The Financial Services Authority (the FSA) has recently warned that clauses in general insurance contracts that use the phrase “consequential loss” may fall foul of the Unfair Terms in Consumer Contracts Regulations 1999 (the Regulations). This warning has ramifications not only for the insurance industry, but also for any business that uses the expression “consequential loss” in its standard-form contracts with consumers.
Meaning of “consequential loss”
The term “consequential loss” has a well-recognised meaning in English law: it is one of the two types of loss that may be recovered following a breach of contract. The first type is direct loss, which arises naturally from the breach. Thus, for example, where a breach of contract results in a building catching fire, the costs of repairing the building will usually constitute direct loss.
Consequential (or indirect) loss is the second type of recoverable loss. It does not arise in the natural course of events, but is foreseeable by the parties to the contract when they enter into it. So, for example, if the parties know when they contract that the (soon-to-be-burned-out) building will be let to a tenant, any loss of rent following the fire will generally constitute consequential loss.
The expression “consequential loss” typically appears in exclusion clauses – contractual provisions that purport to limit one party’s liability to another (in this case, by restricting liability to direct losses). In insurance contracts, it is invariably the insurer that is attempting to limit its liability to the insured.
The FSA’s view of “consequential loss”
According to its recent statement, the FSA considers that the phrase “consequential loss” may offend the Regulations in two ways. First, it is not “plain, intelligible language” because it has a specific legal meaning. The average consumer would not therefore understand what types of loss are covered by a contract that excludes “consequential loss”. The Office of Fair Trading, which enforces the Regulations, has expressed similar concerns.
Second, the FSA considers that a contractual term that excludes “consequential loss” may be unfair under the Regulations, again because most consumers would not know what it means. According to the FSA, this uncertainty constitutes a “significant imbalance in the parties’ rights and obligations to the detriment of the consumer”.
As the FSA’s statement points out, there are significant risks to organisations that rely on standard-form contracts that do not comply with the Regulations. In particular, were a court to agree with the FSA and conclude that a “consequential loss” provision is not written in plain and intelligible language, it could construe the clause in favour of the consumer. If the court deemed the provision unfair, the clause would not bind the consumer. In either event, the organisation could find itself making payments to the consumer for the very losses that it sought to exclude.
The FSA’s statement is explicitly concerned with general insurance contracts, but its observations plainly have a wider resonance. Indeed, any organisation that relies on standard-form terms and conditions when it contracts with consumers would do well to review its “consequential loss” provisions.
The object of such a review should be to ensure that every exclusion clause makes the position clear to the consumer. In this regard, the courts have recently held that the Regulations require not only that the wording of individual clauses is comprehensible to consumers, but that the typical consumer can understand how the term affects the parties’ rights and obligations under the contract.
The FSA’s statement sets out a number of (insurancerelated) illustrations of wording that excludes consequential loss without using the offending terminology. These illustrations include the following:
- “We will not pay for any indirect losses that result from the incident that caused you to claim. For example, …”
- “We will not pay for any losses that are not directly associated with the incident that caused you to claim. For example, …”
It is far from clear that the average consumer will understand this wording, with its references to “direct” and “indirect” losses, more readily than clauses that refer to “consequential loss”. Nevertheless, these examples have the FSA’s blessing.
An alternative approach, which the FSA approved in the case of UK Insurance Limited, is to replace the expression “consequential loss” with a list of the types of loss that are excluded. There are obvious dangers in taking this route, however, one of which is that a reasonably comprehensive clause is likely to be quite lengthy and may offend the Regulations for that reason.
One thing, at least, is clear, however: the days of the “consequential loss” clause are numbered.