Parties to a construction contract should stipulate precisely what types of flow-on losses are intended (or not intended) to be covered by the term "consequential loss".
Construction contracts, procurement contracts, leases, and many other types of commercial contracts often contain a clause excluding or limiting a party’s (or both parties’) liability (including liability under an indemnity) for consequential loss.
Consequential loss is often a discussion point in negotiations, and, in a construction context, contractors may refuse to do business with an owner unless their liability for consequential loss is excluded or limited. If drafted appropriately, this protects the contractor from liability for "indirect" or "consequential" losses such as the owner’s loss of revenue or loss of profit as a result of the contractor’s breach of the contract.
Recent Australian case law has highlighted the importance of carefully drafting consequential loss provisions. If consequential loss provisions are not drafting carefully:
- Owners may find they are completely unable to recover for certain types of losses following a breach of contract by the contractor or supplier – losses which could have drastic consequences on their business;
- Contractors and suppliers they may find that, in breaching the contract, they are liable for certain types of consequential loss and thereby exposed to extensive liabilities, potentially well in excess of the contract value; or
- Owners may find that, in breaching the contract, they are liable to contractors or suppliers for their losses of profits and therefore exposed to extensive liabilities.
Australian courts’ interpretation of consequential loss provisions
Australian courts’ interpretation of consequential loss has evolved significantly since the landmark 1854 case of Hadley v Baxendale (1854) 9 Exch 341.
In Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd  VSCA 26 (Peerless), the Victorian Court of Appeal made a distinction between "normal loss" –loss that every plaintiff in a like situation will suffer – and "consequential loss" in respect of which Nettle JA observed as follows:
In my view, ordinary reasonable business persons would naturally conceive of “consequential loss” in contract as everything beyond the normal measure of damages, such as profits lost or expenses incurred through breach.
However, subsequently in Regional Power Corporation v Pacific Hydro Group Two Pty Ltd (No 2)  WASC 356, Martin J did not follow Peerless, but instead took the approach taken by the High Court in Darlington Futures Ltd v Delco Australia Pty Ltd (1986) 161 CLR 500. In that case, the High Court provided that:
The interpretation of an exclusion clause is to be determined by construing the clause according to its natural and ordinary meaning, read in the light of the contract as a whole, thereby giving due weight to the context in which the clause appears including the nature and object of the contract, and, where appropriate, construing the clause contra proferentem in case of ambiguity.
The subsequent decision in Macmahon Mining Services v Cobar Management  NSWSC 502 has reaffirmed the approach taken in Peerless. However, there remains significant uncertainty about the interpretation of consequential loss provisions in Australia.
The recent Australian cases on consequential loss highlight the importance of precisely stipulating the types of flow-on losses which are, and are not, intended to be covered by the term "consequential loss". In the event of a dispute, this will reduce the possibility of a court interpreting the parties’ intention differently to the bargain reached by the parties.