When entering into a contract, one critical consideration is your business’ exposure to risk if something goes wrong. No matter what the contract entails, you should consider what a breach of contract (from either side) will cost you. If a party breaches the contract, the other party may have to pay compensation, known as damages. This article will outline when parties may need to pay damages and how a court will decide how much a party needs to pay.
What Are Damages?
In Australia, a party who breaches a contract must compensate the other party to place them in the same position as if the breach had never occurred.
A great way to think about this concept is in terms of buying a product from a store. For example, suppose you buy a packet of chips from the supermarket. You take the chips to the checkout, pay $3 and walk out of the store with the chips. In this contract, your obligation was to pay three dollars, and the store had to provide a packet of chips in return.
Upon leaving the store and opening the packet of chips, you realise that the packet of chips is empty. In this case, the store has breached their contract with you by not performing their obligations. Here, the damages would be the price you paid for the packet of chips: $3.
Consequential Loss
In more complex situations, several issues could arise when calculating the amount of damages someone must pay. One more complicated type of loss is known as consequential loss.
This is in contrast to a direct loss, like in the case of the packet of chips above.
An example of consequential loss might be when a business enters into a contract with a software company to provide software to build an online store. A contract term is that the software is functional 100% of the time.
On a typical day, the business may sell $10,000 worth of goods online. One day, the software encounters an error and is not functional. Consequently, the business did not make any money that day and may be able to claim damages for consequential loss from the software company.
In the above example, the business could likely argue for consequential loss and receive damages. However, if the business did not have a steady history of sales, it is less likely to be able to receive damages from the faulty software.
Continue reading this article below the formMitigating Loss
While parties need to ensure that they do not breach any contracts, you also need to make sure that you are mitigating any potential losses. This means you take all steps to minimise your loss after another party breaches a contract.
Using the software example above, mitigating your loss may include contacting the software provider and providing them with any information needed to restore the software. If you take these steps and still incur a loss, the other party may need to pay you damages. However, if you notice the error and do not contact the software provider, you may not be able to claim damages.
Damages in Contract Terms
Some contracts will include terms that impact how damages are calculated.
For example, clauses which can impact the calculation of damages if a matter goes to court include:
- indemnity clauses;
- limitation of liability clauses;
- liability cap clauses;
- obligations to mitigate loss; and
- clauses excluding consequential loss.
Using a contract to change the calculation of damages is a common tool businesses use to make the agreement more favourable. As such, you must review the document carefully to ensure your contractual position is clear. You will also need to check that you are not taking on unnecessary risks or limiting your ability to receive damages.
Unfair Contract Terms
Depending on your business, you may be required to comply with the Australian Consumer Law. This includes the obligation to ensure that your consumer contracts do not include unfair contract terms.
A court may view limitations on liability and indemnity clauses as an unfair contract term where those clauses:
- cause a significant imbalance in the parties’ rights and obligations under the contract;
- are not reasonably necessary to protect the legitimate interests of the party that would benefit from its inclusion; and
- would cause financial or other detriment to a party if it were applied or relied on.
If your consumer contract contains unfair contract terms, those terms may be void and unenforceable. Consequently, you may be subject to significant financial penalties.
This guide provides key information on how to manage a business dispute as quickly and cost-effectively as possible.
Key Takeaways
Calculating damages can be complex, making it essential to consider how your business will handle breaches before you formally enter into a contract. If another business breaches your contract, you should take steps to minimise loss. You may be able to claim compensation if you still suffer a loss.
If you have any questions about calculating damages, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
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