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Managing Consequential Damages in Contracts:

Drafting an Enforceable Exclusion Clause

By: E. Jane Sidnell, W. J. Kenny and Debra Curcio-Lister Miller Thomson LLP

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INDEX

A. INTRODUCTION

1

B. AUTHORITIES FROM THE UNITED KINGDOM

2

1. Hadley v. Baxendale

2

2. British Columbia and Vancouver's Island Spar, Lumber and Saw Mill Co. Ltd. v. Nettleship

4

3. Millar's Machinery Company v. David Way and Son

5

4. Victoria Laundry (Windsor) Ltd. v. Newman Industries, Ltd

6

5. The Heron II; C. Czarnikow, Ltd. v. Koufos

10

6. Croudace Construction Ltd. v. Cawoods Concrete Products

14

7. British Sugar plc v. NEI Power Projects

18

8. Deepak Fertilisers and Petrochemical Corporation v. Davey McKee (London)

20

9. Hotel Services Ltd. v. Hilton International Hotels (UK)

21

10. Farley v. Skinner

25

11. Caledonia North Sea Limited v. British Telecommunications PLC

26

12. Simkins Partnership (A Firm) v. Reeves Lund & Co.

27

C. CANADIAN AUTHORITIES

28

1. General Securities Ltd. v. Don Ingram Ltd

28

2. Munroe Equipment Sales Ltd. v. Canadian Forest Products Ltd

29

3. Scyrup v. Economy Tractor Parts Ltd

29

4. Cornwall Gravel Co. Limited v. Purolator Courier Limited

30

5. McCain Produce Co. Ltd. et. al. v. Canadian Pacific Limited

31

6. Cathcart Inspection Services Limited v. Purolator Courier Limited

32

7. B.D.C. Ltd. v. Hofstrand Farms Ltd

33

8. Kempling v. Hearthstone Manor Corp

34

9. Syncrude Canada Ltd. v. Babcock & Wilcox Canada

36

10. M.J.B Enterprises Ltd. v. Defence Construction (1951)

37

11. D.W. Matheson & Sons Contracting Ltd. v. Canada (Attorney General)

38

12. Rio Nevada Energy Inc. (Re)

39

13. Bank of America Canada v. Mutual Trust Co

40

D. ANALYSIS OF THE CASE LAW

40

E. INTERPRETATION OF EXCLUSION CLAUSES

41

F. DRAFTING AN EFFECTIVE CONSEQUENTIAL DAMAGES LIMITATION CLAUSE

42

G. EFFECT OF CONTRACTUAL EXCLUSIONS ON RECOVERY FOR A FUNDAMENTAL BREACH

43

H. EFFECT OF CONTRACTUAL EXCLUSIONS ON RECOVERY IN TORT

45

I. EFFECT OF FRAUD ON CONTRACTUAL EXCLUSIONS

47

J. CONCLUSION

47

APPENDIX A – SUMMARY OF CASES

48

APPENDIX B – SELECTED CONTRACT CLAUSES

50

1. CCDC 2 (1994) Stipulated Price Contract

50

2. A Guide to the use of CCDC 2 – 1994 Stipulated Price Contract

51

3. RAIC 6 (2002) Canadian Standard Form of Contract for Architectural Services

53

4. Guide to the Canadian Standard Form of Contract for Architectural Services

53

5. FIDIC Conditions of Contract for Plant and Design-Build: For Electrical and Mechanical Plant, and for Building and Engineering Works, designed by the Contractor (Test Edition 1998) and

FIDIC Conditions of Contract for Construction, for Building and Engineering Works Designed by

the Employer (Test Edition 1998)

53

6. COAA (2003) Stipulated Price Contract

54

7. Petroleum Joint Venture Association 1996 Model Construction, Ownership and Operating Agreement (Task Force Report)

54

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Managing Consequential Damages in Contracts:

Drafting an Enforceable Exclusion Clause

By: E. Jane Sidnell, W. J. Kenny and Debra Curcio-Lister 1 Miller Thomson LLP

A.

