In the October 2013 issue of Acumen, we gave an overview of the divergence in approach of courts in England, Australia and New Zealand in the interpretation of “consequential” or “indirect” loss exclusion clauses.

The recent decision of Justice Martin, of the Supreme Court of Western Australia, in Regional Power Corporation v Pacific Hydro Group Two Pty Ltd & Ors1 serves as a further example of the uncertainty continuing to pervade this area of the law.

The decision reaffirms the importance of understanding the allocation of risk where parties adopt the more broad language of, for example, “any indirect or consequential loss of any kind whatsoever”. For suppliers of a commodity who wish to exclude certain types of loss, it will usually be preferable to expressly list those types of loss, rather than simply relying on the broad language above.

The decision also serves as a timely reminder that a detailed liquidated damages regime will not necessarily serve to limit a party’s right to seek common law damages for breach. Contracting parties will need to use carefully drafted language to ensure that the relevant liquidated damages clause achieves its intended purpose; particularly where it is intended to impose a fully-agreed amount of damages for a particular breach (i.e. act a cap on liability).

Background

Regional Power Corporation (which trades as Horizon Power) is the WA State-owned entity responsible for the generation, procurement, distribution and retail sale of electricity in “regional” Western Australia.

In 1994, Horizon Power’s predecessor (the consolidated State Electricity Commission of Western Australia) entered into a power purchase agreement with the Pacific Hydro group for the construction of, and the sale and supply of electricity from, a hydroelectric power station in the East Kimberley (the PPA).

In August 2006, the power station suffered an outage which resulted in water flooding. The component used to automatically start the power station’s emergency generators (which would have, in turn, kick-started the water-pumping system to prevent the flooding) had been wired incorrectly. As a result of the flooding, the power station was inoperative for two months.

In order to generate replacement electricity during that period, Horizon Power spent approximately $4 million in hiring, commissioning and fuelling temporary diesel generation plant at the nearby Kununurra power station (Replacement Energy Costs).

The proceedings and the preliminary issues

In 2012, Horizon Power commenced proceedings against Pacific Hydro for breach of the PPA, and sought to recover the Replacement Energy Costs.

Pacific Hydro rejected any liability for those losses on the basis of, relevantly:

  1. the PPA establishing its own “exclusive code” for relief arising from any breaches of it, and thus excluding any right to common law damages; and
  2. if (a) was rejected, the presence of an express, mutual limitation of liability for “indirect” or “consequential” loss in clause 26.1 of the PPA, and a submission that the Replacement Energy Costs should fall within that excluded category of loss.

These two questions were heard and determined by Martin J separately as preliminary issues.

Issue (a): The right to pursue common law damages in the face of a detailed liquidated damages regime

Pacific Hydro argued that, by the incorporation of a detailed liquidated damages regime in the PPA – with various “potential algebraic damages outcomes” for different “events of default” – the parties (or, more accurately, reasonable business people in their positions) must have intended that any additional right to common law damages be excluded.

His Honour dismissed this submission, noting it is well-established that, absent clear and express exclusionary words, any supplementary contractual damages regime will “augment” a party’s subsisting common law remedies for relief; not “remove” them.2 There is a presumption that a contracting party does not intend to abandon its common law rights for breach of contract, and clear words are needed to rebut that presumption.3 Absent clear language, the incorporation of a detailed liquidated damages regime was not sufficient.

Often, liquidated damages clauses are used to act as a cap on liability, in that a liquidated amount is agreed to be paid as full and final compensation for a particular breach. Much will depend on the language of the liquidated damages clause. However, in this case, it appears that the relevant liquidated damages provisions (not quoted in the judgment) did not go so far as to “liquidate” (that is, fix and agree) the sum payable for the relevant breach.

Issue (b): Not consequential – Categorisation of Horizon Power’s loss as ‘direct’

Clause 26.1 of the PPA read as follows:

Neither the Project Entity [Pacific Hydro] nor SECWA [Horizon Power] 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 damage or loss of profits.

