Law and regulation of consequential damages clauses in the energy sector in New York

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

Yes. As explained below, the words relate to the second limb of the test for recoverable damages originally set out in the English case of Hadley v Baxendale 1 (1854) 9 Exch 341.  (see England Chapter) as subsequently adopted in New York law. 

As far back as 1894, the United States Supreme Court accepted Hadley v Baxendale as “a leading case on both sides of the Atlantic” concerning the recoverability of losses. 2 Primrose v Western Union Tel Co, 154 US 1 (1894).  Hadley v Baxendale has been “cited with approval by the highest court in 43 states”, including New York, and it has since been referred to by academic commentators as ”recognised in American jurisprudence as the definitive source of determining when consequential damages may be recoverable for breach of contract”. 3 Diamond and Foss, ‘Consequential Damages for Commercial Loss: An Alternative to Hadley v Baxendale’ (1994) 63 Fordham Law Review 665.

The Restatement (Second) of the Law of Contracts broadly follows the structure of Hadley v Baxendale – although not articulated in entirely the same manner: 

  1. "Damages are not recoverable for loss that the party in breach did not have reason to foresee as a probable result of the breach when the contract was made. 
  2. Loss may be foreseeable as a probable result of a breach because it follows from the breach
    1. in the ordinary course of events, or
    2. as a result of special circumstances, beyond the ordinary course of events, that the party in breach had reason to know.”

The commentary to the Restatement (Second) of the Law of Contracts explains that “in the ordinary course of events means: ‘Such loss is sometimes said to be the ‘natural’ result of the breach, in the sense that its occurrence accords with the common experience of ordinary persons. The damages recoverable for such loss that results in the ordinary course of events are sometimes called ‘general’ damages.” It goes on to say: “The damages recoverable for loss that results other than in the ordinary course of events are sometimes called ‘special’ or ‘consequential’ damages. These terms are often misleading, however, and it is not necessary to distinguish between ‘general’ and ‘special’ or ‘consequential’ damages for the purpose of the rule stated in this Section.” 4 The Restatement (Second) of the Law of Contracts, 351, Comment b.

In relation to a buyer’s damages for goods accepted in a sale and purchase arrangement, the New York Uniform Commercial Code states that “consequential damages” may be recovered in a “proper case” and that: “Consequential damages resulting from the sellers breach include (a) any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise’. 5 2-714 to 2-715.    

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

Yes. The words ”consequential loss” are widely used in exclusion clauses in the energy and other sectors. For example: 

International Association of Drilling Contractors – Daywork Drilling Contract 

14.12. Consequential Damages: Subject to and without effecting the provisions of this Contract regarding the payment rights and obligations of the parties or the risk of loss, release and indemnity rights and obligations of the parties, each party shall at all times be responsible for and hold harmless and indemnify the other party from and against its own special, indirect or consequential damages, and the parties agree that special, indirect and consequential damages shall be deemed to include, without limitation, the following: loss of profit or revenue; costs and expenses resulting from business interruptions; loss of or delay in production; loss of or damage to the leasehold; loss of or delay in drilling or operating rights; cost of or loss of use of property, equipment, materials and services, including without limitation those provided by contractors or subcontractors of every tier or by third parties. Operator shall at all times be responsible for and hold harmless and indemnify Contractor and its suppliers, contractors and subcontractors of any tier from and against all claims, demands and causes of action of every kind and character in connection with such special, indirect or consequential damages suffered by Operator’s co-owners, co-venturers, co-lessees, farmers, farmees, partners and joint owners.

A.A.P.L. Model Form 710-2002 (Model Form of Offshore Operating Agreement)

19.7 Damage to Reservoir, Loss of Reserves and Profit 

Notwithstanding any contrary provision of this Agreement, other than articles 10.8.6 and 11.8.6, if selected, no Party is liable to any other Party for damage to a Reservoir, loss of Hydrocarbons, loss of profits, or other consequential damages, damages for business interruption, or punitive damages, except to the extent that the damage or loss arises from a party’s gross negligence or willful misconduct, in which case that Party shall be solely responsible for damage or loss arising from its gross negligence or willful misconduct; nor does a Party indemnify any other Party for that damage or loss.

