Law and regulation of consequential damages clauses in the energy sector in Australia

1. Do the words “consequential loss” have a given meaning in law?

Yes. 

Australian law follows the approach taken by the English courts to the assessment of damages set out in the case of Hadley v Baxendale 1 See Hadley v Baxendale [1854] EWHC J70 at [341].  that stated recoverable losses were:

  • Losses arising naturally (i.e., according to the usual course of things) from the breach of contract itself – generally referred to as “direct losses” or the “first limb of Hadley v. Baxendale”; and
  • losses that 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 – generally referred to as “consequential” or “indirect losses”, or the “second limb of Hadley v. Baxendale”.

The words ”consequential loss” were taken to mean losses that “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” (commonly referred to as the ‘second limb of Hadley v. Baxendale’). 

However, please see Section 3 below in relation to the use of the words “consequential loss” in contracts. 

2. Are the words “consequential loss” used in contractual exclusion of liability clauses?

The oil and gas industry frequently uses model form contracts such as those prepared by the Association of International Petroleum Negotiators (AIPN) and AMPLA. 

The AIPN model forms define and exclude “consequential loss”, as part of a defined term “Consequential Loss”. However, the AIPN has also published a ‘User’s Guide’ for use in Australia 2 User’s Guide for Adapting: The 2012 AIPN Model Form International Operating Agreement for use in Commonwealth Waters and/or Coastal Waters, Offshore Australia, Second Edition, published 3 December 2015.  (the “AIPN User’s Guide”). That guide provides as follows in respect of the defined term for “Consequential Loss”:

In light of recent case law, it is uncertain how Australian Courts will interpret the meaning of ‘consequential loss’ going forward. Attention is drawn to the following cases which highlight that parties should carefully consider the drafting and intended extent of coverage of the term ‘consequential loss’: Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd [2008] VSCA 26; Regional Power Corporation v Pacific Hydro Group Two Pty Ltd (No 2) [2013] WASC 356 and Macmahon Mining Services v Cobar Management [2014] NSWSC 502. 3 See page 6.

The approach taken by the Australian Courts is discussed in Section 3 below. 

However, and interestingly, the AMPLA model form Joint Operating Agreements 4 Model Petroleum Joint Operating Agreement, Approved Version 1 and Model Petroleum Exploration Joint Operating Agreement, Approved Version 1, both of which were published on 9 November 2011  define and exclude “Excluded Loss”, which do not use the words “consequential loss” and means:

Excluded Loss means any one or more of: 

  • loss or damage arising out of Petroleum reservoir or formation damage, or any production delay, interruption to or loss of, or any inability to produce, deliver or process, Petroleum;
  • loss or damage incurred, or liquidated or pre-estimated damages or penalties of any kind whatsoever borne or payable under or in connection with any contract for the sale, processing, storage, transportation, or other disposal of Petroleum;
  • loss, or anticipated loss, of use, profit or revenue, loss of business reputation, business interruption of any nature, loss of opportunity, loss of anticipated savings or wasted overheads; 
  • exemplary or punitive damages; or 
  • any loss or damage arising from special circumstances that are outside the ordinary course of things.   

As with most AMPLA model form documents, alternative and optional clauses are also available; there are two alternative definitions of “Consequential Loss” (one refers to “consequential loss” in the definition, the other does not). 5 These are: “Consequential Loss means indirect or consequential loss, damage, loss of production, loss of revenue, loss of use, loss of contract, loss of goodwill or loss of profit, including any such loss or damage suffered by a Participant or the Operator as a result of a claim by any other person against a Participant or the Operator. Consequential Loss means any loss, damages, costs, expenses or liabilities caused (directly or indirectly) by any of the following arising out of, relating to, or connected with this agreement or the operations carried out under this agreement: (i) reservoir or formation damage; (ii) inability to produce, use or dispose of Petroleum; (iii) loss or deferment of income; (iv) punitive damages; or (v) other indirect damages or losses whether or not similar to the foregoing.”  However, in the explanatory note to the Alternative and Optional Clauses for the Model Joint Operating Agreement, users are referred to the AIPN User’s Guide, which (as set out above) contains a cautionary statement regarding the use of the term “consequential loss”. 

