Most Australian lawyers involved in drafting and negotiating commercial contracts are familiar with the Peerless decision.  However a recent unreported judgement of the South Australian Supreme Court takes the concepts one step further, potentially narrowing even further the types of damages recoverable under contracts that exclude liability for “consequential loss”.

The Peerless decision – a quick recap

Before the decision by the Victorian Court of Appeal in Peerless1, it was widely held that an exclusion of indirect or consequential loss was a reference to the second limb of Hadley v Baxendale2.   The seminal case of Hadley v Baxendale established that “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:

  1. such as may fairly and reasonably be considered either arising naturally, i.e., according to the usual course of things, from such breach of contract itself, or 
  2. 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”

(paragraphing added).  In other words, an exclusion of indirect and consequential loss prevented the recovery of losses that were specific to the circumstances of the plaintiff, but not those arising naturally.

In Peerless, the Court stated that the English authorities were flawed, and that the true distinction was “between ‘normal loss’, which is loss that every plaintiff in a like situation will suffer, and ‘consequential losses’, which are anything beyond the normal measure.”  This narrowed the types of damages recoverable under a contract that excluded liability for consequential loss, to only those damages that every plaintiff would suffer in that situation.

The decision in Alstom concerned the interpretation of a subcontract to refurbish a coal fired power station at Port Augusta.  The judgement is extremely lengthy, but is an interesting read that touches on many issues that lawyers drafting commercial contracts ought to be familiar with.

Relevantly, the subcontract provided for the recovery of liquidated damages for a failure to meet certain milestones.  The subcontract also contained an exclusion of liability by the subcontractor “for any indirect, economic or consequential loss whatsoever”.

Alstom (the plaintiff) argued that it ought to be allowed to recover the full amount of its losses where they exceeded the specified liquidated damages.  In considering whether the exclusion of consequential loss defeated such a claim, the Court found that the words “consequential loss” would, unless qualified by their context, extend to all damages suffered as a consequence of a breach of contract.  The Court found that such an exclusion was sufficient to exclude the subcontractor’s liability for “any loss consequential or following, immediate or eventual, flowing from a breach of contract” was excluded from recovery, including loss in excess of the specified liquidated damages.

What does this mean?

Click here to view diagram.

The Peerless decision has always sat rather uncomfortably.  Indeed, as a result of the decision it has become extremely common practice to include a clause clarifying that the parties intend an exclusion of indirect and consequential losses to only exclude second limb Hadley v Baxendale losses i.e. those particular to the circumstances of the plaintiff.

While we appreciate that the courts are trying to give effect to the ordinary meaning of the term, this is almost always at the expense of the true intention of the parties.  An exclusion of indirect and consequential losses, particularly in relation to technology contracts, is a practice that has largely been imported from the United States.  However under United States law, such a reference often imports the meaning given to consequential damages in the Uniform Commercial Code, being “any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know”.3 As you would observe, this is analogous to the second limb of Hadley v Baxendale.

The often-cited rationale of excluding indirect and consequential loss, is that the service provider is not in the business of insuring risks that are particular to the business of the customer.  To expand an exclusion of consequential loss beyond the constraints of Peerless to any loss consequential upon a breach is a large step indeed.  Obviously, Alstom needs to be read in context – the Court was only considering whether losses in addition to the specified liquidated damages were excluded.  However the language of the judgement is stronger than that in Peerless, and ought to give customers strong cause for concern.

In short, the inclusion of a Peerless clause in commercial contracts has become much more critical.  It is important that the parties consider, and make clear, the intended effect that an exclusion of indirect and consequential losses should have.