Horizon Power’s position was that the Replacement Energy Costs constituted “direct” losses arising from the claimed breach, and therefore fell outside the category of unrecoverable losses in clause 26.1 of the PPA. The Replacement Energy Costs, it argued, fell within the ‘first limb’ of Hadley v Baxendale; that is, losses which:

… may fairly and reasonably be considered as arising naturally, according to the usual course of things, from the breach”.

The so-called ‘second limb’, which continues to be relied upon by English courts to aid in the categorisation of indirect or consequential loss, defines that more remote class of loss as that 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”.

Pacific Hydro, on the other hand, submitted – with particular emphasis on the meaning given to the term “consequential loss” by the Victorian Court of Appeal in Environmental Systems v Peerless Holdings Pty Ltd4 – that the Replacement Energy Costs were beyond the “normal measure of damages”. That being the threshold, the Replacement Energy Costs were excluded by clause 26.1 of the PPA.

Martin J held that the Replacement Energy Costs were incurred directly as a result of the claimed breach, and were therefore recoverable under the PPA. Interestingly, in doing so, his Honour rejected both the “usual course of things” test in Hadley v Baxendale, and the “normal measure of damages” assessment espoused by the Victorian Court of Appeal in Environmental Systems.

His Honour acknowledged that the correct approach to the construction of limitation clauses was laid down by the High Court in Darlington Futures Ltd v Delco Australia Pty Ltd.5 The approach requires the clause to be construed:

… according to its natural and ordinary meaning, read in light of the contract as a whole”.

Martin J observed that, in light of the Darlington Futures approach (which is really just consistent with the fundamental manner in which  all commercial agreements must be construed), the courts:

“… should not be artificially fettered towards assessing the character of an economic loss by the rather vague criteria of whether or not the loss arose ‘in the ordinary course of things’ [Hadley v Baxendale]. 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 damages’ [Environmental Systems].6

His Honour placed significant emphasis on the fact that Horizon Power was a statutory corporation with an ongoing public responsibility to supply electricity to consumers. Following the outage at the power station, Horizon Power did not simply have a “discretion” to procure alternative energy supplies for residents and businesses in the East Kimberley.

Martin J held that the parties, assessed objectively, must have appreciated (at the time that the PPA was entered into) that any failure at the power station would have required Horizon Power to take “fall-back or replacement steps” to secure a level of replacement energy for its customers.

Lessons from the case

No general principle: context is the key

This decision should not be taken to lay down some kind of general principle that costs incurred by a customer in obtaining or generating a replacement commodity, upon a failure to supply, will always be categorised as a “direct” loss. Each case must be assessed in light of its own particular circumstances, and the relevant exclusion clause considered in the context of the contract as a whole.

Indeed, Martin J highlighted that his decision was made in the “bespoken context” of a long term supply relationship, where the buyer was an entity carrying its own local community electricity supply obligations.

For certainty, expressly list all categories of excluded loss

The decision reaffirms the importance of undertaking an assessment of key risks and drafting contractual clauses to deal with the parties’ risk allocation.

For example, if the parties’ intention is to exclude liability for certain types of loss, then these should be specifically listed. The decision demonstrates that the broad language of, for example, “any indirect or consequential loss of any kind whatsoever” will not necessarily capture certain losses which one party might well have intended be excluded.

Of course, it may be in a party’s interests to maintain broad language if that party (usually a customer) would be advantaged by certain types of loss being classed as “direct” remaining arguable.

The law remains unsettled

Although it is consistent with the High Court’s decision in Darlington Futures, the approach espoused by Martin J is arguably a departure from the more rigid imposition of a maxim to aid in the categorisation of “consequential” loss, which underpins Hadley v Baxendale and Environmental Systems. As a decision of a single judge of the Supreme Court of Western Australia, though, it does not constitute binding authority in any other jurisdiction, but may well prove to be persuasive in future decisions.