Introduction

In a sophisticated commercial world, the damages that can arise as a result of consequential losses can be enormous and frequently outweigh any possible direct losses. Contractors, service providers or other suppliers often argue that they do not have the financial capacity to take on the loss of damages for loss of profit, continuing overhead and related economic loss arising out of work performed on a project. From an owner's perspective, one needs to ask whether it is appropriate and financially beneficial to allocate the risk of such damages to the contractor. Where the contractor is put into a "bet your company" type of position, is it realistic to expect that, in the event of a catastrophic loss, the contractor will be able to pay for the consequential damages in any event?

Often, the most appropriate method of risk management of consequential losses is not to unload the risk on a party that is in no financial position to pay for it, but to manage the risk through insurance or other means of risk mitigation. Any type of risk management requires a consequential damages clause to be drafted, but exclusion clauses will be rigidly interpreted by courts and require clear and concise language.

However, before consequential losses can be dealt with as an issue of risk to be allocated or managed, the parties need to know the meaning of "consequential damages". Does the term "consequential damages" include lost profits, overhead, increased cost to operate, lost value of related contracts, lost revenue and other types of damages which are thought of as being consequential to the direct damage costs?

This paper addresses what is meant by the term "consequential damages" by reviewing the development of the case law and, in particular examining what courts have held to be direct damages and therefore not consequential. Unfortunately, the scope of the term "consequential damages" is not well explained by the body of case law that has developed since the seminal case of Hadley v. Baxendale 2 .

1 The authors wish to thank Flavia Boll, student-at-law; Kathy Kendrick; Rita Di Marcantonio, librarian; and Chad Zima, student-at-law

2 Hadley v. Baxendale, infra; for an interesting discussion of why the Hadley v. Baxendale case should not be followed in modern contract law see M.A. Eisenberg "The Principle of Hadley v. Baxendale" (1992), 80 Cal. L. Rev. 563

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B. Authorities from the United Kingdom

1. Hadley v. Baxendale 3

Now over 150 years old, the Hadley v. Baxendale case still is the starting point for a review of the meaning of consequential damages. In this case, the plaintiffs were partners in a mill in Gloucester. The mill was powered by a steam engine and which cleaned and ground corn into cornmeal and flour. The crank-shaft of the steam engine broke and the mill was no longer operational. The plaintiffs ordered a new crank-shaft to be made by a company in Greenwich, Kent, which required sending the broken shaft to the manufacturer for sizing of a new crank- shaft.

The defendant in the action was the courier service hired to transport the broken shaft from Gloucester to Greenwich for repair. The plaintiffs' action arose from the agreement that the plaintiffs claimed the defendant made with regard to the time for delivery. The plaintiffs alleged that the defendant promised to deliver the broken shaft in Greenwich the second day after the plaintiffs dropped off the broken shaft at the defendant's office in Gloucester. The plaintiffs plead that the defendant, in breach of the delivery agreement, took 7 days to deliver the broken shaft. As a result of the delay in the delivery of the broken shaft, the completion of the new shaft was delayed for 5 days. This resulted in the plaintiffs being prevented from working the mill and, accordingly, supplying many of their customers with flour. The mill owners claimed for the loss of profits which would have otherwise accrued to them and for the wages paid to workers during the period that the mill was not operational as a result of the delay caused by the courier company.

The plaintiffs claimed £300 damages for lost profits and £25 for the unproductive workers. The defendant paid the £25 in relation to the workers, but defended the suit in relation to the lost profits.

At trial, there was evidence that when the broken shaft was delivered by the plaintiffs to the defendant's courier office in Gloucester, that the defendant's clerk was told that the mill was shut down and that the shaft must be sent immediately to Greenwich. The defendant's clerk said that if it was delivered by noon, it would be delivered at Greenwich the following day.

