Consequential loss is a loss that arises as a result of a breach of contract. In contracts, parties often exclude liability for consequential loss which is provided for in an exclusion clause.
If you are entering into negotiations for a contract, it is important that you understand what consequential loss is, when damages can be claimed for consequential loss, and how to effectively exclude liability.
A question that arises when dealing with consequential loss is how far you can actually go in claiming damages for a consequential loss? Where do you draw the line?
Say, for example, that Mrs Smith has purchased a freezer for her catering business from Mr Jones, which she has filled with ice cream. This ice cream is for a stall that she has been running at the local fair for a few years now, and is a favourite for many fair-goers. Unfortunately, the freezer broke the day before the fair causing all of the ice cream to melt and meaning that Mrs Smith cannot serve ice cream at her ice cream stall and would therefore not make any profit. The lack of ice cream at the stall meant that there were a lot of grumpy children, and grumpy children meant grumpy parents which resulted in a lot of backlash on the fair.
The following year, the fair suffered a 50% reduction in attendance as a direct result of the grumpy children and the lack of ice cream, and the organisers then had to cancel the fair in subsequent years and claimed the amounts they lost from poor Mrs Smith.
Mrs Smith now wants to sue Mr Jones in damages for the loss of profit and the amounts claimed by the fair organisers, which were losses resulting from the breaking of the freezer. But how far can Mrs Jones actually go in claiming these damages? Let’s look at some cases and see what they say.
Hadley v Baxendale
In an 1854 English Court of Exchequer decision Hadley v Baxendale, Alderson B famously established the remoteness test, which is a two-limb approach where the losses must be:
- Considered to have arisen naturally (according to the usual course of things); or
- Reasonably considered to have been in the contemplation of the parties at the time when they made the contract as a probable result of the breach of it.
Alderson B said that in order for a party to successfully claim damages on the grounds of consequential loss, the loss must fall into either of those two categories.
McElroy Milne v Commercial Electronics
In 1992 in New Zealand, Cooke P said this test no longer applied in modern law, and he established a multi-factorial discretionary approach in which a range of factors are to be taken into consideration, including foreseeability.
Transfield Shipping v Mercator Shipping (The Achilleas)
This is more recent English House of Lords decision concerning the late return of a ship. In this case, the judges established that while Hadley v Baxendale is generally a good approach, there are certain circumstances where it may not necessarily apply.
These judgments create confusion in determining what actually constitutes a consequential loss and where to draw the line. Generally speaking, however, the loss must have been in the contemplation of the parties for it to amount to a consequential loss.
A way forward: What should the clause say?
In our view there are three ways forward:
- No exclusion of consequential loss – this means that the parties are leaving it up to the interpretation of the Courts;
- Include a general consequential loss clause; or
- Incorporate a bespoke clause for the specific contract.
Where possible, we recommend a general exclusion of consequential loss with some examples of specific situations (essentially a bit of both 2 and 3 above).
Other options available:
Remember that a contract is ultimately a give and take from each side and another way that a party can limit liability in a contract is by putting a total cap on their liability.
Another option is that a party could limit liability by stating a time period in which the other party can bring a claim. A small company negotiating with a large multinational will have less scope and a template agreement is much more difficult to get changes made to it.
Ultimately, whichever route is taken depends on the preference of the parties, and their negotiations will also play a role in determining what liability is excluded.
Every situation is unique and how much Mrs Smith could claim for will depend on what the contract said and the circumstances of the situation. Whatever your scenario, we have a dedicated commercial team at Parry Field Lawyers who can give you personalised advice on all aspects of your business ventures. This article is also based on a more detailed analysis of the cases mentioned above – contact us if you would like a free copy of that.
This article is not a substitute for legal advice and you should talk to a lawyer about your specific situation. Please contact Kris Morrison or Steven Moe at Parry Field Lawyers (348-8480).