The meaning of the expression "consequential loss" – the ongoing debate

What you need to know

• Where parties seek to exclude or deal with consequential loss in a contract, it is important to define, so far as possible, precisely what types of flow on losses are intended, or conversely not intended, to be covered by the term "consequential loss".

Historical context

Historically, both English and Australian authorities characterised "direct loss" as any loss falling within the first limb of the rule in Hadley v Baxendale², that is, loss "arising naturally" or "in the usual course of things" flowing from the breach of contract itself.

On the other hand, "consequential loss" was characterised as those types of losses as may reasonably be supposed to have been in the contemplation of both parties, at the time of entering into the contract, as the probable result of the breach of it (this was the second limb of the rule in Hadley v Baxendale³).

Accordingly, in a construction contract, loss of profit, loss of revenue or loss of opportunity may, depending on the circumstances, constitute direct rather than consequential loss.

The Peerless decision

Recent Australian decisions in relation to the interpretation of "consequential loss" have moved away from the UK position. In Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd⁴ the Victorian Court of Appeal held that the expression "consequential loss" should not be equated to the second limb of Hadley v Baxendale. Instead, the Court focused on the distinction between "normal loss", being loss that every plaintiff in a like situation will suffer, and "consequential loss". Nettle JA noted that:

In my view, ordinary reasonable business persons would naturally conceive of “consequential loss” in contract as everything beyond the normal measure of damages, such as profits lost or expenses incurred through breach.⁵

The Peerless decision was followed by the Supreme Court of South Australia in Alstom Ltd v Yokogawa Australia Pty Ltd (No 7)⁶.

The Pacific Hydro decision

The ongoing controversy as to the legal meaning of "consequential loss" was considered by the Supreme Court of Western Australia in Regional Power Corporation v Pacific Hydro Group Two Pty Ltd (No 2)⁷. In Pacific Hydro Martin J did not follow Hadley v Baxendale or Peerless, instead preferring the approach taken by the High Court in Darlington Futures⁸ which is to construe the exclusion clause according to its "natural and ordinary meaning", read in its place within the context of the contract as a whole⁹. Further, his Honour noted that the meaning of "consequential loss" in a contract needs to be evaluated by reference to its own unique presenting circumstances.

The Macmahon decisions

Entry into a design and construct contract

In October 2011 Macmahon Mining Services entered into a design and construct contract for the development of Cobar Management's copper mine in New South Wales. In June 2013, Cobar gave written notice to Macmahon terminating the contract. Cobar sought to rely on a contractual provision entitling Cobar to terminate the contract for breach if, in Cobar's opinion, the breach was material and incapable of remedy. Macmahon claimed that the termination was invalid, and that the letter of termination constituted repudiation of the contract. Two weeks later Macmahon notified Cobar that it accepted the repudiation as discharging the contract.

Macmahon sued for damages in excess of $67 million on the basis of a "loss of opportunity to earn profit" had the contract continued to completion. Cobar cross claimed for damages flowing from various alleged breaches of the contract by Macmahon.

Reliance on the exclusion clause by Cobar (the first decision)

In the first application¹⁰, Cobar moved for summary dismissal of Macmahon's claim for "loss of opportunity to earn profit" on the basis that clause 18.5 of the contract excluded liability for Consequential Loss. Clause 18.5 provided that "despite anything else in this contract, neither party will be liable to the other for any Consequential Loss".

Consequential Loss was defined to include "any loss or [sic] profits, loss or [sic] production, loss or [sic] revenue, loss of use, loss of contract, loss of goodwill, loss of opportunity or wasted overheads, whatsoever, whether direct or indirect".

