Wording excluding liability for “indirect or consequential losses” frequently appear in contracts. The familiarity of such wording tends to encourage acceptance and to obscure the fact that its meaning may be uncertain. What exactly does “indirect” or “consequential” mean in legal terms and how are they to be distinguished from “direct” losses? The distinction can be important in determining where liability should fall in the context of large claims under a contract containing a clause excluding liability for indirect or consequential losses.
The approach under English law
Under English law the distinction between “direct” and “indirect” losses is based on what was foreseeable (i.e. what was in the contemplation of the parties at the time when the contract was made) and not upon the type of loss involved (e.g. economic loss, loss of profit, loss of saving, etc.).
Background – What damages are recoverable for breach of contract
Compensation for breach of contract aims to place the innocent party in the same position as if the contract had been performed.
The courts’ approach to assessing damages has been expressed as follows1:
“Where two parties have made a contract which one of them has broken, the damages which the other parry ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered either arising naturally, i.e. according to the usual course of things, from such breach of contract itself or such as may be reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result if it.”
In other words damages may be recovered for:
(a) Losses that at the time of contract were reasonably foreseeable and “which flow naturally from the breach without other intervening cause and independently of special circumstances “2 (i.e. Direct losses); and, if applicable,
(b) Any further losses within the contemplation of both parties at the time when the contact was made that were not the direct and natural result of the breach (Indirect or consequential losses)3.
Any losses that do not fall within either of the above “limbs” are considered as being too remote to be recoverable.
The starting point in any case is likely to be to establish the direct losses in the circumstances of that case.
As mentioned above the type of loss does not itself determine whether it is to be considered a direct or indirect loss. Loss of profit, for example, could be a direct or an indirect loss depending on the circumstances. Examples of loss of profit being held to be direct loss include loss of profit resulting from the loss of use of hired equipment4 and loss of profit resulting from the destruction of a production facility5.
Drafting considerations
It follows that when preparing a contract subject to English law it should not be assumed that any particular types of loss are covered by words referring to indirect or consequential loss. If liability for any particular types of loss is to be excluded then it is recommended that these types of loss should be expressly listed unconnected to any reference to indirect or consequential loss.
If the words “indirect” or “consequential” are to be used then consideration may also be given to what losses these words are intended to cover. It is always open to the parties to treat such words as defined terms by including in the contract an express definition of indirect and consequential losses that may differ from the meaning that would otherwise be applied as referred to above.
1 Hadley & Anor v Baxendale & ors [1854] 9 Exch. 341
2 Saint Line ltd v. Richardsons Westgarth Co Ltd (1940) 67 Ll L Rep 62
3 Croudace Construction v Cawoods (1978) 8 BLR 20
4 Hotel Services Ltd v Hilton International Ltd [2000] BLR 235
5 Deepak v ICI [1999] 1 Lloyds Rep. 387
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