The case of Hadley v Baxendale [1854] EWHC Exch J70 provides a fundamental rule for determining whether the losses stemming from a breach of contract are within the scope of the Defendant’s responsibility (known as remoteness of damage). Although decided in 1854, the same year Florence Nightingale was sent to the Crimean War and Hard Times by Charles Dickens was published, the test for what constitutes direct and indirect (consequential) losses is as sound today as it was 169 years ago. Basically, the principle as it applies to consequential loss is thus:

A loss will only be recoverable if it was “in the contemplation of the parties”, that is, foreseeable. The knowledge the Court prescribes to the parties when evaluating what was in the contemplation at the time the agreement was signed falls into two branches:

• Direct loss – incidents that happen ‘in the ordinary course of things’, whether the party knew about them or not. These are normally easy to identify and damages usually reflect the cost of completing or correcting the work agreed to in the contract, for example, the cost of having to hire a car because the seller did not deliver yours on time.

• Indirect or consequential loss – not losses you would usually expect from the particular breach but are caused by some special circumstance that the party in breach was aware of.

An example of direct and consequential losses is illustrated in Cory v Thames Ironworks Co (1868) LR 3 QB 181. In this case, the Defendants agreed to deliver a floating hull to a firm of coal merchants. The delivery was late. The Claimant suffered direct losses stemming from being unable to store coal in the hull. However, the Claimant also argued consequential losses because they planned to use the hull to hold lifting gear that would move coal directly between coal ships and barges without having to put it ashore. This was new technology in the 1860s and the Defendants did not suspect that the hull would be used for such a purpose at the time the contract was made. Although special circumstances existed, the Defendant was not aware of them, therefore, damage for consequential losses was unrecoverable.

The problem with this interpretation of consequential loss is that it flies in the face of the modern approach to contract interpretation, which says that a contract term means what a reasonable businessperson would think the parties intended by it, which in most cases is a loss of profits. And according to a survey conducted in 2018, a majority of Solicitors disagreed with the Court’s interpretation of the meaning of consequential loss.

Thames Ironworks brings to light an important fact about consequential losses – they are often unrecoverable because the party in breach had no idea of the Claimant’s special circumstances. However, as noted above, defining consequential loss is a contentious issue. Furthermore, if the Court does find the Defendant knew about the ‘special circumstances,’ they can be potentially liable for enormous damages awards. Therefore, to protect your best interests, it is essential to draft a comprehensive consequential loss exclusion clause in your commercial contracts.

How can I exclude liability for consequential losses for breach of contract?

To mitigate your risk of liability for consequential losses, ensure the following when drafting an exclusion clause:

• The language is straightforward and unambiguous. Refer to consequential losses as ‘indirect/consequential losses’ as the other party is likely to be more familiar with the term ‘indirect’. In addition, be conscious of the potential limiting affect of words such as ‘other’ and ‘including’.

• State clearly what losses the clause is excluding. If you want to exclude specific direct losses, for example, loss of profit, as well as consequential losses, this needs to be set out clearly, for example, ‘Neither party shall be liable for loss of profits, revenue, business, goodwill, indirect loss…’

• Point out the exclusion clause to the other party – never try to bury it in small print, the only thing you will gain is a lawsuit.

• If there are multiple issues that could lead to consequential losses, list them separately and spell out all the categories of loss you will not be responsible for.

• Negotiate the possibility of each party having an express obligation to take out insurance cover and make this a contractual term.

Wrapping up

Although we have tried to make this article as simple as possible, the fact is that the current law around defining and excluding consequential losses in contracts is a minefield. Although it is easy to criticise the Courts for insisting on clinging to the principles set out in a Victorian case which has little relevance for 21st century businesses, moving away from the Hadley v Baxendale principle is fraught with difficulty, not least the danger of extending the concept of remoteness too far thereby rendering most commercial contracts unviable. As it stands, the best way to protect your interests is to have any exclusion clauses related to direct and indirect contractual losses drafted or reviewed by an experienced Risk Management Solicitor.

To find out more about any matters discussed in this article, please email us at info@43legal.com or phone 0121 249 2400.

To find out more about any matters discussed in this article, please email us at info@43legal.com or phone 0121 249 2400.

Please note that this article does not constitute legal advice.