A supplier contracts to deliver power-generating equipment. In breach of contract, it supplies equipment that does not work. The customer claims damages including:
- £225,000 replacement equipment cost.
- £159,000 spent on experts, contractors and staff in fixing the problem.
- £558,000 extra power costs while the equipment was not working.
- £666,000 lost revenue while the equipment was not working.
The contract says the supplier is not liable for indirect or consequential loss. Which of these claims, if any, does that exclude? (Answer at the end of the blog.)
Considering how often English-law contracts exclude liability for indirect and consequential loss, there is a surprising gap between what the English courts say it means, and what contract users understand by it.
In January 2018, we asked IACCM members what English-law contracts mean by “The supplier is not liable for indirect or consequential loss”? Of the 221 who answered, just four said they didn’t know. Of the rest, more than half were wrong, according to the Court of Appeal for England and Wales.
What do the English courts say it means?
According to the English Court of Appeal, when used in a limitation clause, both indirect and consequential loss have the same well-established meaning from which the courts cannot, or should not, depart.
And what is that meaning? Well, not any of the usual types of loss you would expect from a breach, because that’s “direct” loss, in the language of damages law. And not a loss that couldn’t have been predicted, because that’s not recoverable (in the language of damages law, it is “too remote”). No, indirect and consequential loss are the exception; they are an unusual sort of loss, caused by a special circumstance. They are recoverable only if they were predictable because the parties were both in a position to know about that special circumstance.
In principle, the Court of Appeal cannot dictate what “indirect or consequential loss” means, outside the context of a specific contract. That’s because each contract is different and because the correct interpretation of a contract term is what a reasonable business person would understand by it.
However, the Court of Appeal has consistently interpreted both indirect and consequential loss in this way, rejecting arguments based on context or on what a reasonable business person might think, in:
- 1935: Millar's Machinery v David Way (1935) 40 Com Cas 204.
- 1978: Croudace Construction Ltd v Cawoods Concrete Products Ltd (1978) 2 Lloyd's Rep 55.
- 1997: British Sugar Plc v NEI Power Projects Ltd  EWCA Civ 2438.
- 2000: Hotel Services Ltd v Hilton International Hotels (UK) Ltd  EWCA Civ 74.
- 2003: Leicester Circuits Ltd v Coates Brothers Plc  EWCA Civ 290, paragraph 63.
The lower courts have, almost without exception, done the same, either because they feel bound to follow the higher court’s decision or because they agree with it. The judges sometimes reason that business parties who limit liability for indirect and consequential loss must have meant what so many courts have said they mean. But that would not have been true for the majority of respondents to our survey.
What did IACCM members think it means?
Less than half of the respondents knew how the English courts interpret an exclusion of indirect or consequential loss.
The “right” answer. Only 47% of respondents picked the Court of Appeal’s normal answer for indirect loss, falling to 32% for consequential loss. (In the survey, they picked the answer “The supplier need not pay losses caused by special circumstances, not arising in the usual course of things.” (A few other respondents gave a more nuanced explanation of this interpretation. And a few linked indirect and consequential loss to remoteness and the law on damages in various ways, not all of them compatible with the Court of Appeal’s view.)
Second or later results. About a third (29%) thought that indirect losses were not the first results of a breach but the second or later results. Rather more (40%) thought this was the meaning of consequential loss. This was the supplier’s argument in the claim summarised at the top of this blog. The judge rejected it in favour of the normal interpretation (see Answer).
Loss of profits. Under 10% said that indirect or consequential loss meant loss of profits. That’s what the supplier argued in the British Sugar case, only to be met by the normal interpretation.
All financial losses. Only about 6% of respondents thought that all financial losses were indirect or consequential. Figure 1: Proportion of respondents choosing each answer
Who were these IACCM members who mostly did not mean what the Court of Appeal says they must be taken to mean? Well, they were fairly evenly divided between those who said they had studied English law and those who said they had not. And all but six of them were working with English-law contracts:
Figure 2: Respondents' training and experience
Perhaps surprisingly, there was little difference between the answers given by those who had studied English law and those who had not, or between the answers of those who identified themselves as drafters or as enforcers.
How should the courts interpret this exclusion?
English judges, without the benefit of evidence, have imagined that the reasonable businessperson would understand “consequential loss” in the same way as they do. That seems unlikely, since most businesspeople have not mastered the law on indirect and consequential loss in awarding damages as an English judge must do. Now, this survey provides evidence that, of 221 lawyers and contract managers who thought they knew what was indirect or consequential, and cared enough to answer a survey about it, less than half understood it in the sense that the Court of Appeal has dictated.
According to the Court of Appeal’s interpretation, indirect and consequential losses are unusual and often not recoverable (even if not excluded). So a supplier doesn’t gain much by the exclusion. That could be one reason the courts have chosen this interpretation, as they try to restrict the impact of a clause that might otherwise exclude most or all of what they would normally award as damages. The courts may continue to use this interpretation to reduce the impact of exclusions they find unjust.
In the one English judgment I have found that departed from the normal interpretation, liability was not completely excluded. A shipbuilding contract created an agreed remedy for breach (to replace and repair all physical damage) and excluded all consequential loss. In 2016, a Commercial Court judge decided that the parties to this contract had departed from the normal meaning of “consequential”. Having created a contractual remedy for breach, they had intended to exclude all other claims, especially financial claims, using “consequential” to mean “as a result or consequence” (Star Polaris LLC v HHIC-Phil Inc  EWHC 2941 (Comm)).
This survey is now one more reason for a court to give a more natural meaning to indirect and consequential loss, as some American, Australian and Scottish courts have done. For example, a court could adopt the interpretation suggested by the judge in an American case (cited in one survey response):
How should we draft our exclusions?
It is still common to exclude indirect and consequential loss. But is it sensible, when half the people negotiating and using the contract don’t agree what that means, and when one English judge has been persuaded to depart from the “normal” interpretation?
“Liabilities” is consistently the top most negotiated term in IACCM’s annual survey. The principle can be very significant financially; does a party accept the risk of unlimited liability if something goes wrong? Yet the clauses we use to redistribute that risk may be inadequate. A supplier may feel secure, after excluding all consequential loss, only to find that hardly anything has been excluded. And the customer who happily accepts the exclusion may be caught out if the Star Polaris decision turns out to be the start of a new interpretation, where most financial losses are excluded. And the definition of consequential loss is only one of the many difficulties in drafting and interpreting traditional exclusions.
One possible alternative is to create a contractual remedy and exclude all other claims for damage, as the parties to the Star Polaris contract did. Another is to identify in plain language the losses a party expects to recover and cap them in the contract, excluding all claims above the cap, as lawyers at London law firm Slaughter and May suggest in their article: Limitation of liability: taking an inclusive approach.
Respondents to the survey offered this practical advice:
- “Without wider drafting the clause doesn't provide a definitive answer: what is included and excluded.”
- “We would request that the customer clarifies and defines consequential losses. We can then price accordingly.”