In its recent decision in Regional Power Corporation v Pacific Hydro Group Two Pty Ltd [No 2]  WASC 356, the Western Australian Supreme Court has rejected both the approach to the construction of the words Consequential Loss adopted by the courts in England and the approach adopted by the Victorian Court of Appeal in Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd (2008) 19 VR 358;  VSCA 26, saying at  – :
To reject the rigid construction approach towards the term 'consequential loss' predicated upon a conceptual inappropriateness of invoking the Hadley v Baxendale dichotomy as to remoteness of loss, only then to replace that approach by a rigid touchstone of the 'normal measure of damages' and which always automatically eliminates profits lost and expenses incurred, would pose equivalent conceptual difficulties. Accordingly, I doubt whether the  observations in Environmental Systems were intended to carry any general applicability towards establishing a rigid new construction principle for limitation clauses going much beyond the presenting circumstances of that case.
…on my assessment, is the correct approach to a limitation or exclusion clause required by Darlington Futures Ltd v Delco Australia Pty Ltd, as recently applied by the Western Australia Court of Appeal in Electricity Generation Corporation t/as Verve Energy v Woodside Energy Ltd ,  (McLure P), ,  (Murphy JA).
The approach to construction of exclusion clauses set out in Darlington Futures Ltd v Delco Australia Pty Ltd (1986) 161 CLR 500 at 510-11 is as follows:
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.
The facts in the Regional Power case were that SECWA and Pacific Hydro Pty Ltd had entered into a Power Purchase Agreement (PPA) in 1994. By the PPA, Pacific Hydro agreed to supply electricity from the Ord Hydro Power Station to SECWA. As a result of a legislative enactment, Regional Power now holds all the rights of SECWA. The power station suffered an outage, resulted in flooding which in turn led to it becoming inoperative for 2 months. As a result, Regional Power was required to arrange alternative power to meet its supply obligations, and in doing so it incurred expenses of $1,293,394 for delivering, commissioning, and hiring diesel generators, $113,389 for travel, airfares and wages, $19,318 for the accommodation and meal costs; $6,443 for the hire of cranes and $2,727,287 for the diesel fuel to run the extra generators required to produce the requisite electricity for the relevant period, or a total of some $4,000,000, more than 95% of which related either to the cost of procuring diesel generators to generate replacement electricity, or the cost of diesel fuel that was needed to run the generators. Cl 26.1 of the PPA reads:
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.
In allowing the amounts claimed by Regional Power, the court said at  -  that the clause was not intended to exclude those amounts, which it considered to be ‘fully direct damages or losses’ and that:
More removed consequential customer type losses, arising out of the possible wider customer disappointments would deliver as against any claims made against SECWA and the defendants for interruption a more plausible scope for the exclusionary work and viable operation in that context of cl 26.1's words, 'indirect' or 'consequential' (loss or damages).
The three current approaches
In summary, there are now three different approaches to the meaning of the words indirect or consequential when used in an exclusion clause:
- the English approach, where the words are construed as a reference to damages resulting from special circumstances under which the contract was made communicated by one party to the other;
- the Environmental Systems approach, where the word consequential was said to refer to everything beyond the normal measure of damages, such as profits lost or expenses incurred through breach.
This formulation was based on the views expressed in McGregor on Damages 17th ed at 1-036 where McGregor defines normal loss as loss that every claimant in a like situation will suffer, but then goes on to say that:
In contract the normal loss can generally be stated as the market value of the property, money or services that the claimant should have received under the contract, less either the market value of what he does receive or the market value of what he would have transferred but for the breach.
So in the case of the supply of defective goods, on the adoption of this approach to the construction of a clause excluding liability for consequential loss the purchaser would be entitled to damages representing the difference between the value of the goods had they not been defective and the value (if any) of the defective goods, but not expenses incurred or profit lost as a result of the breach.
- the Regional Power approach, where the words are said to exclude losses that are in some way less direct and more removed when considered in the context of the transaction at hand.
What can a poor client do?
It is common for sellers of property or service providers to propose the inclusion of a clause that excludes some or all of indirect, consequential, special, punitive or exemplary damages or loss of profits, revenue, business opportunity, product, production, use, goodwill or business reputation. None of these shorthand phrases is likely to provide a bright line distinction between the losses a party may suffer as a result of a breach that are recoverable and those that are not.
However, it would be tedious and time consuming to try to envisage at the time when the contract is being negotiated how and to what extent these exclusions would apply to all of the various scenarios that could arise in the event of a failure to comply with all of the various contractual, tortious, statutory, equitable or other obligations that arise under or in connection with the contract at hand. Rather, the parties generally elect to accept carve outs of this kind in the hope that the words will be given a meaning that makes commercial sense, and which reflects their natural and ordinary meaning, read in the light of the contract as a whole. In effect, the parties are taking a punt that there won’t be a breach, or if there is the carve outs will be sensibly and commercially applied by the parties, or if not by the other party at least by the court or an arbitrator.
An alternative approach would be to think more carefully, and invest in your lawyers thinking more carefully, about whether clearer and more succinct form of wording would be more appropriate in the context of the particular contract at hand, and then to try to negotiate that wording with the other party. This would involve going through each of the kinds of loss that could be suffered as a result of a breach and considering how the words could potentially operate in the case of the contract at hand.
