A party to a contract cannot recover damages for loss of profit arising from a breach of contract if the contract states that the parties are not liable for consequential or indirect losses.
It is a common myth that where a contract excludes parties’ liability for consequential or indirect losses, this means neither party can recover damages for any loss of profit arising from a breach of the contract. Whilst it is true that consequential and indirect losses are treated as synonymous (and here, we will use the phrase “indirect”), these are not necessarily the same as loss of profit.
As a rule of thumb, a party’s losses arising from a breach of contract are only recoverable if they are a foreseeable consequence of a breach of the contract at the time the contract was entered into.
When assessing the scope of what is foreseeable, the courts have distinguished between the following types of losses:
- Direct – losses which arise naturally from the breach in the “ordinary course of things” which either are, or should have been, in the contemplation of the parties; and
- Indirect – losses that are not the natural results of the breach in the usual course of things but arise from a special circumstance known to the liable party when it entered into the contract.
In the absence of a contractual exclusion, both types of loss are recoverable. The difficulty comes when, as is commonly the case, indirect losses are excluded as it is generally accepted that loss of profit can either be a direct loss or indirect loss, depending on the relevant circumstances. In practice, decided cases show that most types of loss will be viewed as ‘direct’.
A business (the seller) enters into a contract for the supply of goods with a business which operates as a wholesaler (the buyer). The contract states that “neither party shall be liable for any indirect losses of the other party”. The seller fails to deliver the goods to the buyer and refuses to supply.
In addition to any other remedies the buyer may have, the buyer may wish to claim damages for the profit it would have made from reselling the goods had the seller delivered them.
When determining whether the buyer’s loss of profit is excluded by the above clause, the court would consider its scope and the surrounding circumstances to assess if the loss of profit is direct and recoverable or indirect and excluded.
The buyer will argue that the loss is direct on the basis that the buyer was known to be a wholesaler in business to resell the goods purchased. The seller therefore either knew or should have known that the buyer was likely to suffer a loss of profit if the goods were not supplied and that the claimed loss was a natural result of the breach. On that basis the loss of profit may well be considered direct. The seller may seek to argue that the losses are indirect on the basis that they arose from a special circumstance of which it was unaware (e.g. that the buyer had secured a very favourable resale price) but this seems unlikely to succeed given the buyer’s position.
Contracting parties should take care when drafting and negotiating exclusions in contracts, for example by:
- considering at the outset the types of loss that may be incurred as a result of either party failing to perform the contract (e.g. loss of profit, loss of data, damage to reputation etc);
- considering which of those categories of loss should be excluded and which should be subject to a financial cap;
- drafting appropriate provisions which aim to exclude the relevant categories of loss (and cap the others) – to avoid arguments about whether a loss is direct or indirect.