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Dangers of drafting liability clauses

Hadley & Anor v Baxendale & Ors [1854] EWHC J70 (Hadley v Baxendale) was a landmark decision in English law defining the classification of different types of loss. However, both the UK courts and academia and the Australian courts and academia have been pursuing modified and newly developed principles in this area of law.

As the Australian line of cases develops, contracting parties need to be more careful in the drafting of their liability clauses regardless of whether the party is trying to include or exclude liability.

What is consequential loss?

The idea of consequential loss first emerged in Hadley v Baxendale, as that case categorised loss into two different limbs:

  1. First limb (Objective Test) – Where the loss fairly and reasonably is to be considered to have arisen naturally (i.e. according to the usual course of things) from the breach; or
  2. Second limb (Subjective Test) – Where the loss could be supposed to have been in the contemplation of both parties, at the time of entering the contract, as the probable result of a breach.

While the assumption is that direct loss falls under the first limb and indirect (consequential loss) under the second limb, the Australian Courts have taken a different or modified approach to consequential loss.

Australian approach – some recent cases


The case of Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd (2008) 19 VR 358 (Peerless) marked Australia’s movement away from the strict two limb approach of Hadley v Baxendale.

In Peerless, the Court found that it was not correct to construe ‘consequential loss’ as limited to the second rule in Hadley v Baxendale[1] and that consequential loss should be given it’s natural an ordinary meaning.  The Court defined direct loss in that case as loss “that every plaintiff in a like situation will suffer[2] and consequential loss as anything beyond that normal measure of loss.


Regional Power Corporation v Pacific Hydro Group Two Pty Ltd [No 2] [2013] WASC 356 (Pacific-Hydro) took a narrower view of consequential loss than the Court in Peerless.  In Pacific-Hydro, the Court emphasised that consequential loss be construed in its natural and ordinary within the context of the entire contract.

The Court preferred that approach based on principles set out by the High Court in Darlington Futures v Delco Australia Pty Ltd (1986) 161 CLR 500 (Delco).  In particular, the Court in Pacific Hydro referred to the principle that the meaning of an exclusion or limitation clause must be determined by construing the clause according to its natural and ordinary meaning, read in light of the contract as a whole.[3]

This means that, depending on the facts, loss of profits or economic loss (as was found in Pacific-Hydro) can be considered a direct loss instead of a consequential loss.

Additionally, Pacific-Hydro refers to consequential loss as to “connote a loss at a step removed from the transaction and its immediate effects.”[4]


Patersons Securities Ltd v Financial Ombudsman Service Ltd and Others (2015) 108 ACSR 483 (Patersons) extends the Peerless approach and effectively combines it with Pacific-Hydro’s emphasis on the contract as a context to the liability clause.

Patersons differentiates direct loss as loss which flows naturally from the breach (without another cause) and consequential loss as not flowing naturally from the breach.[5]

This case demonstrates how loss of profits can become a direct loss under the first limb instead of a consequential loss under the second limb depending on its causal proximity to the contractual breach.

Key Takeaway

The key takeaway is that how you deal with the defining or drafting of consequential loss will very much depend on what the contracting parties wish to achieve.  In some instances, a specific narrow definition is appropriate to avoid any unfavourable or unexpected interpretation of the contract by the courts in this unstable and developing area of law.  In others, a broader description enabling court interpretation may be appropriate.

The point is that the issue of defining consequential loss must be addressed and cannot be ignored.

If you would like to discuss this article us, please contact Mike Ellis, partner, or Sarah Kanjanakorn, paralegal on (02) 9261 5900.

[1] Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd (2008) 19 VR 358, 93.

[2] Ibid, 87.

[3] Darlington Futures Ltd v Delco Australia Pty Ltd [1986] HCA 82; (1986) 161 CLR 500, 16.

[4] Regional Power Corporation v Pacific Hydro Group Two Pty Ltd [No 2] [2013] WASC 356, 109.

[5] Patersons Securities Ltd v Financial Ombudsman Service Ltd and Others (2015) 108 ACSR 483, 132.