A breach of a contract will likely result in a loss for one or all parties to the contract. The loss in a contract which both parties reasonably foresee at the time they enter into the contract is called consequential loss and is typically limited or excluded from liability in the contract. Australian courts have emphasised that parties should define the consequential loss they seek to exclude in specific terms. Below, we explain the court’s position and the importance of careful drafting.
A party who suffers loss as a result of the breach of contract can claim damages. Damages are awarded to put the party affected by the breach in the same financial position as if the breach had not occurred. That is, the same financial position had the other party performed their obligations under the contract. Damages are the principal remedy available for breach of contract.
Courts awarded damages primarily for two different kinds of loss. That is, damages for:
- Direct loss; and
- Consequential (or Indirect) loss.
These two types of loss are known as the two limbs of Hadley v Baxendale  EWHC J70. This case concerns the late delivery of a new crankshaft for a steam engine in nineteenth-century England. In this case, the Court held that for cases of breach of contract, there existed two distinct types of damages. These were damages for loss arising naturally from the breach according to the usual order of things (direct loss) and damages for losses that were within the reasonable contemplation of the parties when they contracted as the probable result of breach (consequential loss).
Until recently, the judgement in Hadley v Baxendale provided the definition for consequential loss in Australian contract law. It was the loss that a party suffered on account of breach of contract that was reasonably contemplated by the parties when they made their agreement. It typically included losses such as loss of revenue, profit or opportunity on account of the breach. It could also encompass other losses that were the subject of discussion between the parties at the time they executed their agreement.
Following the Victorian Supreme Court of Appeal’s decision in Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd VSCA  26, the meaning of “consequential loss” has become more ambiguous. Here, Judge Nettle casted doubt on the idea that the second limb in Hadley v Baxendale limits consequential loss. The Court noted that “ordinary reasonable business persons” would naturally understand the term consequential loss to include “everything beyond the normal measure of damages, such as profits lost or expenses incurred through breach”.
The Court blurred traditional distinctions between direct and consequential loss. Subsequent decisions on this point in different states suggest that the exact meaning of consequential loss is unclear and depends on, to a significant degree, context. That is, according to the unique facts and agreement that characterise a dispute rather than any orthodoxy.
This ambiguity in the meaning of consequential loss suggests that when parties draft their final agreement, they expressly define what types of loss are or are not recoverable in the event of a breach. Parties to a contract should avoid references to consequential loss in a generic sense. If you have any questions or need assistance drafting your agreement to reflect any exclusions or limitations, get in touch with our contract lawyers on 1300 544 755.