exclusion of certain circumstances in different situations. This has resulted in a whole set of tests as to what is foreseeable.

The application of foreseeability depends on the degree of relevant knowledge the breaching party had at the time the contract was entered into. The courts therefore look to the knowledge the breaching party had at the time the contract was entered into in order to determine what damages were foreseeable by them.

The application of Hadley v Baxtable today

Contracting parties will try and limit their liability for losses that are too remote, or in the control of the other party by drafting an exclusion for liability for consequential loss clause in their contract.

In Environmental Systems v Peerless Holdings the Victorian Court of Appeal rejected the idea that consequential loss flowing from a breach of contract is confined to the second limb of Hadley v Baxendale. The Court held that consequential loss covers losses such as expenses and loss of profit. This Victorian Court of Appeal decision became binding in New South Wales with the NSW Supreme Court decision in Waterbrook v Yowie Bay Pty Limited v Allianz.

Waterbrook v Yowie Bay Pty Limited v Allianz

Under section 18B of the Home Building Act 1989 (NSW) every residential contract has implied into it certain statutory warranties, such as that work is to be performed in a proper and workmanlike manner, materials and work will be reasonably fit for their purpose and work will be done with due diligence. Under section 99(b), a contract insuring residential building work must insure against the risk of loss that may arise out of a breach of the statutory warranty.

In Waterbrook v Yowie Bay Pty Limited v Allianz one of the main issues was that Allianz’s insurance policy covering the building work done by Waterbrook was issued with a clause that stated it would not be liable for any loss or damage “for consequential loss arising directly or indirectly out of any event listed in the building owner’s indemnity…” In the Supreme Court, Justice McDougall stated that excluding liability for consequential loss in an insurance policy may exclude liability under the first limb of Hadley v Baxendale. However, in this particular case Allianz’s exclusion of consequential loss was held to be incompatible with the statutory entitlement Waterbrook had under the Home Building Act.  Nevertheless, this decision and Environmental Systems v Peerless Holdings has greatly extended the scope of consequential loss.

Consequential loss is not to be equated with the second limb of Hadley v Baxendale and has been expanded in recent years by the courts to encompass loss of profits and expenses incurred through a breach. Contracting parties need to be more specific about what they include and exclude from liability.‘Consequential loss’ needs to be clearly defined in a contract and specify each particular type of loss parties want to exclude.

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