Indirect/Consequential Loss – why does this continue to be of importance?

November, 2014

Canberra Parliament House at Twilight

Key points:

Recent decisions, both in Australia and the UK, have confirmed that there is no standard legal definition of what constitutes indirect/consequential loss flowing from a breach of contract. Further, what constitutes indirect/consequential loss in the context of a particular contract can have a significant impact on the liability of the parties to that contract.

The Commonwealth (as Principal) is increasingly being presented with provisions by Contractors which seek to limit the Contractor’s liability for breach of contract. Commonly, these provisions have two components:

In this event, determination of what constitutes indirect/consequential loss is critical. If such a provision is included in a contract the Contractor will have no liability for whatever is determined to be indirect/consequential loss suffered by the Principal – the Contractor’s liability will be capped to the monetary limit applicable to the Principal’s direct loss.

What is direct loss and indirect/consequential loss? 

Direct loss is loss that occurs naturally as a consequence of the breach of contract, for example, if the breach of contract causes physical damage to the Commonwealth’s property the cost incurred by the Commonwealth in rectifying that damage will be a direct loss to the Commonwealth.

Indirect/consequential loss is loss that the parties have contemplated will probably result from the particular breach of contract that has occurred. For example, in the situation where the Commonwealth incurs additional costs to a third party as a consequence of the Contractor’s breach of contract. Because recent court decisions have been made purely on the facts of the case before the court it is not possible to identify a definitive legal determination of what will constitute indirect/consequential loss in all cases. In other words, what might be indirect/consequential loss under one contract could be direct loss under another.

Therefore, in the absence of a specific definition in a contract, it is extremely difficult to make a clear determination as to what the Commonwealth is agreeing to when the Contractor’s liability for the Commonwealth’s indirect/consequential loss is excluded.

The Commonwealth Procurement Rules (CPRs)

The CPRs provide that as a general principle contractual risk should be borne by the party best able to manage it. One would normally expect that the Contractor is in the best position to manage the risk of the Commonwealth suffering loss, whether direct or indirect/consequential, resulting from the Contractor’s breach of contract. However, notwithstanding this general principle the Commonwealth may be prepared to agree to limit a Contractor’s liability, for example, in Information and Communications Technology contracts, provided value for money can be demonstrated.

Where a Commonwealth Agency agrees to exclude or limit a Contractor’s liability for breach of contract it is agreeing to change the risk profile under the contract. Once an exclusion and/or limitation of liability is agreed the Commonwealth will bear the losses, which exceed the exclusion or the limit of liability, suffered by it as a result of the Contractor’s breach of contract.

The CPRs, at 8.2, provide:

Relevant entities must establish processes for the identification, analysis, allocation and treatment of risk when conducting a procurement. The effort directed to risk assessment and management should be commensurate with the scale, scope and risk of the procurement. Relevant entities should consider risks and their potential impact when making decisions relating to value for money assessments, approvals of proposals to spend relevant money and the terms of the contract.

Given that there is no standard legal definition of indirect/consequential loss, if an Agency is being asked by a Contractor to give an exclusion or limitation of liability for indirect/consequential loss, the Agency will need to:

Satisfaction of the first point, will involve the Agency and the Contractor settling on what indirect/consequential loss, potentially suffered by the Commonwealth in the event of a breach of contract, will be the subject of the exclusion of liability. It may be that the Contractor will proffer a definition of indirect/consequential loss which can be the basis of negotiation between the Agency and the Contractor. If no definition is proffered by the Contractor then the Agency will need to consider what elements of indirect/consequential loss, if any, should come within the exclusion.

Once the nature and extent of the indirect/consequential loss has been settled the Agency can then conduct the appropriate analysis, most commonly a formal risk assessment, of the risk assumed by the Commonwealth to assess whether value for money is achieved by the Agency agreeing to the particular exclusion.

 

Contact Mills Oakley:

rohan-white

Rohan White
Partner
T: +61 2 8289 5863
M: +61 407 969 606
E: rwhite@millsoakley.com.au

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