The defendant defended the claim on the basis that the damage was too remote. When the Court of Exchequer heard the matter on appeal, it set out the principles for damages arising out of breach of contract. Excluded from this rule were breaches of contract in relation to non-payment of money, and damages for failure to make good title to land. The general rules set out by the Court were as follows:

To recover damages, the loss must fall into one of the following two rules:

1. those losses that arise naturally, according to the usual course of things, from the breach of contract itself; or

3 Hadley v. Baxendale, [1843-60] All E.R. Rep. 461 (Ex. Ct.)

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2. if special circumstances were communicated by the plaintiff to the defendant, then losses that may have been reasonably supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach.

On the basis of the two rules laid out in Hadley v. Baxendale, direct damages under the first rule have been distinguished from consequential damages under the second rule. Direct damages are those damages which arise naturally which every plaintiff in a similar situation will suffer. Direct damages, by definition, should "fairly and reasonably be considered as either arising naturally, i.e., according to the usual course of things, from such breach of contract itself, or such as 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 of it." 4

It is the second rule in the Hadley v. Baxendale that gives rise to the issue of whether or not

consequential damages are recoverable. These damages are only available where special circumstances have been specified to the party in breach. This was explained by Alderson J. in Hadley v. Baxendale 5 :

If special circumstances under which the contract was actually made were communicated by the plaintiffs to the defendants, and thus known to both parties, the damages resulting from the breach of such a contract which they would reasonably contemplate would be the amount of injury which would ordinarily follow from a breach of contract under the special circumstances so known and communicated. But, on the other hand, if these special circumstances were wholly unknown to the party breaking the contract, he, at the most, could only be supposed to have had in his contemplation the amount of injury which would arise generally, and in the great multitude of cases not affected by any special circumstances, from such a breach of contract. For, had the special circumstances been known, the parties might have specially provided for the breach of contract by special terms as to the damages in that case; and of this advantage it would be very unjust to deprive them.

In the Hadley v. Baxendale case, Alderson J. declined to award damages to the plaintiffs because, based on the principles set out above, the only circumstances communicated by the plaintiffs to the defendant at the time the contract was made was that the defendant was to deliver the broken shaft and that the plaintiffs were the owners of a mill. 6 The Court pointed out that if the plaintiffs would have had another crank-shaft in their possession, it could have been used for continued operation of the mill while the new crank-shaft was being manufactured. The

Court also pointed out that it was possible that other essential elements of the mill were defective and that the mill would have been non-operational regardless of the date of delivery of the broken crank-shaft and the return of the new crank-shaft. Given that the special circumstance of

a new crank-shaft being required before the mill could be put back into operation was not

communicated by the plaintiffs to the defendant, the defendant could not be liable for those

4 Hadley v. Baxendale, supra, page 465E

5 Hadley v. Baxendale, supra, page 465F

6 Quaere whether a properly worded entire agreement clause precludes parole evidence of special circumstances.

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damages arising from such special circumstance. The Court determined that the damages claimed for loss of profit did not flow naturally from the breach of the contract and no special circumstances which would have made it a reasonable and natural consequence of the breach of contract, were communicated to, or known by, the defendant.

From Hadley v. Baxendale the distinction arose as to direct damages (those arising naturally) and consequential damages (those requiring knowledge of special circumstance). Without that special knowledge, no consequential damages could be awarded. The first branch encompassed damages naturally occurring regardless of whether they were contemplated by the parties. The second branch related to damages which the defaulting party, from the circumstances known at the time the contract was made, should have objectively foreseen would result from a breach.

Exclusion clauses limiting consequential damages are not needed where the defendant never has knowledge of special circumstances and consequential damages in such circumstances could not, under this original formula of the rule, be awarded. However, this result then begged the question as to what could be categorised as damages arising naturally and thereby not limited by the rule in Hadley v. Baxendale. As is set out in Appendix A - Summary of Cases, claims for damages for loss of profits are sometimes considered to be consequential and barred by the second rule, as in Hadley v. Baxendale and Nettleship, and sometimes are not, as in Victoria Laundry.

