Consequential Loss – it’s not what you think.

Consequential Loss – Do you know what it means?

In the offshore energy business, it is common to find contractual provisions that exclude “consequential loss”.  Drafting these exclusion clauses properly is critical because any imprecision in the drafting can lead to unpleasant surprises (often in relation to big ticket liabilities) – and yet the term, “consequential loss” is routinely misunderstood or used imprecisely. Laypersons/business colleagues often assume that a consequential loss must mean any loss that arises as a consequence of a breach (i.e., a loss in a cause-and-effect sense). The assumption is understandable but incorrect.

The prevalent view - under English law is that the term, “consequential loss,” has a specific “legal” meaning, which is traceable back to the case of Hadley v Baxendale (1854) 9 Ex 341[1] which identified two categories of recoverable loss from breach of contract:

• losses arising naturally  (i.e., according to the usual course of things) from the breach of the contract itself (i.e., “direct losses” or the “first limb” of Hadley v. Baxendale);

• losses that do not arise in the usual course of things but that, because of special circumstances, may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it (i.e., “consequential losses” or “indirect losses”, or the “second limb” of Hadley v. Baxendale).

The generally accepted view is that the term “consequential loss” is a term of art that refers to the second limb of Hadley Baxendale (namely those losses which do not arise in the usual course of things but which the parties specifically contemplated to be recoverable).  

The first limb (direct losses) encompasses losses that are usual and foreseeable whilst the second limb (consequential loss) entails losses that are not inherently usual and foreseeable but take on that character by virtue of special circumstances.

However, in legal world nothing is entirely cut and dried - There have been exceptions to the ‘generally accepted view’ where “consequential loss” has been defined in the wider “cause-and-effect sense”. In these cases, the meaning of the term was gleaned from its particular usage and construction in the relevant clause (and contract as a whole) overriding the usual Hadley v. Baxendale sense of the term.

So where does that leave us?

·       It is still fair to say that the term, ‘consequential loss’ is generally associated with the second limb of Hadley v. Baxendale, namely an indirect loss that involved specific advertence and was therefore reasonably contemplated by the parties as a likely outcome of the breach.

·       However, the traditional interpretation of the term  “consequential loss” may not apply if it would be inconsistent with the overall intent of the clause or contract as a whole[2].  

·       To avoid any confusion, contracting parties may wish to define the ‘excluded losses’ as a separate stand-alone concept without reference to “consequential loss” according to the description/ category of costs that are agreed to be irrecoverable (e.g., loss of revenue, loss of profit, loss of opportunity, loss of use … etc.). For greater certainty these categories of loss should be excluded “in each case whether they are direct, indirect or consequential”. If the term, “consequential loss” is used in a clause as a legal term of art, please be aware that it may be challenged (as having a wider meaning).

·       As with any limitation or exclusion clause, the exact wording is important and specific prior legal advice is necessary to ensure that the clause applies as intended[3].

The foregoing provides only an overview for discussion and thought and does not constitute legal advice. Readers are cautioned not to make any decisions based on this post alone. Specific legal advice should always be obtained.

[1] Background. Hadley operated a mill, which was in the business of processing corn into meal and flour. The crankshaft of the steam engine that powered the mill cracked and the shaft had to be replaced. The mill shutdown and Hadley hired Baxendale as carrier to deliver the old crankshaft to the manufacturer (the broken shaft was needed as a template for the fabrication of a new one). Baxendale, the carrier, was notified that the mill was shutdown; it was understood that the old shaft had to be delivered on a rush, next day, basis. Baxendale, inexplicably, did nothing for several days during which time the mill remained shutdown and unable to earn a profit. The court found that the loss of profit claim was not actionable because Baxendale was not contractually aware of the special circumstances underpinning a loss of profit claim. This was a curious finding considering that there appeared to be evidence that the carrier knew the mill had shutdown and it was a rush order. In arriving at its decision, the court was influenced by the idea that a service provider, earning  a modest fee, does not assume responsibility for all the myriad consequences of a  breach, absent a clear undertaking of such risk, especially those risks that are unquantifiable, unpredictable, or would result in a disproportionate liability.

 [2] See for example Star Polaris LLC v. HHIC – PHIL [2016] EWHC 2941 where the term consequential loss was interpreted in the wider “cause and effect” sense.  In the context of the contract the Court was persuaded that the term “consequential loss” must have been used in the wider sense in order to be consistent with the defect guarantee provisions, which were meant to operate as an exclusive code of liability. 

[3] For example, regardless of fault language should be considered to address issues of whether the provision is, as is often the case, intended to apply regardless of cause and even in the event of negligence, breach of duty (whether statutory or otherwise) etc.