North American Energy Standards Board - Base Contract for Sale and Purchase of Natural Gas

For breach of any provision for which an express remedy or measure of damages is provided, such express remedy or measure of damages shall be the sole and exclusive remedy. A Party’s liability hereunder shall be limited as set forth in such provision, and all other remedies or damages at law or in equity are waived. If no remedy or measure of damages is expressly provided herein or in a transaction, a party’s liability shall be limited to direct actual damages only. Such direct actual damages shall be the sole and exclusive remedy, and all other remedies or damages at law or in equity are waived. Unless expressly herein provided, neither Party shall be liable for consequential, incidental, punitive, exemplary or indirect damages, lost profits or other business interruption damages, by statute, in tort or contract, under any indemnity provision or otherwise. It is the intent of the parties that the limitations herein imposed on remedies and the measure of damages be without regard to the cause or causes related thereto, including the negligence of any party, whether such negligence be sole, joint or concurrent, or active or passive. To the extent any damages required to be paid hereunder are liquidated, the parties acknowledge that the damages are difficult or impossible to determine, or otherwise obtaining an adequate remedy is inconvenient and the damages calculated hereunder constitute a reasonable approximation of the harm or loss.

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

Judicial precedent on the interpretation on the meaning of “consequential loss” in contractual exclusion clauses is controversial and, arguably, not always consistent. 

In New York law, there is no ‘bright line’ between “direct loss” and “consequential loss”. Any such approach would violate the case-specific approach of New York law.

There are various New York court precedents on whether loss of profits amounts to excluded consequential loss. The distinction at the heart of many such cases decided by the New York courts is whether the lost profits flowed directly from the contract itself or were, instead, the result of a separate agreement with a non-party (see Tractebel Energy Mktg. v. AEP Mktg. (487 F3d 89, 109 [2d Cir2007] )). In most cases the second category is considered to be “consequential loss”. The logic of this approach flows from Hadley v Baxendale: If the loss flows specifically from a separate agreement, it will usually require some form of special knowledge (or “reason to know”) of the terms of that separate contract by the breaching party to create a liability in damages for losses flowing – which makes it “consequential loss”. 

However, where the very nature of the contract itself establishes that the loss in question must be known to the breaching party, New York law considers loss of profits to be direct loss. For example, in Biotronik AG v Conor Medsystems Ireland Ltd 6 2014 WL 1237154 (NY 27 March 2014).  the New York Court of Appeal was required to consider a clause in a distribution agreement that excluded: “any indirect, special consequential, incidental or punitive damage”. The issue was whether a loss of profits under a separate onward sale agreement between the innocent buyer and a third party were excluded. Interestingly, the price the innocent buyer was to pay to the breaching seller was based on the pre-agreed on-sale price between the buyer and the third party. As such, the majority of the New York Court of Appeal decided the price under the separate agreement formed part of the contractual arrangements and resulted in a “direct loss” as it was a loss that ordinarily flowed from the breach. 

Arguably, the reasoning in Biotronik AG v Conor Medsystems Ireland Ltd would support a proposition that ”consequential loss” shall be construed to mean the second limb of Hadley v Baxendale as restated in The Restatement (Second) of the Law of Contracts. 

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

 In Biotronik the majority of the New York Court of Appeal took the following approach to interpreting a consequential loss exclusion clause:

  1. First, does the clause specifically preclude recovery of the loss claimed, or explicitly define the item as excluded “consequential damages”? 
  2. Second, if not, it is necessary to consider precedent for guiding principles to assist in determining whether, under the agreement in question, the losses claimed are general (“direct”) damages and therefore recoverable.
  3. Third, the distinction between general and consequential/special contract damages is well defined, but its application to specific contracts and controversies is usually more elusive. 
  4. Fourth, New York law adopts a case-specific approach to distinguish general damages from consequential damages.
  5. Finally, any distinction sourced solely from precedent should be viewed cautiously, as any attempt to establish a ‘bright-line rule’ violates New York law’s case-specific approach. 

New York law will not permit an exclusion clause that seeks to exclude liability for harm wilfully inflicted or caused by gross or wanton negligence.

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

New York courts have the discretion to grant preliminary injunctions. The movant for such an injunction must show: (i) probability of success on the merits; (ii) irreparable harm absent the injunction; and (iii) the balance of the equities favouring the relief sought.

It is possible to see arguments as to how the existence of a ”consequential loss” exclusion clause, where all of the losses suffered fell within the scope of the exclusion, might impact: the existence of “irreparable harm” and “the balance of the equities”. The movant would doubtless argue that absent the injunction it may be left with no remedy, which would be “irreparable harm” and “inequitable”. The party responding to the motion would doubtless argue “irreparable harm” and “inequality” cannot occur when the movant receives the remedy (or lack thereof) for which it bargained.

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