The Victorian Court of Appeal has recently handed down a decision which overturns the traditional thinking concerning the meaning of the phrase 'consequential loss' in contracts. This decision should cause all parties to revisit contracts which contain clauses excluding 'consequential loss'.
Previous legal position
Prior to the unanimous decision in the Victorian case
of Environmental Systems Pty Ltd v Peerless Holdings Pty
Ltd [2008] VSCA 26, Australian courts have followed a line
of English authority which equated the phrase
'consequential loss' in exclusion clauses with
losses that fell within the second limb of the rule in the case
of Hadley v Baxendale. These were losses which did not arise
naturally from a breach of contract in the usual course, but
which the parties reasonably knew when they contracted would be
the probable result of a breach.
As a result, in the last decade these decisions ruled that a
reference to 'consequential loss' in an
exclusion clause was not sufficient to exclude liability for
lost profits, lost production and other consequential losses
that which arose naturally from a breach in the usual
course:
- British Sugar plc v NEI Power Projects Ltd
(1998) 87 BLR 42, held that increased production costs
and loss of profit (the result of faulty power station
equipment) did not fall within an exclusion of
'consequential loss'.
- Deepak Fertilizers and Petrochemicals Corp v ICI
Chemicals and Polymers Ltd [1999] 1 Lloyd's Rep
387held that wasted overheads incurred during reconstruction
of a plant following its destruction did not fall within an
exclusion of 'consequential
loss'.
- Hotel Services v Hilton International Hotels (UK) Limited [2000] BLR 235 confirmed that the costs of removal and loss of profit associated with defective minibars in an hotel were not excluded as 'consequential losses'.
This line of authority has been followed in Australia but
last week was rejected by the court in Environmental
Systems v Peerless.
The Court of Appeal held that these earlier cases were wrongly
decided and that the true distinction is between
'normal loss' (the loss every plaintiff in a
like situation will suffer on the one hand) and
'consequential loss', (anything beyond the
normal measure, such as profits lost or expenses incurred
through breach).
This case brings about a fundamental shift in the
interpretation of clauses that purport to exclude consequential
loss. Before this decision, clauses that excluded
'consequential loss' would not have been
interpreted by the courts as excluding lost profits, lost
production and certain classes of consequential expense, unless
those losses fell within the second limb of the rule in
Hadley v Baxendale.
As a result of this decision, it is now likely that
clauses that exclude 'consequential loss' will
be interpreted by the courts as excluding all losses which are
not 'normal losses', and will be effective to
exclude lost profits, loss revenue and lost production, whether
those classes of loss are expressly referred to in the clause
or not.
The usual advice provided to parties drafting
'consequential loss' exclusion clauses has been
to precisely identify the classes of 'consequential
loss' sought to be excluded. Whilst the judgment in the
Environmental Systems v Peerless case significantly
changes the way the phrase 'consequential loss'
will be interpreted, the previous advice to precisely identify
the particular type of loss to be excluded by such clauses
remains good.
Peter Wood of Minter Ellison's Melbourne Construction, Engineering & Infrastructure Group will be hosting a breakfast seminar on this important decision at 7.45am on Wednesday 2 April 2008 at our Melbourne office.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
