Beware Unfortunate Consequences

If the other contracting party is in breach, you can can bring a claim for damages to put you in the position you would have been in had the other performed its duties under the contract correctly.

Under English law, damages (or compensation) can only be recovered if they are foreseeable, a question in legal jargon of ‘remoteness’. The damages are generally held to fall into two categories:

  1. damages arising naturally, i.e., according to the usual course of things, from such breach of contract itself ,
  2. damages such as 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.

This categorisation comes from the seminal case of Hadley v Baxendale [1854] – they are generally referred to as the two ‘limbs’ of damages.

Direct loss

The first limb is based on presumed knowledge, and cover the sort of loss that occur in the great multitude of such cases under ordinary circumstances. No leaps of imagination are needed!

Indirect or consequential loss

The second limb depends on actual knowledge.

The court said that if there were special circumstances under which the court was actually made AND these were communicated to the other contracting party, any damages arising from those special circumstances would be in their reasonable contemplation (second limb).

This categorisation is important as many contracts seek to limit or exclude liability for indirect or consequential losses. However, doing so is quite tricky as recent cases have debated whether eg loss of profits is both direct and indirect. There have also been attempts to redefine consequential loss to cover:

  • anything beyond the normal measure such as profits lost or expenses incurred through the breach [New Zealand]
  • all damages suffered as a consequence of a breach of contract [Australia]

What should you do?

When negotiating a contract, discuss the impact for both contracting parties of the other’s breach and decide which types of direct and indirect losses you should have to pay by way of compensation if you breach the contract.

If there are any that you do not feel you should be liable for, consider whether these can be insured against, avoided, limited or excluded. If you need to do so, identify and precisely list the losses which are insured, excluded or limited – rather by the uncertain and inconsistent categorisation of cases.

An unlimited liability for consequential losses can be extremely risky – a way of betting your business on a single project.

Reference: Hadley v Baxendale [1854] EWHC J70; For more on the approach of English, US, Australian and New Zealand courts to indirect loss, read this Lexology article.

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