Exclusion clauses in UK contract law are contractual terms that aim to limit or exclude liability for certain types of losses or damages that may arise from a breach of contract. They are typically included in commercial contracts and take various forms, including limitation clauses, exemption clauses and indemnity clauses.
Regularly, an exclusion clause includes reference to indirect or consequential loss. In this guide we’ll consider the meaning of indirect or consequential loss and discuss how to best deal with it. If you need advice on exclusion clauses used in your agreements, our friendly team of expert commercial solicitors can assist.
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What is indirect or consequential loss in contract law?
It’s any type of loss that does not flow naturally from a breach of contract - a consequence either too unlikely to have been thought of or having too tenuous a connection to the nature of the contract to be within the minds of the parties at the time it was signed.
Indirect or consequential loss exclusion clauses are attempts to limit the parties’ liability to such disproportionate and unbudgeted exposure to losses if something goes wrong in the contract between them.
What is the difference between a direct and indirect loss?
To be able to assess potential losses, which may arise from a breach of contract, it is important to understand the distinction between direct and indirect or consequential loss.
Direct:
A loss which arises as:
- a direct and natural result of a breach and
- in the ordinary course of events.
Indirect or consequential:
A loss which arises from:
- particular and unusual circumstances that
- the parties knew or should have know about at the time the contract was entered into, which
- do not flow naturally from the breach.
What is the effect of that difference?
It is not unusual for liability for indirect or consequential loss to have to be decided in court (ie. through expensive litigation) and the importance of open communication at the start of the contracting process and the use of specific and unambiguous wording cannot be overemphasised.
As courts are often involved, the difference is reflected most obviously in the ability to recover damages for the breach which caused the loss.
An example:
A buys a car from B and immediately starts out on a drive to Folkestone. The car breaks down on the way.
A can claim the cost of the repairs to the car as this is a direct loss.
A then also claims the cost of his lost holiday which was the result of not getting to Folkestone in time for his Eurotunnel booking.
Bearing in mind that remedies for indirect loss must be ‘reasonable’ and not too remote in the circumstances, as B did not know about the planned holiday or the consequences of the breakdown, B is not liable for the indirect loss constituted by the missed holiday.
Where might I come across indirect or consequential loss?
Indirect or consequential loss is typically referred to in contracts under ‘Liability’ clauses or ‘exclusions’. Discover more in our guide on limiting liability.
Remember that exclusion clauses are primarily intended to exclude indirect or consequential losses, not direct losses.
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The law around indirect loss is complex. To help protect your business from unexpected liabilities, our commercial solicitors can review, negotiate and draft exclusion clauses and any contracts on your behalf.
How should you deal with indirect and consequential loss?
- If you are presented with a clause limiting indirect loss, first consider whether you are happy with the exclusion. Sometimes the clauses are drafted so widely that it seems nothing will be recoverable but, equally, you may agree with it as it stands.
- If you are not happy, use this situation as an opportunity to mitigate or distribute risk between your business and that of your counterparty, notwithstanding any unequal bargaining power.
- Draw up a list of all foreseeable losses and send it to your counterparty at the beginning of the contracting process.
- Be as specific and precise as possible about the types of loss - direct or consequential - that should and should not be recoverable.
- Both parties will then have the opportunity to consider what risk they will and won’t take and a compromise can be sought far earlier, improving goodwill and avoiding the risk of litigation.
- Alternatively, when faced with a widely-drawn clause, request a re-draft such as: ‘…excluding all indirect losses, including but not limited to…’ noting specific types of loss that you want excluded (again, the emphasis is on clarifying those losses agreed by the parties to be indirect).
- Consider whether the risk can be addressed by adjusting the contract price, or taking out insurance, or can be easily controlled by one of the parties.
- Consider a financial cap on liability in addition to the exclusion of all indirect losses.
Important points to note
- Just including an exclusion clause in a contract is not a means of escaping liability for any sort of loss.
- Exclusion clauses do not guarantee that, if a dispute went to court, the judge would agree that the loss suffered does constitute indirect loss and is covered by the exclusion clause. If a court decides that the loss is in fact direct then relying on an exclusion clause for indirect loss will not help.
- The more unexpected the loss is, the safer the ‘defendant’ is likely to be.
- Including an exclusion clause does give a claimant more obstacles to overcome in attempting to enforce their claim.
