The law surrounding consequential loss remains complex and unclear following a recent decision in the Western Australian Supreme Court which emphasises the need for fulsome, clear drafting of consequential loss exclusion clauses.

In Regional Power Corporation v Pacific Hydro Group Two Pty Ltd [No 2] [2013] WASC 356, Justice Martin rejected both the English approach to the construction of the term “consequential loss” as falling under the second limb of Hadley v Baxendale1 and the view adopted by the Victorian Court of Appeal in Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd2.
 
Background
 
In 1994 Pacific Hydro entered into Power Purchase Agreement (“PPA”) with the Regional Power Corporation (“Corporation”) for the construction of, and then the supply of electricity from, the Ord Hydro Power Station to the Corporation.
The Power Station was constructed and operated by Pacific Hydro, and under the PPA, Pacific Hydro was to sell electricity generated by the Power Station to the Corporation and other customers, including Argyle Diamond Mines.
 
On 27 August 2006 the Power Station suffered an outage resulting in flooding which consequently led to the Power Station becoming inoperative for a two month period. As a result, the Corporation claimed $4,020,681 in damages for breach of the PPA. These damages were made up of the following:
  • the cost of delivering, commissioning, and hiring of diesel generators to generate the replacement electricity at the nearby Kununurra Power Station;
  • the cost of the travel, airfares and wages of the operators and employees required for the establishment of the Kununurra Power Station;
  • the cost of the accommodation and meals of the employees who Horizon Power was required to fly to the Kununurra Power Station;
  • the cost of hiring cranes to mobilise and demobilise the Kununurra Power Station; and
  • the cost of the diesel fuel to run the extra generators required to produce the requisite electricity from the Kununurra Power Station for the relevant period.

Pacific Hydro argued that the damages claimed by the Corporation were indirect or consequential losses and accordingly were excluded from recovery by clause 26.1 of the PPA.

Clause 26.1 of the PPA provided:

“Neither the Project Entity nor SECWA shall be liable to the other party in contract, tort, warranty, strict liability, or any other legal theory for any indirect, consequential, incidental, punitive or exemplary damages or loss of profits.”

The Corporation commenced proceedings in the Supreme Court of Western Australia to recover the claimed damages.

Consequential Loss prior to Regional Power Corporation

The recognised approach to recovery of damages for breach of Contract is found in the English case of Hadley v Baxendale (1854) 9 Exch 341 which provides that damages that are recoverable are:

  • those which may fairly and reasonably be considered either arising naturally, that is, according to the usual course of things, from the breach of contract itself (“the first limb”); or
  • those which 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 (“the second limb”).

The losses contemplated in the first limb of the test are commonly referred to as ‘direct losses’, while the losses contemplated by the second limb of the test are commonly referred to as ‘indirect’ or ‘consequential’ losses.

In Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd [2008] VSCA 26, the Victorian Court of Appeal moved away from the “second limb test” and decided that the term ‘consequential loss’ should be given its ordinary and natural meaning. The court identified the distinction between non-consequential loss and consequential loss as:

  • normal loss – loss that every plaintiff in a like situation will suffer; and
  • consequential loss – anything beyond the ‘normal measure’.

The test for determining whether a loss is a ‘consequential loss’ is objective; what losses are objectively beyond the normal measure? This is not an entirely clear test. However, it is apparent that this interpretation of consequential loss may include a broad degree of losses such as “profits lost or expenses incurred through breach”.3

The Court's decision

Justice Martin stated that the proper approach to construction is set out in the High Court decision in Darlington Futures Ltd v Delco Australia Pty Ltd. He noted that the approach required by Darlington v Delco required that the natural and ordinary meaning of clause 26.1 be determined, beginning with the words themselves, assessed in their place within the context of the PPA as a whole.

Martin J noted that the approach used in Hadley v Baxendale was entirely ‘unhelpful’. His Honour noted that beginning the assessment “encumbered by some fettering predisposition towards reading words of its text…as only embracing a head of loss which falls under the second limb of the rule in Hadley v Baxendale” was conceptually inconsistent with the approach which commences with the interpretation of the words of the clause itself, understood in the context of the contract construed against the provisions within that contract. Martin J also rejected the approach taken by the Victorian courts in Peerless stating that it was inappropriate to interpret consequential loss in reference to the ‘normal measure of damages’.

However, Justice Martin did approve of Professor Carter’s view that the approaches taken in both Hadley v Baxendale (in reference to the second limb) and Peerless (determining consequential loss in relation to the ‘normal measure of damages’) were artificial. Justice Martin also approved of Professor Carter’s observation that these decisions approached the interpretation of ‘consequential loss’ from a legal perspectives rather than a commercial perspective which will vary from case to case.

Following on from his rejection of approaches in both Hadley v Baxendale and Peerless, Justice Martin determined that at [115]:

“Construing clause 26.1 within the PPA as a whole, the court should not be artificially fettered towards assessing the character of an economic loss by rather vague criteria of whether or not the loss arose ‘in the ordinary course of things’. Nor should the court be oriented from the start towards trying to determine if a claimed loss falls under the equally porous concept of a ‘normal measure of damage’.”

Martin J held that the losses claimed by the Corporation as a result of the Flooding Incident were not excluded by clause 26.1 of the PPA. This decision was based on the following factors:

  • the PPA provisions generally noted the Corporation’s statutory responsibilities as a public supplier of electricity (not merely to make profit);
  • Clause 16 was founded on the reliable operation of the Power Station through a take and pay electricity regime;
  • clause 16.3 noted that the Corporation may need to generate its own electricity to make up any shortfall or obtain that electricity from another source; and
  • clause 16.4 noted that the electricity under the PPA was being provided under circumstances where the Corporation may have to maintain a “reliable supply of electricity to its customers during the period that Reliable Operation is lost’.
Implications

This decision has done little to clarify the position regarding the interpretation of the term “consequential loss”. It is a quite a bold step for a single judge to depart from the position of the court of appeal of another state which, though not strictly binding, would be highly persuasive. Instead of a focus on the legalities of the clause (i.e. which head of loss it falls under), this decision recommends a case by case commercial approach to the interpretation of these clauses. It appears that more types of loss, under the rationale of this decision, may not be excluded by a consequential loss clause.

This result emphasises even more strongly the need to be precise when drafting consequential loss exclusions. Parties will need to ensure that the types of losses which are intended to be excluded are clearly expressed and in some detail. To avoid a clause being ineffective, the party seeking to rely on it should clearly set out, exhaustively, the types of losses which are intended to be categorised as ‘consequential’ and thus excluded from recovery.