Most types of energy-related contracts contain some form of clause seeking to limit the liability of one party or all parties for losses suffered by a party due to breaches of the contract1 . Frequently, these clauses include reference to “consequential” or “indirect” loss. However, there is often a misunderstanding about what these terms mean or how to draft clauses to ensure that they exclude all the intended losses.
Meaning of “consequential” or “indirect” loss
The term “consequential loss” is a classic case of words not bearing their dictionary meanings in a legal context. Under the rule in Hadley v. Baxendale (1854) 9 Exch. 341, a person who breaches a contract is generally liable to the innocent party for any loss that falls within one of the following two “limbs”:
- Loss that arises “naturally” or “according to the usual course of things” from the breach. The courts often refer to this first limb as “direct” loss: see, for example, Victoria Laundry (Windsor) Limited v. Newman Industries Limited  2 KB 528.
- Such additional loss as the parties would, at the time when they made the contract, have reasonably expected to be the probable result of such a breach. The courts generally refer to this second limb as “consequential” or “indirect” loss: see, for example, Hotel Services Ltd. v. Hilton International Hotels (UK) Ltd.  1 All ER (Comm) 750 and British Sugar plc v. NEI Power Projects Ltd.  87 BLR 42.
When a contractual clause excludes or limits liability for “consequential” loss or damage, as a matter of law, it only excludes loss under the second limb of Hadley v. Baxendale. The scope of such an exclusion may therefore be far narrower than commercial negotiators realise. In particular, they may believe that it excludes liability for all loss that is a consequence of a breach including, for example, loss of profit. But the law often regards loss of profit as a direct loss.
So, for example, in one reported case, a limitation clause purported to exclude liability for “loss of anticipated profits … or for indirect or consequential damage”. The court held that the clause did not prevent the claimant from recovering fixed costs and overheads that resulted from an explosion at a methanol plant. See Deepak Fertilisers & Petrochemical Corporation Limited v. Davy McKee (London) Ltd.  1 All ER (Comm) 69.
Misunderstanding the legal distinction between “consequential” and “direct” losses can lead to exclusion clauses that do not achieve their intended aims. Typically, one of the parties wants to exclude liability for all loss of profit, but the contract describes loss of profit as a species of consequential loss. The clause may not then cover direct loss of profit.
What loss is in or out?
The best guide to the effectiveness of wording is to look at how the English courts have decided cases where the same or similar wording has been examined. Set out below is a selection of examples from recent case law:
- “Neither [party] shall bear any liability to the other … for loss of production, loss of profits, loss of business or any other indirect loss or consequential damages …”
The court considered that the word “other” implied that loss of production, profits or business was only excluded in so far as it was consequential. The court concluded, however, that the parties had actually meant to exclude all such liability, as well as any other indirect or consequential liabilities. In effect, the parties had intended to exclude liability “for loss of production, loss of profits, loss of business or indirect or consequential losses of any kind”. (BHP Petroleum Ltd. v. British Steel plc  2 Lloyd’s Rep. 277.)
- “[The defendant] shall not in any event be liable for any indirect, special or consequential loss, howsoever arising (including but not limited to loss of anticipated profits or of data) …”
The court held that this clause did not exclude all liability for loss of profits, but only loss of profits of an indirect or consequential kind. As the claim was for direct loss of profit, the clause did not protect the defendant. (Pegler Limited v. Wang (UK) Limited  BLR 218.)
- “We accept liability to pay damages in respect of loss or damage suffered by you as a direct result of our providing the Services. All other liability is expressly excluded, in particular consequential loss, failure to realise anticipated savings or benefits …”
The court held that this provision did not exclude direct loss of tax savings. The court focused on the word “other”, which it said made clear that the parties anticipated that the first part of the clause would take precedence over the second. The second part of the clause therefore only excluded loss and damage not covered by the first part i.e., only indirect loss. (University of Keele v. Price Waterhouse  PNLR 43.)
- “… [the defendant] … shall have no liability … which is of an indirect or consequential nature including without limitation the following: (i) loss or deferment of profit; …”
The court held that, by using the words “including without limitation”, the parties were identifying the type of loss that could fall within the exemption clause so long as it met the prior requirement that the loss was “of an indirect or consequential nature”. Direct losses were not therefore excluded. (Ferryways NV v. Associated British Ports  EWHC 225;  1 Lloyd’s Rep. 634.)
Points to remember on drafting
In light of these, and other, cases, there are several points to bear in mind when drafting exclusion clauses:
- Before you start drafting, clearly identify the liability that you want to exclude. For instance, are you happy with an exclusion of consequential loss only or do you also want to exclude certain direct losses such as direct loss of profit?
- Consider listing as precisely as possible the categories of loss for which you will not be liable, e.g., loss of opportunity, loss of profit, loss of production and loss of business.
- Be wary of words like “other” and “including”, which may have a limiting effect on an exclusion clause.
- Use the word “indirect” instead of “consequential” to describe loss. Commercial parties are more likely to understand the clause if you do.
- Be alive to the other provisions of the contract, particularly those that establish liability, so that any exclusion clearly covers the likely losses.
Contracts involving consumers
The OFT (Office of Fair Trading) and the FSA2 (Financial Services Authority) have recently advised businesses not to use the term “consequential loss” when dealing with members of the public. They say that it is not plain and intelligible to the ordinary consumer without legal advice, contrary to the Unfair Terms in Consumer Contracts Regulations 1999.