The following is a sample clause that could make more clear the kinds of losses that parties may wish to exclude:
Neither party shall be liable to the other for:
- loss of the chance to pursue a business opportunity, to make an investment or to effect a sale to a third party that occurs as a result of or in connection with this Contract, including as a result of the breach of any obligation of any kind whatsoever that arises under or in connection with the Contract;
- in the case of non-delivery, an amount in excess of [$] as compensation for the amount by which the contract price is less than the price reasonably paid by the buyer to obtain replacement goods or services;
- in the case of the supply of goods or services other than in accordance with the Contract, an amount in excess of [$] as compensation for the difference between the value of the goods or services at the time when they are provided to the buyer and the value they would have had if they had been supplied in accordance with the Contract;
- an aggregate amount in excess of [$] for all other expenses incurred or wasted as a result of or in connection with this Contract, including as a result of the breach of any obligation of any kind whatsoever that arises under or in connection with the Contract.
The exclusion of liability for loss or damage caused by loss of the chance to pursue a business opportunity, to make an investment or to effect a sale to a third party is an alternative formulation of the usual exclusion for damages for loss of profits or revenue, and the exclusion would also cover heads such as loss of business opportunity, product, production, goodwill or business reputation. The clause does not use the terms loss of profits, as on a literal reading the term would exclude the right to recover expenses caused by the breach (profit being income less expenses) or loss of revenue, since revenue is all that the supplier is entitled to receive under the contract. Liability for special damages has not been excluded (at least to the extent that those damages do not fall within the excluded losses that are listed in the clause) and nor are punitive or exemplary damages: why should liability for damages awarded as (usually relatively nominal) compensation for egregious misconduct be excluded? The clause does not expressly refer to negligence, because it is now accepted in Australia that words such as ‘the breach of any obligation of any kind whatsoever that arises under or in connection with the Contract’ are sufficiently wide to encompass liability for breach of a duty to exercise reasonable skill and care: MWH Australia Pty Ltd v Wynton Stone Australia Pty Ltd (in liq)  VSCA 245 said at  –  and Glenmont Investments Pty Ltd v O’Loughlin & Ors  SASC 429 at  – .
This sample clause could be used as a starting point for the negotiation of a bespoke exclusion clause, and the parties should then turn their attention to a consideration of the sorts of losses discussed below.
Damages for non-delivery or for breach of warranty
A key risk to the supplier of goods and services is the prospect that there could be a substantial difference between the price at which it agrees to provide them and their market value.
For example, the Sale of Goods Act legislation provides that where there is an available market for the goods in question, the measure of damages for non-delivery is, prima facie, to be ascertained by the difference between the contract price and the market or current price of the goods at the time when they ought to have been delivered. Sellers often seek to limit their liability to avoid circumstances where, for example, they agree to supply goods at $2.00 per unit only to find that the market price for those goods at the time when they are unable to deliver has risen to $12.00 per unit.
The legislation also provides that in the case of breach of a warranty of quality the measure of damages is, prima facie, the difference between the value of the goods at the time of delivery to the buyer and the value they would have had if they had answered to the warranty. Again, a seller can be exposed to very substantial damages if the value of the item it promised (but is unable) to supply is substantially higher than the purchase price payable under its contract with the buyer.
It’s unlikely that any of the approaches by the courts to the meaning of consequential loss would exclude liability for losses of this kind, but paragraphs (b) and (c) of the sample clause above provide a starting point for the inclusion of a cap on liability for them.
Other expenses incurred or wasted
The other kinds of losses to which the parties would need to turn their attention in developing a bespoke exclusion clause include:
- property damage and personal injury;
- expenses incurred in remedying the defect, or in hiring alternative plant and equipment while the defect is being remedied or during the period of the delay;
- expenses wasted, such as plant and equipment or staff lying idle while the defect is being remedied or during the period of the delay;
- expenses that would have been saved, but for the breach. For example, in Environmental Systems substantial energy costs would have been saved had the regenerative thermal oxidiser performed as promised; and
- expenses incurred, including damages payable, by being unable to honour existing contracts with third parties. For example, if a wholesaler fails to supply a retailer, the retailer may not be able to honour its obligation to supply to its customers.
One common outcome might be for the parties to agree to:
- a liquidated damages provision to cover delay losses;
- a defects liability clause which expressly requires the seller to remedy defects which are detected within a particular period, or to pay to the buyer the cost of remedying the defects;
- cross indemnities and a requirement to take out umbrella insurance coverage for property damage and personal injuries,
but to otherwise exclude or cap the other kinds of losses set out above.
The market will influence the approach taken
The key drivers for the negotiation of an exclusion clause are generally a desire to avoid liability for indeterminate loss or to avoid liability for losses that can be covered by insurance. Obviously, a lot depends on the relative bargaining power of the parties. For example, a seller will be in a strong bargaining position where all other sellers in the market market their products on terms providing for a wide ranging exclusion of liability.
In practice, parties tend to accept a clause that excludes some or all of indirect, consequential, special, punitive or exemplary damages or loss of profits, revenue, business opportunity, product, production, use, goodwill or business reputation, and not infrequently a cap on total liability, but save for example in building contracts or master service agreements. It has to date been less common for parties to negotiate bespoke clauses that contain caps on different types of liabilities and liquidated damages, defects liability, cross indemnity and insurance provisions.