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When entering into a contract, one of the critical things to consider is your business’ exposure to risk if something goes wrong. No matter what the contract entails, you will need to 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 the Court will decide how much a party needs to pay. 

What Are Damages?

In Australia, if one party has breached a contract, they must compensate the other party to ensure that they are 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, you bought a packet of chips from the supermarket. You took the chips to the checkout, paid three dollars, and walked 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 — three dollars.

Consequential Loss

In more complex situations arise, several issues could arise when trying to calculate the amount of damages someone needs to pay. One more complicated type of loss that may be included in the calculation of damages is known as consequential loss.

Consequential loss is a loss that has occurred as a consequence of a party’s breach of contract. 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 where a business enters into a contract with a software company to provide software so they can build an online store. A term of the contract 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. The business consequently does not make any money that day and may be able to claim damages for consequential loss from the software company.

For consequential loss to be considered in the calculation of damages, it must:

  1. naturally arise from the breach; and
  2. be something that the parties contemplated as a probable result of a breach.

In the above example, the business would likely be able to successfully 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.

Mitigating 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 that you take all steps you can 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 have taken these steps and still incur a loss, the other party may need to pay you any damages.

However, if you notice the error and do not contact the software provider or provide them with the necessary information, you may not be able to claim damages. This is because you have not taken steps to minimise the damage to your business.

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; and
  • clauses excluding consequential loss.

Using a contract to change the calculation of damages is a common tool used by businesses to make a contract more favourable. As such, you must review the document carefully to make sure you are clear on your contractual position. You will also need to check that you are not taking on unnecessary risks or limiting your ability to receive damages.

Key Takeaways

Although a simple concept in theory, calculating damages can be complex, so you must consider how breaches should be handled right from the start of drafting a contract. If another business has breached your contract, you should take every step you can to minimise your loss. You may be able to claim compensation if you still suffer a loss. If you have any questions about calculating damages, contact LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page. 

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