Melinda Parisotti - Exemption of liability for consequential losses is contentious - its meaning is often unclear and it may not provide the protection that firms think it will
Mr Smith arranges for a new telephone line to be laid at his house. He emphasises that the back lawn, nurtured to bowling green perfection, is to be the setting for his daughter's wedding that weekend and must not be touched. The workmen arrive on the appointed day. Two hours later, Mr Smith emerges with a tray of tea to see his lawn looking like a hippo's playground with a monstrous trench dug across it. Mr Smith incurs huge expense booking an alternative venue for the wedding and his wife is not speaking to him. To cap it all, his contract with the telephone company exempts it from liability for consequential losses. A bad day in anyone's books.

Can Mr Smith recover the substantial extra wedding expenses or even the measly cost of re-laying a bit of turf? Well, it all boils down to the meaning of consequential loss.

Anyone who has dealt with collateral warranties in the construction industry will have come across an exemption of liability for consequential loss and will have argued as to whether it should remain in a draft contract or be struck out. But there isn't always a clear idea of exactly what "consequential loss" means.

Lord Atkinson examined this issue way back in the 1940 case of Saint Line Ltd vs Richardsons, Westgarth and Co Ltd. At the risk of inducing cardiac arrest in the claimant, he mused, "the word 'consequential' is not very illuminating, as all damage is, in a sense, consequential". Very true, but not intended as a legal definition as the exclusion otherwise amounts to a mass eradication by a contracting party of any possible claim against them.

In order to determine the true meaning of consequential loss, we need to look at the meaning of direct loss. This has been described by the courts as losses that "naturally flow from the breach without other intervening cause and independently of special circumstances" or, more simply, that "arise in the usual course of things". Consequential losses are those additional losses which were within the contemplation of the parties at the time of entering into the contract. In other words, the defendant had knowledge of the particular circumstances that would lead to those losses.

It's useful to examine some cases to gain a better idea of which losses are deemed to be direct and so escape an exclusion of liability for consequential losses.

To avoid liability for particular heads of loss, your best bet is to list them specifically and exclude them

For example, you might not expect loss of profits resulting from defective goods or services to fall within the ambit of direct losses, but there is substantial case law to that effect. In Hotel Services vs Hilton International Hotels (UK) Ltd, Hilton hotels claimed for the loss of profit it incurred on defective minibars supplied by Hotel Services, along with the costs of their removal and storage.

Hotel Services had excluded liability for any "indirect or consequential losses" (terms found to be synonymous when used together). The court found that all those heads of loss, including loss of profit, were direct losses and so were not caught by the exemption clause.

In another case, the explosion of a methanol plant caused by the breach of a maintenance contract resulted in reconstruction costs, loss of profits and wasted overheads. None of the losses were held to be consequential and so the exemption clause in the contract did not bite.

Surprisingly, even finance or interest charges have been held to be direct losses, except where the breach of contract was late payment of a debt, in which case they could possibly be regarded as consequential.

These cases provide some guidance but it is important to note that there is no strict rule – each case will be decided on the basis of its own facts. If you wish to avoid liability for particular heads of loss, your best bet is to list them specifically and exclude them. Relying on a generic exclusion of "consequential losses" may not provide the protection you thought you had.