Commercial contracts often include a clause that limits one party’s liability for certain losses (often referred to as a limited liability clause). These provisions are particularly common in the building, construction and energy industries because of the possibility of unforeseeable circumstances. But you might notice that a limited liability clause will often include the term ‘consequential loss‘. What does this mean? This article unpacks the concept of consequential loss, and how the courts have interpreted its meaning to date.
What is Consequential Loss?
Much of the discussion around consequential loss is whether a contract can exclude another party from claiming lost profits or the costs incurred from remedying a breach.
The courts have recognised two types of losses that could result from a breach of contract, namely:
- Direct losses: Those that flow naturally from the breach and can be reasonably foreseen (e.g. the costs of repair where defective building works have caused property damage); and
- Indirect (or consequential) losses: Those that do not arise in the natural course of events but were caused by particular circumstances. Such loss would only be recoverable if the parties could reasonably contemplate the particular circumstance occurring when they entered into the contract.
The courts considered that losses such as lost profits or costs incurred from remedying the breach of contract were outside this definition of consequential loss. As such, even where a contract attempted to exclude consequential loss, it could not exclude lost profits or costs incurred from remedying the breach.
Post-2008: Victoria, New South Wales and South Australia
The meaning of consequential loss shifted in 2008. In the Victorian Supreme Court of Appeal decision Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd VSCA  26 (Peerless), Justice Nettle stated that the consequential losses in the case would include things like lost profits and expenses incurred in remedying breaches.
That meant that a clause which excluded consequential losses would be effective in excluding lost profits and expenses incurred in remedying breaches. The New South Wales Court of Appeal and South Australian Supreme Court followed this approach.
Post-2013: Western Australia and New South Wales
In the Western Australian decision Regional Power Corporation v Pacific Hydro Group Two Pty Ltd [No 2]  WASC 356, the Court declined to follow the strict approach in the Peerless decision.
In 2006, the Hydropower station, which supplied energy to Regional Power Corporation, had an outage. Resultingly, the power station flooded and was out of operation for two months.
Regional Power Corporation incurred significant expenses to provide replacement electricity. However, the contract had a clause limiting liability, which excluded liability for indirect or consequential loss.
The Court took the approach of the High Court in Darlington Futures Ltd v Delco Australia Pty Ltd (1986) 161 CLR 500 (Delco). It said the correct approach was to read the exclusion clause within the context of the contract.
The Court went on to find that the losses incurred were direct losses meaning the contract could not exclude these losses. This approach was also taken in the recent New South Wales Supreme Court case MacMahon Mining Services v Cobar Management  NSWSC 502, which also applied the Delco reasoning.
Will Lost Profits and Expenses Incurred From Remedying a Breach be Recoverable or Excluded?
The answer to that question has become unclear due to the divergence of authority and is likely to stay that way until another higher court decision is made that reconciles the different approaches.
For now, it seems the courts may have to approach the question on a case-by-case basis, and the outcome will largely depend on the context of the contract as a whole.
How Should You Draft Your Building Contract?
What is clear is when drafting a commercial contract, a party that wants to limit its liability and exclude indirect and consequential loss will need to ensure the contract explicitly deals with what kinds of loss will be considered consequential. A catch-all type clause which says that ‘consequential losses will be excluded’ will not have much weight in the courts.