Unexpected consequences when contracts exclude consequential loss

It is common for a supplier of goods and services to a local council to include in their standard T&Cs, not only a monetary cap on their liability, but also an ‘exclusion of consequential loss’ clause.  This is not surprising because the economic loss that a local council can suffer, from a breach of contract or negligence, can be significant and will often dwarf the value of the goods or services supplied.

Because they are so common, a lot of procurement teams don’t think twice about them and often accept them as a ‘standard’ clause.

However, the phrase ‘consequential loss’ has no well-defined meaning, and is often misunderstood by business people.  The use of the phrase ‘consequential loss’ in a contract can often lead to unexpected consequences, sometimes leaving a supplier with no liability at all.  

What is consequential loss?

Courts have traditionally held that where one party breaches an agreement, the other party should receive damages:

• which fairly and reasonably arise naturally from the breach of contract; and

• which were reasonable in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it.[1]

Until recently it was thought that ‘consequential loss’ was equated with paragraph 2 above – ie ‘consequential loss’ was considered to be loss which did not arise naturally from a breach of the contract, but which the parties reasonably knew when they contracted would be the probable result of a breach. 

As a result, most business people equate consequential loss with loss of profits or loss of revenue.   However, a series of Australian cases has clouded that traditional line of thinking.

In the most recent decisions on this topic in Australia[2], the Courts have held that the phrase ‘consequential loss’ should be interpreted in accordance with its natural and ordinary meaning, in light of the contract as a whole.  This means ‘consequential loss’ could include all loss and damage suffered as a consequence of a breach of contract.

Be specific

The key lesson from recent Australian cases is that if a loss is going to be excluded, it is not sufficient to merely state ‘consequential losses are excluded’. The categories of loss being excluded now need to be expressly defined. It is necessary to be specific about the types of loss that are not recoverable and to avoid using broad catch-all expressions.

Common types of loss include: loss of actual or anticipated profits; loss of revenue; loss of savings; loss of production; loss of business; loss of opportunity; loss of access to markets; loss of goodwill; loss of reputation; loss of credit; loss of publicity; loss of data; loss of use and loss arising from business interruption.

Care also needs to be taken when considering the type of loss to exclude from a supply contract. For example, it may not be appropriate to exclude:

• loss of profit – if it is the only loss likely to be suffered;

• loss of data – if the supplier is required to provide a ‘back-up’ or disaster recovery service; and

• loss of goodwill – if reputational loss is likely to be significant

Conclusion

Local councils and their procurement teams should carefully review supplier T&Cs, and alarm bells should ring when suppliers attempt to exclude ‘consequential loss’. 

Any exclusion of liability agreed by the local council should clearly indicate what types of loss are not recoverable.  Broad catch-all expressions like ‘indirect loss’ and ‘consequential loss’ should be avoided.  Instead, phrases like ‘loss of profit’ or ‘loss of opportunity’ should be used instead (where appropriate).

If not, a local council may unwittingly accept a clause that excludes a supplier’s liability for all loss suffered by the local council.

Author: Michael Cossetto