CMS Guide to Consequential Loss in Israel

The Israeli legal system in general, and Israeli contract law in particular, cannot be categorized as part of one unified legal family (e.g. common law or civil law). Israeli law is a unique mixed jurisdiction. Although Israeli contract law (namely: legislation, court rulings 1  and jurisprudence) is based on civil law, common law and Jewish law, it is an autonomous system. 

In order to establish whether the words “consequential loss” have a given meaning in law, it is necessary to consider the position both under legislation and by reference to court rulings.

Israeli legislation

The words “consequential loss” do not appear in the any Israeli statute. Therefore, these words do not have a specific given meaning under Israeli statute law.

The relevant statute which deals with delimitation of damages for breach of contract is the Contracts (Remedies for Breach of Contract) Law 1973 (the “Remedies Law”). Section 10 provides as follows:

• The injured party is entitled to compensation for the damage caused to him by the breach and its consequences and which the person in breach foresaw or should have foreseen, at the time the contract was made, as a probable consequence of the breach.

This provision therefore stipulates four cumulative conditions which must be met in order for the injured party to be entitled to the right to compensation due to breach of contract. First, damage caused by the breach. Second, causation between the damage and the breach. Third, foreseeability of the damage due to the breach. Fourth, the extent of the damage.

Section 10 of the Remedies Law lays down two delimitation tests: causation and foreseeability. The causation test restricts the application of the foreseeability test: In delimiting the damage, the court will first determine which damages were caused by the breach. Following the application of the causation test, the court will then determine, in relation to the damages caused by the breach, which damages were also foreseeable. Compensation will be awarded only in respect of such damages which pass both tests.

The following rules, established in the provision of Section 10 of the Remedies Law, assist in the application of the foreseeability test:

• In contrast to the rule laid down in Hadley v Baxendale, 2  the court is concerned only with what was foreseen or foreseeable by the party in breach (and not what may reasonably be supposed to have been in contemplation of both parties). 
   
• Foreseeability is subject to an objective test: damage which a reasonable person is expected to have foreseen and expect, which will be assessed by the court. Where the damage should have been foreseen it matters not whether it was in fact foreseen. Conversely, where the damage was in fact subjectively foreseen, it matters not whether it should have been foreseen.
   
• Foreseeability, both actual and potential, is determined in relation to the time the contract was made, and in accordance with the factual data known at the time, or which should have been known, to the party in breach. Subsequent events will not be taken into account in applying the foreseeability test.
   
• Actual foresight has an objective aspect: compensation will be awarded against the party in breach in relation to damage foreseen as a probable, and not only as a certain, consequence of the breach. The objective determination of the probability of the damage resulting from the breach applies to both actual and potential foreseeability.

Israeli court rulings

The words “consequential loss” have not been defined by the courts. Therefore, these words do not have a specific given meaning under case law. However, please see Section 3 below in relation to the use of the words “consequential loss” in contracts.

Yes. Contracts governed by Israeli law sometimes seek to exclude or limit the scope of the right to compensation for “indirect” and/or “consequential” loss.

The energy industry has recently gone through a process of liberalisation. In turn, liberalisation has resulted in market structures and contracting on the basis of international model form agreements and concepts. Experience suggests that “consequential loss” exclusions have appeared and proliferated as part of this process.

Example clauses are as follows:

• In respect of an agreement relating to a construction project: “…neither Party, nor its officers, directors, agents, employees, or affiliates, shall be liable to the other Party, its subsidiaries, affiliates, officers, directors, agents, employees, successors or assignees, for claims for incidental, indirect or consequential damages of, or in any nature connected with or resulting from, performance or non-performance of this Contract, including, inter alia, claims for loss of profit or revenue, loss of use of equipment, and cost of capital or return on capital irrespective of whether such claims are based upon warranty, negligence, strict liability, contract, operation of law or otherwise…”
   
• In respect of a power purchase agreement: “Neither party shall be liable to the other party for indirect or consequential loss or damage, or punitive damages or indirect costs or expenses or loss of profits, loss of production, loss of revenue, loss of contracts, or loss of personal injury or damage to property…”
   
• In respect of a gas sale and purchase agreement: “The Buyer shall not be liable to the Sellers and the Sellers shall not be liable to the Buyer for any indirect (which includes loss of profit and business interruption claims), consequential, exemplary or punitive losses or damages.”

