A recent decision of the NSW Court of Appeal has applied the 2008 decision of the Victorian Court of Appeal in Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd1 which effectively created a new definition of “consequential loss”.

Background

In the Peerless decision, the Victorian Court of Appeal held that exclusions of "consequential loss" in contracts may also exclude losses falling within the first limb of the English case Hadley v Baxendale2, being those losses which flow naturally from the breach. This was a departure from well-established case law, under which "consequential losses" were understood to be losses falling under the second limb of the test in Hadley and Baxendale, being those which the parties actually contemplated at the time of entering into the contract, and not losses flowing naturally from the breach. In other words, following Peerless, an exclusion for consequential losses is, in the State of Victoria at least, likely to be broader than was previously the case. However, it was not clear if the Courts of other States would adopt the Peerless definition of “consequential loss” when the question came before them.

The position on consequential loss pre-Peerless

The few Australian decisions which considered the meaning of "consequential loss" in exclusion clauses followed English authorities, under which "consequential loss" was equated with losses which could reasonably be supposed to have been in the contemplation of both parties at the time they contracted as being the probable result of a breach. The Australian decisions held that if a clause was only stated to exclude "consequential loss", this would not exclude loss of profits which flowed directly from the breach, as these losses fell within the first limb of Hadley v Baxendale.

The Peerless decision

In the Peerless decision, the Court held that the concept of consequential loss should be restored to "the natural meaning of which commercial and legal usage in exclusion clauses has long since robbed it". It concluded that rather than distinguishing between the two types of loss in the first and second limb of Hadley v Baxendale, the true distinction was between on the one hand, "normal loss", being loss that every plaintiff in an identical situation would suffer, and on the other hand, "consequential loss" being "anything beyond the normal measure, such as profits lost and expenses incurred though breach". Therefore the meaning of “consequential loss” was expanded significantly by this decision.

Allianz v Waterbrook

In the decision of Allianz v Waterbrook3, the NSW Court of Appeal granted leave to Allianz to appeal the NSW Supreme Court decision of Waterbrook at Yowie Bay Pty Ltd v Allianz4, and in granting such leave to appeal, the Court accepted the Peerless definition of “consequential loss”.

The plaintiff in the initial case was Waterbrook at Yowie Bay Pty Ltd (Waterbrook), the owner of a retirement village south of Sydney. This development had been constructed by a builder under a contract with the developer, Yowie Pty Ltd, from which Waterbrook went on to acquire the development. The builder of the properties was in liquidation. After Waterbrook acquired the retirement village, certain building defects which had not been rectified were identified. Waterbrook made a claim under a builders home warranty policy issued to the builder (the Allianz Policy) for the cost of rectifying the defects. When Allianz refused to accept liability, Waterbrook issued proceedings against Allianz, claiming an entitlement to indemnity under the Allianz Policy in relation to its claim for the cost of rectifying the defects.

As the retirement village was residential building work, NSW legislation5 implied into the Allianz Policy certain warranties, which had to be supported by insurance granting certain indemnities. The benefits of warranties and insurance also applied to successors in title to the person who had been in contract with the builder, which in this case was Waterbrook. The relevant primary legislation provides that these statutory warranties and statutory insurance rights (the Relevant Rights) cannot be excluded or restricted.

However, the Allianz Policy included a clause that provided that the insurer would not be liable for any loss or damage arising from consequential loss. It also included an indemnity clause which stated that Allianz would not be liable for “...any defects in the work which would have been reasonably visible at the time any successor in title acquired the dwelling”. One of the questions for the Court to consider was whether the relevant clauses in the Allianz Policy were void on the basis that they sought to exclude or restrict the Relevant Rights, and this was answered in the affirmative.

The Court further held that the relevant measure of damages reflected the first limb of Hadley v Baxendale (losses which flow naturally from the breach), and that, under Peerless, those damages may include consequential loss. Therefore the limitation in the Allianz Policy which purported to exclude all consequential loss was inconsistent with the full statutory entitlement to indemnity.

Implications

The key effect of the Peerless and Allianz decisions is that excluding liability for consequential loss will now be likely to exclude liability for all “loss of profits” and “expenses incurred through breach” even if they are not specifically mentioned in the exclusion clause, or if they fall within the first limb of Hadley v Baxendale. Therefore any customer in an IT contract agreeing to such an exclusion will, until such time as the High Court decides otherwise, be signing away the right to recover a far broader category of damages than it may have thought. From both sides’ point of view, best practice remains to set out clearly in the relevant clause each type of loss for which one or both parties will not be liable.