Counsel for Cobar submitted that clause 18.5 was clear and all-embracing, and something that the parties had agreed (i.e. that neither would be liable for Consequential Loss as defined). On the other hand, Counsel for Macmahon submitted that if Cobar's construction was correct this would have the effect of defeating the main object of the contract – that Cobar receive the benefit of the works and Macmahon receive the benefit of payment – and further, would entitle Cobar to be able to terminate the contract, relying on an asserted but non-existent breach, without exposing itself to liability for compensation (as it would if it terminated the contract in accordance with the termination for convenience provisions). Counsel for Macmahon submitted that this construction led to an absurd result.

The decision by McDougall J to dismiss Macmahon's claim came down to a question of interpretation regarding the definition of Consequential Loss and the words of clause 18.5.

His Honour was of the view that the definition of Consequential Loss made it clear that any form of loss, whether direct or indirect, of the various categories specified, fell within the defined term. Turning to Macmahon's claim for "loss of opportunity to earn profit", his Honour noted that one of the categories captured by the definition of Consequential Loss – "loss of contract" – which his Honour construed as meaning "loss of [the benefit of a] contract" was intended to catch loss of benefit both of the particular contract in which the words appear (being the contract between Macmahon and Cobar) as well as other third party contracts.

In relation to the interpretation of clause 18.5, his Honour accepted that the correct approach to the interpretation of clauses excluding or limiting liability was laid down by the High Court in Darlington Futures Ltd v Delco Australia Pty Ltd¹¹, which provided that:

the interpretation of an exclusion clause is to be determined by construing the clause according to its natural and ordinary meaning, read in the light of the contract as a whole, thereby giving due weight to the context in which the clause appears including the nature and object of the contract, and, where appropriate, construing the clause contra proferentem in case of ambiguity.¹²

Therefore, as loss of the benefit of a contract would ordinarily be the consequence of accepted repudiation, his Honour held that the clear words of clause 18.5 did not need to be read down as they represented a carefully constructed bargain, and consequently extended to exempt Cobar from repudiation of contract damages – as such damages were excluded by virtue of the exclusion clause – although accrued rights and liabilities would remain unaffected.

Reliance on the exclusion clause by Macmahon (the second decision)

In the second application¹³, Macmahon moved for summary dismissal of Cobar's claim for damages flowing from various alleged breaches of the contract by Macmahon. Cobar alleged that Macmahon failed to employ "Good Industry Practice", and delayed progress of the work, which caused a greater cost of labour, equipment and materials to be incurred.

McDougall J once again considered the definition of Consequential Loss and the terms of clause 18.5.

Turning to the definition of Consequential Loss, his Honour noted that the definition excluded two types of loss – it excluded the specified heads of loss referred to above plus "any special or indirect loss or damage". His Honour considered the additional limb of the definition to be a "catch-all" mechanism.

In considering the proper construction of the phrase "indirect loss or damage", his Honour favoured the observation of Atkinson J in Saint Line Ltd v Richardsons, Westgarth & Co Ltd¹⁴ that direct damage is that which flows naturally from the breach without other intervening cause – with consideration being given to the causal relationship between the breach and the damage (not, as the rule in Hadley in Baxendale tends to do, to questions of remoteness). In applying the words of Atkinson J to the present case his Honour went on to say:

indirect loss or damage is simply loss or damage which flows other than naturally from the breach, or which is related to the breach only because of some intervening cause or special circumstance.¹⁵

Further, his Honour noted that the question of what is direct or indirect requires consideration of the proper construction of the contract between Macmahon and Cobar in the context of facts that are proven and found.

As the arguments in this application were based on assertions made in pleading, without any investigation of the facts, his Honour concluded that the damage claimed by Cobar could not be said, with the necessary degree of confidence, to be so plainly within the definition of Consequential Loss that it must be defeated by clause 18.5.

Summary

The two Macmahon decisions highlight the importance of defining, so far as possible, precisely what types of flow on losses are intended, or conversely not intended, to be covered by the term "consequential loss". This will limit the likelihood of a court interpreting the commercial intention of the parties in a way which is inconsistent with their intended bargain, or in a way which leads to unintended consequences for one or both parties.