Exclusions of Consequential Damages - Are They Inconsequential?

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1 Exclusions of Consequential Damages - Are They Inconsequential? Prepared For: Legal Education Society of Alberta Construction Law Presented by: E. Jane Sidnell Calgary, Alberta For Presentation in: Edmonton February 17, 2015 Calgary February 24, 2015

2 EXCLUSIONS OF CONSEQUENTIAL DAMAGES - ARE THEY INCONSEQUENTIAL? LESA Construction Law Conference February 2015 Prepared by E. Jane Sidnell Partner An updated version of "Consequential Damages: Are Exclusions of Consequential Damages Inconsequential" (2010) I J.C.C.C.L. 109 File:

3 EXCLUSIONS OF CONSEQUENTIAL DAMAGES ARE THEY INCONSEQUENTIAL? E. Jane Sidnell TABLE OF CONTENTS 1. INTRODUCTION ORIGINS OF THE RULE APPLICATION OF THE RULE AND THE DETERMINATION OF DIRECT VS. INDIRECT DAMAGES OVERVIEW OF SIGNIFICANT DECISIONS DEPARTURE FROM THE PREVAILING VIEW NEW AND OLD PERSPECTIVES (a) Canadian Perspective (b) Australian Perspective (c) American Perspective APPLICATION OF PRINCIPLES OF FORESEEABILITY PITFALLS IN DRAFTING CONCLUSION LIST OF AUTHORITIES Page 1 of 30

4 1. INTRODUCTION How often have you seen a bald exclusion of "consequential damages" in a contract? Exclusions of "consequential damages" are widespread and, amongst business people and lawyers alike, there appears to be an ordinary and natural meaning commonly associated with that phrase which encompasses "everything beyond the normal measure of damages, such as profits lost or expenses incurred through breach". 1 In other words, "consequential damages" are commonly understood to be those damages that are economic in nature and that are beyond the damages associated with physical loss. This is not, however, the prevailing legal interpretation of the phrase. How is it possible that business people have a common understanding of the phrase "consequential damages" that is not aligned with the legal interpretation? Have the courts taken an approach that does not reflect business as it is negotiated? In 1854, the Court of Exchequer issued its decision in Hadley v. Baxendale, 2 likely unaware of the legacy it would leave. 3 Now we are entering a new era where the old rules, often applied, though not always consistently, are under scrutiny as courts assess them to determine whether they are applicable to modern commercial transactions. This article looks at the origins of the Hadley v. Baxendale rules, considers how those rules have been applied over the years and assesses the new cases that are taking a different view of the interpretation of the phrase "consequential damages". 2. ORIGINS OF THE RULE The facts that gave rise to Hadley v. Baxendale related to a contract to transport parts for a flour mill. The crank-shaft of the steam engine broke and the mill could not be operated. The plaintiff owners ordered a new crank-shaft to be made, which required sending the broken shaft to the repair facility for sizing. The owners alleged that the defendant courier promised to deliver the broken shaft to the repair facility the second day after the owners dropped it off but that the courier took seven days to deliver the broken shaft. As a result of the delay, the completion of the new shaft was delayed for five days, which translated into lost profits for those days and the payment of wages paid during the shut-down period. The courier paid for the cost of the wages for the workers, but resisted the claim for lost profits. 1 Environmental Systems Pty Ltd. v. Peerless Holdings Pty Ltd. [2008] VSCA 26, Hadley v. Baxendale (1854), [ ] All E.R. Rep. 461 (Ex. Div.). 3 For a discussion of why the Hadley v. Baxendale case should not be followed in modern contract law see M.A. Eisenberg, "The Principle of Hadley v. Baxendale" (1992) 80 Cal. L. Rev Page 2 of 30

5 The courier defended the claim on the basis that the damage was too remote. When the Court heard the matter on appeal, it set out two rules for the recovery of damages. Losses had to fall into one of the rules to be recoverable: 1. those losses that arise naturally, according to the usual course of things, from the breach of contract itself; or 2. if special circumstances were communicated by the plaintiff to the defendant, those losses that may have been reasonably supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach. Alderson J. declined to award damages to the owners because the only particulars communicated by the owners to the courier at the time the contract was made was that the courier was to deliver the broken shaft and that the owners were the owners of a mill. 4 It is the second rule in the Hadley v. Baxendale that gives rise to the issue of whether or not "consequential damages" are recoverable as they are only available where special circumstances have been contemplated by the parties. This was explained by Alderson B: If special circumstances under which the contract was actually made were communicated by the plaintiffs to the defendants, and thus known to both parties, the damages resulting from the breach of such a contract which they would reasonably contemplate would be the amount of injury which would ordinarily follow from a breach of contract under the special circumstances so known and communicated. But, on the other hand, if these special circumstances were wholly unknown to the party breaking the contract, he, at the most, could only be supposed to have had in his contemplation the amount of injury which would arise generally, 4 Note that at the trial there was evidence that an employee of the owner attended at the courier's office the day before the shaft was dropped off and made enquiries. During this exchange, the courier's clerk was advised that "the mill was stopped and the shaft must be sent immediately" and that in reply to this comment the courier's clerk said that if the broken shaft was dropped off before noon, it would be delivered the following day. This brings into focus that part of the second rule, which states the special circumstances must be in the parties' contemplation at the time they made the contract. See Hadley v. Baxendale, supra note 2, at p. 464H This point is taken up in Victoria Laundry (Windsor) Ltd. v. Newman Industries Ltd., [1949] 2 K.B. 528 (C.A.), where Asquith L.J. states, "If the Court of Exchequer had accepted these facts as established, the court must, one would suppose, have decided the case the other way round must, that is, have held the damage claimed was recoverable under the second rule, but it is reasonably plain from the judgement of Alderson, B., that the Court rejected this evidence... ". See Victoria Laundry, supra at p F. Page 3 of 30