Out-Law / Your Daily Need-To-Know

Direct and indirect loss for contractors

Out-Law Guide | 16 Aug 2011 | 10:05 am | 4 min. read

This guide was last updated in August 2011.

This guide will summarise the difference between direct and indirect, or consequential, loss resulting from breach of contract and the issues to be aware of when attempting to exclude liability for loss under a contract.

The basic test: "remoteness of damages"

Under English law, parties to a contract will not always recover all of their losses. The party in breach of contract will not be liable for losses that are considered too remote. This means that even if it is shown that that party's breach caused the loss, if that loss was sufficiently unusual or unlikely then he will not usually be liable for it unless he was aware of some special or unusual circumstances when he entered into the contract.

The test for remoteness dates back to a case in 1854 and says that a person who breaches a contract is generally liable for two types of loss:

  • loss that arises naturally, according to the usual course of things, from the breach. Direct loss happens in what a reasonable person would consider to be the 'usual course of things' or 'ordinary circumstances'.
  • loss that does not arise naturally but that "may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach". Indirect, or consequential, loss is that which could have reasonably been contemplated by someone with knowledge of special circumstances outside the usual course of things.

Any loss which is more remote than either or the above is considered to be too remote, and a party to a contract will not generally be liable for it. As far as direct and indirect loss are concerned, although the default position is that a party will be liable for both it is not uncommon for both parties to a contract to exclude liability for indirect loss and certain types of direct loss.

Limitation of damages in practice

Most contracts deal with the general principle that a party will not be able to recover all its losses by imposing a limit on liability. The International Federation of Consulting Engineers (FIDIC) provides model contracts that companies base their contracts on. Its Conditions of Contract Clause 17.6 says:

"Neither Party shall be liable to the other Party for loss of use of any Works, loss of profit, loss of any contract or for any indirect or consequential loss or damage which may be suffered by the other Party in connection with the Contract..."

So what types of loss can be recovered by contractors under FIDIC contracts? Only some of the items which contractors will usually seek to recover are included. These break down as follows:

  • direct loss and expense: if these fall within FIDIC's definition of 'cost' - "all expenditure reasonably incurred (or to be incurred) by the Contractor whether on or off the Site, including overhead and similar charges but [not including] profit" - and are directly linked to the clause giving rise to the claim, they can be claimed;
  • preliminaries: as above, these are also recoverable;
  • overheads: also recoverable – the cost of running the business as distinct from general site costs is expressly allowed for in the definition of Cost;
  • loss of productivity/disruption: in principle this is recoverable, but in practice proving this loss is difficult. The 'measured mile' approach compares work in disrupted and undisrupted conditions, with the difference between the two being the disruption factor;
  • profit: this is not recoverable, unless expressly allowed for in the Contract. Profit is excluded, from both the definition of Cost and by Clause 17.6;
  • interest: recoverable; the Contractor has an express right to interest on any unpaid sums under the standard FIDIC forms;
  • finance charges: recoverable - under English law, it is possible to claim finance charges as part of a claim for direct loss and expense;
  • inflation/exchange rate fluctuation: not recoverable - increased costs resulting from inflation/exchange rate fluctuation are classed as 'consequential loss' and are therefore excluded by Clause 17.6;
  • claims preparation costs: may be recoverable – under English law, these can be recovered in principle but such claims are hard to establish;
  • lost commercial opportunity and business interruption: generally not recoverable.

Drafting tips for exclusion clauses

An exclusion clause outlines what a company is specifically refusing liability for in a contract. When drafting an exclusion clause, you need to be very careful to ensure that the clause accurately captures the type of loss that you intend to exclude.

As we have seen, the FIDIC exclusion clause expressly excludes "loss of profit". In addition, it excludes indirect and consequential loss. A mistake people have often made, as can be seen from various English court judgements, is to think that profit is always classed as indirect loss and that therefore loss of profit will be excluded by a clause that excludes this type of loss.

The English courts have held that loss of profit can sometimes be a direct loss. If your clause only excludes indirect or consequential loss, then you will still be liable for any loss of profit that can be classed as direct loss. An example of this includes a 1998 case between British Sugar and NEI PowerProjects, where a claim for increased production costs and loss of profits caused by defective electrical equipment was found to be direct loss.

In a case in 2000 between Pegler Ltd and Wang UK, the court considered the following clause:

            "[Wang UK] shall not in any event be liable for any indirect, special or consequential        loss, howsoever arising (including but not limited to loss of anticipated profits or of        data)..."

The court held that this clause did not exclude liability for all loss of profits, but only for loss of profits of an indirect or consequential kind. As the claim was for direct loss of profit, the clause did not protect Wang.

Be careful about using words like 'other' and 'including' in an exclusion clause, as these can limit the scope of such clauses.

However, it is not enough just to cover both direct and indirect loss of profits in your clause. You need to consider the different types of loss for which you are and are not accepting liability in advance, and then draft the contract clearly and precisely to reflect this.

A 2010 case between GB Gas and Accenture is relevant in illustrating this point. Although the exclusion clause in this case excluded liability for loss of profits and also for indirect losses, when the court analysed the specific losses GB Gas was claiming – including compensation paid to customers and additional borrowing charges – it found that these were neither losses of profits nor indirect profits. They were therefore not covered by the exclusion clause, and were recoverable by GB Gas.