In the construction sector, the model forms that are routinely used do not contain clauses excluding consequential loss (although such forms are routinely amended). 6 The usual standard forms are Australian Standard General Conditions of Contract: AS2124, AS4000, AS4300 and AS4902.

However, the NEC4 Engineering and Construction Contract, while not yet among the most common standard forms of contract in use, has gained significant popularity where a more balanced risk allocation is desired. It includes an exclusion for consequential loss at X18.2 (as set out below), however it does not define consequential loss: 

The Contractor’s liability to the Client for the Client’s indirect or consequential loss is limited to the amount stated in the Contract Data. 7 NEC4 Engineering and Construction Contract.

Based on the above, it can be seen that more recent model forms, designed specifically for use under Australian law, seem to avoid using the words “consequential loss” in exclusion clauses. For example, the AMPLA model form Joint Operating Agreements use “Excluded Loss” 8 Perhaps amusingly, although the AMPLA model form Joint Operating Agreement avoids the use of the words “consequential loss” in its drafting (unless the alternatives are elected), it does not in its own disclaimer that disclaims: “AMPLA accepts no responsibility for any loss, cost or expense arising from the use of this Model Exploration JOA and shall not be liable in any manner whatsoever for any direct, incidental, consequential, indirect or punitive damages arising out of the use of the Model Exploration JOA, or any errors or omissions in its contents.”  (It seems that the last exclusion in the AMPLA model form Joint Operating Agreements definition of “Excluded Loss” covers the second limb of Hadley v Baxendale without using the words “consequential loss”.) However, international model forms used in Australia continue to use the term (albeit with a note of caution as to how the words “consequential loss” may be interpreted by the Australian Courts). 

3. If so, what meaning is attributed to the words “consequential loss” in contractual exclusion clauses?

Historically, Australian law followed a line of English Court of Appeal authorities that suggested that, where used in a contractual exclusion or limitation clause, the words “consequential loss” would be taken to mean the second limb of Hadley v Baxendale (absent further definition).  

However, the English approach came under criticism from the Victorian Supreme Court (Court of Appeal) in Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd. 9 Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd [2008] VSCA 26. Arguably, the position changed in 1986 when the High Court of Australia established that the meaning of an exclusion or limitation clause was to be “determined by construing the clause according to its natural and ordinary meaning, read in the light of the contract as a whole” – see Darlington Futures Ltd v Delco Australia Pty Ltd [1986] HCA 82. This was the view of the Western Australian Supreme Court when, in 2013, it came to consider the meaning of “consequential loss” as of 1994 (that being the point in time that the agreement under consideration was executed, and which one of the parties argued was the relevant point in time for determining what “consequential loss” meant; that party also argued that it was well understood in 1994 amongst lawyers and legal draftsmen, that the term “consequential loss” when used in a contractual exclusion or limitation of liability clause, meant the class of contractual losses recoverable under the second limb of Hadley v Baxendale). Nevertheless, it was not until the 2008 Peerless decision that an appeal court considered the meaning of “consequential loss” directly.  In that decision, the court took the view that the English authority appeared to be flawed, since “the true distinction is between ‘normal loss’ which is loss that every plaintiff in a like situation will suffer, and ‘consequential losses’, which are anything beyond the normal measure, such as profits lost or expenses incurred through breach”. 10  Ibid at [87].

The court cited with approval a passage from McGregor on Damages (in which the authors criticised the English approach), which proposed that the “conception of consequential loss should be restored to ‘the natural meaning of which commercial and legal usage in exclusion clauses has long since robbed it”. 11 Ibid at [90].  

The observation was subsequently made that it was possible to read the Peerless decision in one of two ways. First, that it was intended to replace the traditional approach to reading “consequential loss” in an exclusion clause to mean the second limb of Hadley v Baxendale with “a rigid touchstone of the ‘normal measure of damages’ and which always automatically eliminates profits lost and expenses incurred”; 12 Regional Power Corporation v Pacific Hydro Group Two Pty Ltd (No 2) [2013] WASC 356 at [96].  second (and alternatively), that the judge was simply “construing the clause according to its natural and ordinary meaning, read in light of the contract as a whole.” 13 Alstom Ltd v Yokogawa Australia Pty Ltd & Anor (No 7) [2012] SASC 49 at [285].  

