April 17, 2023

Brief: Consequential Loss

In this Brief, our team analyses the origins and current law applying to the principle of consequential losses. In particular, best practice in drafting exclusions of consequential loss in contract.

Navigating the uncertainty of consequential loss limitations

What you need to know:

  • Compensation for loss as a result of a breach of contract has been traditionally considered in two categories: direct loss; and indirect (or consequential) loss.
  • Contracting parties routinely seek to limit or exclude liability for consequential loss claims to reduce their risk exposure.
  • Australian case law highlights the risk of relying on broad (and ill-defined) terms such as 'consequential loss' or 'indirect loss' when attempting to carve out liability for particular losses.

What you need to do:

  • When drafting a contract, ensure that each party has considered the full scope of loss which could be (or should be) recoverable by each party in the event of a breach by either party.
  • When excluding consequential loss from recoverable damages, drafting should clearly identify the specific heads of damage which are to be excluded - to ensure any limitation clauses operate as intended.

Detailed Insights

Historical position

Consequential loss is a term that is not clearly defined within Australian case law.  Hadley v Baxendale (1854) 9 Exch 341 served as the authoritative case on the types of losses recoverable by a party, holding that loss is recoverable due to breach of contract if the loss is not too remote (ie, under the principle of causation). The English Court of Exchequer held that the loss is not too remote where it:

  1. flows naturally or ordinarily from the breach (first limb); or
  2. was within the reasonable contemplation of both parties at the time of entering into the contract (second limb).

Indirect or consequential loss has been traditionally equated with the second limb in Hadley v Baxendale. Contracts commonly include provisions which limit or exclude this category of loss in an attempt to ensure that one or more parties are only liable for the losses naturally or ordinarily flowing from their own breach of the contract (ie, the first limb, as direct losses arising from the breach).

More recent developments in Australian case law

Over time, courts have shifted their focus to determining the natural and ordinary meaning of provisions which attempt to exclude consequential loss.

The use of the term 'consequential loss' in contracts has been commonly used in an attempt by parties to describe the second limb of Hadley v Baxendale, although this has led to some confusion and uncertainty. The second limb test focused on knowledge, while the plain and ordinary meaning of ‘consequential’ relates to a causal link between the breach of contract and the loss.

This shift in focus is demonstrated in the following decisions:

  • Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd (2008) 227 FLR 1 (Peerless)

Peerless Holdings Pty Ltd claimed that Environmental Systems (ES) had breached its contract by supplying a defective vapour emission control system and related services. ES contended that compensation for the cost of labour incurred in attempting to make the system operate and the extra cost of gas items was not recoverable as the contract excluded 'consequential loss'. The Victorian Court of Appeal reconsidered the Hadley v Baxendale test and defined:

  • normal losses as meaning losses that ‘every plaintiff in a like situation would suffer’, and
  • consequential losses as meaning any loss ‘beyond the normal measure … incurred through the breach’.

Based on this approach, the court construed the reference to consequential loss in the contract as including both loss of profit and expenses incurred due to breach of contract. The reasoning in Peerless was later adopted by courts in both NSW and South Australia

  • Regional Power Corp v Pacific Hydro Group Two Pty Ltd (No.2) [2013] WASC 356 (Pacific Hydro)

In Pacific Hydro, the defendant was required to supply electricity to the plaintiff under contract. The defendant failed to supply the electricity, resulting in the plaintiff incurring extra expenses in sourcing supplementary electricity to meet their demand. The defendant sought to rely on a clause excluding damages for consequential loss to reduce their liability.

The WA Supreme Court considered that consequential loss should be given its natural and ordinary meaning in the context of contract. Consideration of the context may include:

  • the construction of the contract as a whole;
  • the intention of the parties; and
  • the commercial context

The court determined that loss of profit and the expenses incurred were not consequential losses and, as a result, were recoverable as direct losses. The court held that Peerless did not intend to establish an inflexible principle that loss of profits can only be categorised as consequential loss, but that it implicitly adopted the constructional approach as applied in this case.

  • Patersons Securities Ltd v Financial Ombudsman Service Ltd and Others (2015) 108 ACSR 483 (Patersons)

In Patersons, the plaintiff invested its clients’ money in a manner that breached the relevant contracts. During preceding independent arbitration, the arbitrator determined that the plaintiff should pay a sum of money to the clients to compensate them for direct financial loss caused by the breach, being the difference between:

  • the value of their actual portfolios; and
  • their portfolios had the monies been invested in accordance with the agreement.

The plaintiff subsequently brought proceedings against the arbitrator and relevant clients (the defendants) to challenge the arbitrator's determination. The plaintiff claimed that the sum should have been properly characterised as consequential losses, which was subject to a contractual limitation.

The court held that, until the point where the clients liquidated their investments (ie selling the securities), the difference between the value of their actual portfolios and their portfolios had the monies been invested in accordance with the agreement was properly characterised as direct loss. This is because the contracts mandated that the clients' money be invested in a particular way, so the plaintiff not complying with the investment strategy directly caused loss equal to that difference in value.

Similar to Pacific Hydro, the court focused on the specific facts of the case when determining the scope of consequential loss. The court went as far as to say that the Peerless decision was not intended to establish an authoritative rule.

What does this mean?

Where parties has previously used the term ‘consequential loss’ as a short-hand catch-all to refer to all losses which are not direct losses (ie, everything within the second limb of Hadley v Baxendale), Australian common law has shifted its focus to interpreting exclusion clauses through their natural and ordinary meaning on a case-by-case basis.

As 'consequential' or 'indirect' loss is not clearly defined or referred to in Hadley v Baxendale, there is a risk that a broadly drafted exclusion clause (ie, which uses this terminology) may be interpreted more narrowly than intended by the parties.

To ensure that the intended head of loss or damage are properly excluded from a contract, best practice is to ensure that exclusion clauses are drafted with specific reference to certain heads of identified damage.  Examples include:

  • loss of profit;
  • loss of opportunity;
  • loss of goodwill; and
  • exemplary, special or punitive damages.

How does this apply to a Defence context?

The current Defence position represents best drafting practice, albeit noting that the types of losses excluded could be expanded. Instead of general exclusion clauses for consequential loss, the ASDEFCON suite of contracts exclude liability for both parties by reference to heads of damage that are often considered 'consequential'. These heads of damage are

  • damage to reputation; and
  • exemplary or punitive damages incurred.

The contractor is also not liable to the Commonwealth for any diminished revenue, profits or business opportunity suffered by the Commonwealth. In other words, the Commonwealth could be liable to the contractor for diminished revenue, profits or business opportunity (except in respect of Government Furnished Facilities, if any), as this exclusion is not reciprocal.

This approach is consistent with Defence Liability Principle 17 (see our recent article) which provides that ‘the Contract will not provide for a general exclusion for “consequential loss”, “indirect loss” or any such similar expressions.’

It is important to remember that the ASDEFCON suite documents are only templates and should be adapted to meet each project's needs. During contract drafting and negotiations, the Commonwealth should identify any additional or other types of loss that should be excluded, and ensure those are included in the exclusion provisions.

Further Information

If you have any questions, or would like specific advice on consequential loss, please feel free to contact us.


Rory Alexander, Principal

Brenton Lam, Associate

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