Excluding liability for consequential loss in M&A deals

• Consequential loss no longer appears to equate to special types of losses contemplated by the parties at the time of making the contract, that is, to the second limb of Hadley v Baxendale.
• Consequential loss is all loss beyond the normal kind of loss that every plaintiff in a like situation will suffer.
• For certainty, parties should specifically identify in the agreement the types of loss intended to be excluded.

In a recent decision, Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd [2008] VSCA 26 (26 February 2008) (Environmental Systems), the Victorian Court of Appeal considered the meaning of ‘consequential loss’ in the context of an exclusion clause. The court unanimously held consequential loss is all loss beyond the normal kind of loss that every plaintiff in a like situation will suffer.

The decision in Environmental Systems runs contrary to previous, but limited, single-judge decisions in Australia as well as the position in the United Kingdom, and has important consequences for drafting exclusion clauses in agreements, and in particular, liability clauses in negotiated M&A deals.

Recoverable loss

In order to successfully recover loss incurred upon a breach of contract, the plaintiff must show that the loss is not too remote from the breach. For this purpose, it must be able to categorise the loss in one of two ways:

• as loss flowing naturally, in the usual course of things, from the breach, or  
• as a special type of loss that was contemplated by the parties at the time of making the contract.  

These tests are respectively known as the first and second limb of Hadley v Baxandale.

Prior to Environmental Systems, it had been generally thought, and suggested by single-judge decisions in Australia and authorities in the United Kingdom, that consequential loss equated to the second limb of Hadley v Baxandale. As such, clauses excluding consequential loss would only be effective in limiting liability for special types of losses that had been contemplated by the parties at the time of making the contract. The decision in Environmental Systems has altered this position in Australia. 

The facts of the case

The relevant facts of Environmental Systems are: 

• the purchaser entered into an agreement with the seller for the purchase of a Regenerative Thermal Oxidiser (RTO)  
• the agreement between the parties contained a clause that stated that the seller does ’not accept liquidated damages or consequential loss’  
• the RTO failed to perform as per the terms of the agreement 
• the purchaser brought an action against the seller for breach of contract  
• the purchaser claimed, amongst other things, damages for additional gas costs that it had incurred as a result of the breach, and 
• the seller defended the claim on the basis that the loss suffered by the purchaser was consequential loss, and therefore liability was excluded under the above clause.

The decision

The judge at first instance followed previous decisions in Australia and in the United Kingdom, and read ‘consequential loss’ as confined to the second limb of Hadley v Baxandale. It therefore upheld the purchaser’s claim for additional gas costs.

However, the Victorian Court of Appeal unanimously overturned the decision at first instance, deciding that that approach was ‘flawed’. The court held that it was not correct to construe consequential loss as limited to the second limb in Hadley v Baxandale.

The court was of the opinion that consequential loss should be given its ordinary and natural meaning. As such, the relevant distinction was between ‘consequential loss’ and ‘normal loss’, where:

• normal loss is loss that every plaintiff in a like situation will suffer, and
• consequential loss is all loss beyond the normal loss.

This expansive definition of consequential loss includes loss that would fall under the first limb of Hadley v Baxandale, such as lost profits and expenses incurred as a result of the breach.

Consequences

The decision in Environmental Systems dramatically alters the previously generally understood meaning of ‘consequential loss’  in Australian law. Accordingly, when drafting clauses excluding liability for consequential loss:

• care should be taken by the parties as until the issue is considered by the High Court of Australia, the law in this area is not settled
• the parties should be aware that ‘consequential loss’ will be interpreted as all loss beyond the normal measure, where the normal measure is the loss that every plaintiff in a like situation will suffer. Consequential loss may include loss of profits and expenses incurred as a result of the breach, and
• for certainty, the parties should specifically identify in the agreement the types of loss intended to be excluded. Where there has been express agreement between the parties the courts will give effect to the parties’ intention.

Name : Martin Shakinovsky
Title : Partner
Office : Sydney
Phone : +61 2 9225 5766
Fax : +61 2 9322 4000
Email : martin.shakinovsky@freehills.com