It is this latter approach which was taken to be the correct approach (and what had likely been intended in the Peerless decision) in the decision of the Western Australian Supreme Court in Regional Power Corporation v Pacific Hydro Group Two Pty Ltd [2013] WASC 356. In its judgment, the court went on to state that the “natural and ordinary meaning of the words [consequential loss] begins with these words themselves, assessed in their place within the context of the [contract] as a whole”. 14 Regional Power Corporation v Pacific Hydro Group Two Pty Ltd (No 2) [2013] WASC 356 at [97].

This is the approach to be taken in relation to limitation or exclusion clauses generally, as encapsulated in the earlier High Court decision of Darlington Futures Ltd v Delco Australia Pty Ltd (“Darlington Futures”), in which the Court held as follows:

the interpretation of an exclusion clause is to be determined by construing the clause according to its natural and ordinary meaning, read in the light of the contract as a whole, thereby giving due weight to the context in which the clause appears including the nature and object of the contract, and, where appropriate, construing the clause contra proferentem in case of ambiguity. … the same principle applies to the construction of limitation clauses. 15 Darlington Futures Ltd v Delco Australia Pty Ltd (1986) 161 CLR 500 at [16]. [emphasis added]

In Darlington Futures, the court also stated that “[t]he terms of exception clauses must sometimes be read down if they cannot be applied literally without creating an absurdity or defeating the main object of the contract … But such a modification by implication of the language which the parties have used in an exception clause is not to be made unless it is necessary to give effect to what the parties must be understood to have intended”. 16 Darlington Futures Ltd v Delco Australia Pty Ltd (1986) 161 CLR 500 citing a statement by statement by Walsh J (Barwick CJ & Kitto J agreeing) in H & E Van der Sterren v Cibernetics (Holdings) Pty Ltd (1970) 44 ALJR 157, 158.  

Although it is now generally accepted that the term “consequential loss” should be given its natural and ordinary meaning, the courts continue to grapple with its meaning. 

By way of illustration, in Alstom Ltd v Yokogawa Australia Pty Ltd (No 7), 17 [2012] SASC 49 at [281].   the court stated as follows:

To limit the meaning of indirect or consequential losses and like expressions, in whatever context they may appear, to losses arising only under the second limb of Hadley v Baxendale is, in my view, unduly restrictive and fails to do justice to the language used. The word “consequential”, according to the Shorter Oxford English Dictionary means “following, especially as an effect, immediate or eventual or as a logical inference”. That means that, unless qualified by its context, it would normally extend, subject to rules relating to remoteness, to all damages suffered as a consequence of a breach of contract. That is not necessarily the same as loss or damage consequential upon a defect in material where other remedies are also provided. 18 Alstom Ltd v Yokogawa Australia Pty Ltd & Anor (No 7) [2012] SASC 49 at [281].   [emphasis added]

That approach may be contrasted with that taken in GEC Alsthom Australia Ltd v City of Sunshine, 19 (FCA, 20 February 1996, unreported, Library No BC9600288, 20 February1996), as referred to in by Kenneth Martin J in Regional Power Corporation v Pacific Hydro Group Two Pty Ltd (No 2) [2013] WASC 356 at [109].  in which the court stated that in legal parlance the expression “consequential loss” was understood to connote “a loss at a step removed from the transaction and its immediate effects”. 

There is therefore a degree of uncertainty as to what meaning will be attributed to the words “consequential loss” in contractual exclusion clauses (in the absence of such a term being clearly defined).

4. Where a clause includes other heads of loss alongside consequential loss, how will the law approach such clauses?

Each clause will be construed on its own merits (following the approach set out in Darlington Futures).

However, the following considerations are relevant to interpreting a “consequential loss” clause:

