“Consequential Loss” revisited

When drafting an exclusion clause in a contract, ask yourself: ‘what sort of loss do I want to protect myself from if a claim for damages arose against me in the future?’ If your answer includes ‘indirect or consequential loss’, or ‘loss of profits’ then read on…

Exclusion of liability for ‘indirect or consequential loss’ is a common feature of commercial contracts. Therefore it is important to understand the meaning of the term at common law.

What is the definition of ‘indirect or consequential loss’?

Firstly it should be noted from the outset that no distinction should be drawn between ‘consequential loss’ and ‘indirect loss’1. The clause is not to be read disjunctively.

Secondly, and perhaps even more importantly, the term ‘consequential loss’ does not have the meaning that the commercial man might expect it to. The natural meaning of ‘consequential’ is: ‘following as a result or consequence’. However this is not the meaning given to the phrase by the courts. Typically ‘consequential loss’ is interpreted by the courts to describe a distinct subset of loss that can be contrasted with other types of loss and damage. To the legal eye it is clear that the distinction is drawn along the first and second limb of Hadley v Baxendale2. ‘Direct loss’ has been described by the courts as loss or damage which can be said to flow directly and naturally from a breach of contract i.e. in the usual course of things (the ‘first limb’ in Hadley v Baxendale). ‘Consequential loss’ is the additional loss or damage which was within the contemplation of the parties at the time of entering the contract (the ‘second limb’ in Hadley v Baxendale).

So what does an exclusion clause for ‘indirect or consequential loss’ exclude?

The line of cases from the Court of Appeal3 indicates that an exclusion for ‘indirect or consequential loss’ will not cover loss which directly and naturally results in the ordinary course of events, but only loss which is less direct or more remote. So, if losses are deemed to be direct, they will escape an exclusion clause for consequential loss. Let’s take some examples:

• In Hotel Services v Hilton International the court found that loss of profit incurred on defective minibars, along with the costs of their removal, were direct losses and not caught by an exclusion clause that stated the supplier was not liable ‘for any indirect or consequential loss’.
• In Deepak v ICI Chemicals the explosion of a methanol plant resulted in reconstruction costs, loss of profits and wasted overheads. None of the losses were held to be consequential so the exclusion clause (which expressly excluded liability for loss of profits as well as indirect and consequential loss) was ineffective.
• In British Sugar v NEI Power Projects faulty power station equipment supplied by the defendant led to increased production costs and loss of profit for the claimant. The limitation clause for ‘consequential loss’ did not protect the defendant from liability for either loss because they could be said to flow directly from faulty goods.

Does an exclusion clause for ‘consequential loss’ exclude claims for ‘loss of profit’?

Put simply, no. The case law suggests that generally normal loss of profit is direct loss, as opposed to consequential loss, and so it would not be excluded by an exclusion clause for ‘consequential loss’.

How should I draft an exclusion clause to exclude claims for ‘loss of profit’?

Very clearly! Particular care should be taken when listing an exclusion for ‘loss of profit’ alongside an exclusion for ‘indirect or consequential losses’ (e.g. ‘no liability for indirect or consequential losses such as loss of profits’). There is a risk that such an exclusion might be interpreted so that claims for ‘loss of profit’ can still be made, in spite of the exclusion clause, if the loss is said to occur as a direct result of the breach.

This is demonstrated in the Court of Appeal decision in University of Keele v Price Waterhouse4. Price Waterhouse was engaged to establish a profit related pay scheme for Keele. The engagement letter contained a clause:

“…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 and a failure to obtain registration of the scheme”.

The Court found Price Waterhouse liable for loss arising from failure to realise anticipated savings in spite of the exclusion clause. It was said that the loss was directly caused by Price Waterhouse’s work so the exclusion clause was ineffective.

Let’s take a typical exclusion clause and interpret the clause in the light of this decision:

“neither party shall be liable to the other party hereto for any indirect or consequential loss (which terms shall for the purpose of this clause include but not be limited to loss of profit), suffered (or incurred) by the other party arising out of the performance of this contract…”

By analogy with the University of Keele decision there is a risk that this clause would not exclude liability for loss of profit. Liability will still occur, irrespective of the exclusion clause, if the loss can be considered to be ‘direct’ loss.

Tips for drafting in relation to ‘indirect or consequential loss’ and ‘loss of profit’

In practice it will be difficult to tell whether particular losses are direct or indirect. Therefore it is important to follow some practical advice:

• An exclusion clause should be drafted in plain English and explicitly state what liability is intended to be excluded or limited.
• Loss of profits should be excluded in clear terms.
• It should be noted that the following types of clauses should be avoided:

– “no liability for indirect or consequential losses such as loss of profits”;

– “all consequential or indirect losses whatsoever including any loss of business or profit”;

– “loss of profits or other indirect or consequential losses”.

All clauses carry the risk that loss of profits will not be excluded. bThe best advice would be that the exclusion for ‘loss of profits’ should be distinct from an exclusion for ‘indirect or consequential losses’.

This article first appeared in our Construction and development legal update Spring 2006. To view this publication, please click here to open it as a pdf in a new window.