There is no developed jurisprudence of the Israeli courts on the meaning of ‘consequential loss’ when used in the context of exclusion or limitation clauses in contracts. Every contract and each clause will be construed on its own merits, and in accordance with the general principles of interpretation.

The main rule of contractual interpretation is stipulated in section 25(a) of the Contracts (General Part) Law 1973 as follows: “A contract shall be interpreted in accordance with the presumed intention of the parties as it appears there-from and as appearing from the circumstances. However, if the intention of the parties is clearly implied from the language of the contract, the contract shall be interpreted according to its language”. 3

The test applied is an objective test of reasonableness: the intention of the parties, who are assumed to be reasonable, is determined objectively in accordance with the language of the contract and the external circumstances of the case. 4

Although the distinction between direct and indirect losses has been considered most often in insurance contracts, it seems likely that the court will adopt the same approach in energy cases. See C.A. 3577/93 Phoenix Insurance Co. v. Mariano, PD48(4)70,83-84 and C.A. 78/04 Hamagen Insurance Co. v. Gershon (Nevo, 2006). The Israeli courts have distinguished direct loss from indirect or consequential loss as follows:

• Direct loss is the loss arising naturally in the normal course of things from the breach of contract itself. It is the first manifestation of the harm to the injured party’s wellbeing, which can be identified and separated from the other damages for breach that arise after it.
   
• Indirect or consequential loss, on the other hand, is damage to the injured party's wellbeing that has been rolled over from the initial damage but is not an integral part of it. This loss is a separate and later link in the causation chain that begins with the act of the breach.

However, it is not apparent whether the meaning attributed in insurance law would have an application in the different context of exclusion or limitation clauses.

Each clause will be construed on its own merits (applying the rules of contract interpretation set out in Section 3 above).

In addition, section 25(b) of the General Contracts Law provides as follows:

• Where a contract is capable of different interpretations, and one of the parties had precedence over the other in the formulation of its terms, an interpretation against the formulating party is preferable to an interpretation in his favour.

As a result, the law now stipulates that an ambiguity in the contract giving rise to two equal reasonable interpretations will be interpreted against the party who drafted the contract and in favour of the other party. The justification for this provision rests on the principle that a person is responsible for his or her actions. As in the case of English law, from which the rule was adopted, Israeli courts had applied the rule primarily in the context of standard contracts (especially insurance contracts), where the party drafting the contract is usually also the stronger of the two parties to the transaction.

Section 25(b) is broader than the contra stipulatorem rule and does not refer only to cases whereby the contract was entirely drafted by one of the parties, but also applies to situations where one of the parties had precedence in the formulation of the terms of the contract.

Upon the occurrence of an anticipatory breach, the injured party is entitled to the remedies under the Remedies Law, as if the breach had occurred already. The contract is regarded as breached, backdating the performance of the contract and the right to any remedy to the date of the anticipatory breach.

The first alternative of anticipatory breach is a subjective one, sometimes referred to as repudiation or renunciation. It occurs when the party in breach indicates his intention not to perform the contract or when circumstances show that he is unwilling to perform it. The second alternative of anticipatory breach is an objective one, sometimes referred to as disablement performance. It pertains to a situation where it is apparent that the other party will be unable to perform the contract.

However, these remedies will likely result in damages. It is unlikely that the courts will require performance by restraining a breach from occurring. Also, there is no existing court jurisprudence to suggest that any exclusion or limitation on the innocent party’s right to damages would alter this position.