This is our third Update on an aspect of Alstom v YDRML.[1] In this Update we discuss a new approach to the classification of compensation for breaches of contract.
Historical background
The general rule is that when one party breaches a contract, the innocent party is entitled to damages to compensate for the breach. The amount of compensation is usually calculated by reference to the damage suffered because of the breach. Compensation should be sufficient to put the innocent party into the position they would have been in, if the defaulting party had not breached the contract.
This general rule has been the subject of modification and clarification over the centuries as judges have applied the law to particular cases. Quite apart from judge made law, parties entering into contracts usually agree to clarify in writing who is assuming the risks that might arise if either party breaches the contract.
By way of example, a contractor building a factory might exclude in the contract terms the possible loss of profits that would arise if the completion date of the factory is delayed.
Hadley v Baxendale
The 1854 English case of Hadley v Baxendale has long been considered as a guide to classifying the types of damages that are compensable after a breach of contract.
Hadley operated a flour mill. Baxendale was a carrier and entered into a contract with Hadley to carry the flour mill’s faulty crankshaft to the repairer. Baxendale breached the contract by delaying delivery for an extra 5 days. Hadley then claimed the loss of profit suffered because the mill remained closed for the extra 5 days
The Court distinguished between two types of damages, the first of which is typically recoverable for a breach of contract and the second of which may, depending on the circumstances, be recoverable. Since 1854 these two types of damages have been classified as the “first limb” and the “second limb” of Hadley v Baxendale damages.
An injured party may recover damages:
1. reasonably considered to arise naturally from a breach of contract (“first limb”); or
2. those damages within the reasonable contemplation of the parties at the time of contracting (“second limb”).
Baxendale thought that Hadley possessed a spare crankshaft. The court said that if Baxendale had known that Hadley’s mill only had one crankshaft, he would have been liable for the loss of profit, i.e the second limb damages. However, because Baxendale did not know that the mill was closed, the loss of profits was not within his reasonable contemplation.
The court held that in this case the rule should be that the only damages payable were those fairly and reasonably considered to have arisen naturally from the breach itself, i.e. any first limb damages. Hence Baxendale did not have to pay Hadley’s loss of profit over the extra 5 days.
Over the years, this “second limb” of Hadley v Baxendale losses has been described as indirect or consequential loss. Frequently, parties include a term in their contract stating that if either party breaches the contract, it is not liable for consequential loss. Otherwise, there can be disagreement as to who knew what about the likely consequences of any particular breach.
Alternatively, the consequence of a breach might be clearly expressed in the contract and the defaulting party is made aware at the time of entering the contract that if it breaches, it will be liable for the loss and damage that flows.
We now turn to discuss the change to this position in Alstom. A brief recap of the facts of Alstom follows.
The background
Playford B power station was to be refurbished by Alstom under a turnkey head contract with Flinders Power Partnership (“FPP”). The head contract sum was $148.5 million.
The refurbishment contract involved bringing the 1950’s power station up to date. A substantial component of the works was the installation of electrical, control and instrumentation systems in order to allow remote buyantibioticsonline.org operation of the power station. Alstom subcontracted these works to Yokogawa and Downer EDI (“YDRML”). The subcontract was for $33.88 million.
The subcontract contained an exclusion clause in bold font stating:
“Notwithstanding any other Article of this [subcontract], [YDRML] shall not be liable for any indirect, economic or consequential loss whatsoever.”
Other terms of the subcontract required YDRML to pay damages if it did not complete the works on time or if the works did not meet various performance tests.
Alstom made various claims against YDRML for breaches of contract and sought compensation in relation to those breaches. Alstom said that YDRML’s breaches of contract had resulted in losses that flowed naturally from the breach and were therefore damages included within the “first limb” of Hadley v Baxendale.
YDRML disagreed with this submission and said that the exclusion clause quoted above should be read more generally to include losses that occurred as a consequence of breaches of contract and that, even if YDRML had breached the contract and caused loss to Alstom, the exclusion clause relieved it of any liability for those breaches.
The Findings of the Court
The Court reviewed various authorities on exclusion clauses and noted that these clauses are to be interpreted literally. The Court said that the losses claimed by Alstom were indeed losses that fell within the first limb of Hadley v Baxendale but that the breadth of the exclusion clause meant that YDRML was not liable for any damages that occurred as a consequence of any claimed breaches of contract. Accordingly, consequential losses were found to lie within the first limb of Hadley. This is a significant move in judicial thinking. The following quotation from Alstom clarifies the position:
“The expression “indirect … or consequential loss” appears, in this case, as part of a freestanding and powerfully expressed exclusion clause. It is not affected by the immediate presence of any concession as to liability which it might qualify, although it must be read against the background of the qualified exposure of YDRML to the exclusive remedies of Liquidated Damages and reimbursement of Performance Guarantee Payments. The Article in question was intended to operate in respect of potential liability for loss incurred by Alstom, which was caused by a breach of contract by YDRML in circumstances other than those giving rise to the payment of Liquidated Damages and reimbursement of Performance Guarantee Payments. The words must be given their ordinary and natural meaning. In those circumstances any loss consequential or following, immediate or eventual, flowing from a breach of contract by YDRML is excluded from recovery by Alstom.”
Conclusion
Many written contracts in existence today include exclusions for consequential loss and were drafted by lawyers on the basis that such losses were limited to losses within the “second limb” of Hadley v Baxendale. It is apparent that this classification is not now as distinct as previously thought and parties should revisit their risk profiles.
The result of the finding of the Court was that while YDRML would have been liable for liquidated damages if it delayed in completion or for breaches of performance guarantees, it was not liable for damages caused by any other breaches of contract, even where they flowed from the breach.
Contributor:
Tom Grace