  • It is from the contractual wording, read in context, that the parties’ intentions must be ascertained.
  • The court “should not impose a strained construction upon an exclusion clause, but should give effect to the intentions of the contracting parties who are capable of protecting their interests and deciding how to allocate risks”. 20 Glenmont Investments Pty Ltd v O'Loughlin [No 2] [2000] SASC 429 at [258].   
  • A commercial instrument should be given a commercial interpretation. 21 Regional Power Corporation v Pacific Hydro Group Two Pty Ltd (No 2) [2013] WASC 356 at [78].  
  • As to when it will be appropriate to construe a clause contra proferentum, this should “apply only when ambiguity remains after all other avenues of construction have been exhausted.” 22 Zhang v ROC Services (NSW) Pty Ltd [2016] NSWCA 370 citing among others, the remarks of Bathurst CJ in Beefeater Sales International Pty Ltd v MIS Funding No 1 Pty Ltd [2016] NSWCA 217 at [66]   
  • Arguments seeking the application of general rules or principles (for example, that limitation or exclusion clauses are generally not to be construed to apply to wilful and deliberate breaches of contract, or so as to defeat the main object of the contract) are, in and of themselves, likely to be of limited persuasion. Rather, the correct approach is that the nature and scope of a limitation or exclusion clause should be “determined by reference to its proper construction rather than by the application of [a] suggested general rule.” 23  Electricity Generation Corporation t/as Verve Energy v Woodside Energy Ltd [2013] WASCA 36 at [139]. In Nissho Iwai Australia Ltd v Malaysian International Shipping Corporation [1989] HCA 32, an exclusion clause was applied, notwithstanding that it was found to defeat the main object of the contract. Glebe Island Terminals Pty Ltd v Continental Seagram Pty Ltd (1993) 40 NSWLR 206, cited in Electricity Generation Corporation t/as Verve Engergy v Woodside Energy Ltd [2013] WASCA 36 at [142], demonstrates that limitation clauses, on their construction, may apply to wilful or unauthorised breaches of contract

5. Do consequential loss exclusion clauses have an impact on non-damages claims?

In an application for an injunction, consideration of whether or not damages will be an adequate remedy forms part of the court’s inquiry as to whether the balance of convenience favours the granting of the injunction. As to the question of whether or not a consequential loss exclusion clause will be relevant in assessing the adequacy of damages in such circumstances, it appears that the answer is ‘yes’, although the issue has been given only limited judicial consideration.

The English Court of Appeal decision of AB v CD, 24 [2014] EWCA Civ 229.  (in which the English Court decided that in circumstances where a limitation clause exists in a contract, justice will tend “to favour the grant of an injunction to prohibit the breach in the first place”) has been referred to on at least two occasions by Australian courts:

  • The matter of Kaperskey Lab UK Ltd v Hemisphere Technologies Pty Ltd 25 [2016] NSWSC 1476  concerned an injunction to prevent the plaintiff from taking any action or step pursuant to a notice of termination of a distributorship agreement. Under that agreement, the defendant had limited recourse to damages, which the defendant submitted should be taken into account by the court in exercising its discretion as to whether to grant the injunction. The defendant cited the decision in AB v CD in support of its position. However, the court was not satisfied that the English case was relevant, stating as follows:  

I am not satisfied that case is on all fours with these proceedings. It is authority for the proposition that a provision in a contract limiting recovery of damages is not an agreement to excuse the performance of the primary obligation of the contract. I do not regard it as authority for the proposition that a clause limiting the recovery of damages entitles an applicant for an injunction to claim that damages would be an inadequate remedy.

On the other hand, the plaintiff submits that the parties agreed to a regime; they struck a commercial bargain; and the defendant should live with that bargain, having regard to the obvious profits that were made between the parties over the years. Prima facie the plaintiff's submission seems to have force. However, in the circumstances of this case I will take into account the fact that there is limited recourse for the defendant in any claim for damages, if the termination is valid. 26 [2016] NSWC 1476 at [23] and [24].  [emphasis added]

  • In the matter of Sino Iron Pty Ltd v Mineralogy Pty Ltd [No 2] 27 [2017] WASCA 76. , the party seeking an injunction submitted that the effect of an exclusion clause (which excluded liability for indirect or consequential loss or damage) was such that lost profits and special damages would be irreversible, such that if it were to be confined to its legal remedies of debt or damages, that would not be just in all the circumstances. In its observations on the law, the Court of Appeal of the Western Australian Supreme Court referred to the decision of AB v CD. Ultimately, the Court distinguished AB v CD, deciding that in the case before it, the contractual limitation on damages did not point to or give rise to any inadequacy in the claiming party’s legal remedies. 28 [2017] WASCA 76 at [169].  However, the correctness of the approach taken in AB v CD seems to have been accepted. 

It remains to be seen whether AB v CD will be followed in future cases before the Australian courts. 

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