2. British Columbia and Vancouver's Island Spar, Lumber and Saw Mill Co. Ltd. v. Nettleship 7

This is a decision referred to in some of the old English authorities and distinguished by the court in Victoria Laundry. 8 The plaintiff saw mill contracted with the defendant Nettleship, a ship owner, to transport machinery from Britain to Vancouver Island. A box containing parts, without which the rest of the machinery could not be used, was lost by the ship owner. The ship owner knew that the box contained parts and that the machinery was to be used for the operation of a saw mill, but did not know that the lost parts were essential to the operation of the machinery.

The court did not award the consequential losses claimed by the saw mill due to delay and only awarded the actual value of the parts lost. In arriving at this decision, Willes, J., in reviewing the authorities, recounted the following case: 9

… There have been various cases on this subject, and in one a man was going to be married, and his horse cast a shoe, and the smith having injured the horse in putting it on the man was late, and the lady refused to marry him; and it was held that the smith was liable for the damages resulting from the loss of the marriage. We shall fall into a like absurdity unless we restrict the liability of a man for breach of contract within proper limits.

7 British Columbia and Vancouver's Island Spar, Lumber and Saw Mill Co. Ltd. v. Nettleship, [1861–73] All E.R. Rep. 339 (Ct. Com. Pleas)

8 Victoria Laundry, infra, note 13

9 Nettleship, supra, page 341H, no citation provided to the referenced case

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Articulating the rule, as he saw it, Willes, J. said: 10

… I think that an extraordinary loss suffered by one of two contracting parties

ought not to be borne by the other unless the former has given some consideration for the greater risk. We ought not to fix on the shipowner a liability for all the supposed profit which the mill would have made if it had been built and has turned out successful. If such a proposal had been made to the shipowner when the contract was entered into as a basis of his liability, it must be presumed that he would not have made himself liable for such a claim unless he received an additional amount of freight. Mere knowledge on the part of the carrier of the use to which the article is to be put cannot, per se, increase his liability; there must have been knowledge under such circumstances as would raise the presumption

that he intended to make himself liable for the special consequences, and that the person contracting with him believed, and had reasonable grounds for believing, that he intended to undertake such liability, and unless there was a special payment it would be very difficult to get a jury to come to such a conclusion.

The court identified the conundrum of consequential damages: on a commercial basis, has the party against whom the consequential damages are claimed received compensation for this risk (or as Willes, J. puts it: consideration)? If not, is it commercially reasonable to expect a party who has agreed, for instance to transport goods, to hold the other party harmless for its possible damages resulting from delay? The court claimed that this conclusion was not reasonable, but did not address what that meant for the party who could not use the saw mill machinery for 11 to 12 months while a replacement part was obtained. As will be seen in the cases below, in the absence of contractual language, the courts favour placing the risk on the party performing the service or providing equipment and the judgment in this case is generally distinguished.

3. Millar's Machinery Company v. David Way and Son 11

In Millar's Machinery Company v. David Way the English Court of Appeal considered a case in which a gravel washing and grading machine was sold to a purchaser who found it unacceptable and was required to purchase an alternate machine at a higher cost from a third party. The court found that the rejection of the first machine was valid and had no difficulty in awarding the amount paid for the defective machine back to the purchaser. At issue was a further claim for the increased cost of the second machine purchased on short notice to replace the defective machine. The contract between the parties contained an exclusion for consequential damages which provided as follows:

… We do not give any other guarantee and we do not accept responsibility for

consequential damages or for alteration or repairs done without our approval. 12

The Court of Appeal considered the word "consequential" in the exclusion clause to determine whether or not the difference in the price of the original, but defective, machine and the machine

10 Nettleship, supra, pages 341I to 342B

11 Millar's Machinery Company, Limited v. David Way and Son (1935), 40 Com. Cas. 204 (C.A.)

12 Millar's Machinery, supra, page 207

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bought on short notice was recoverable by the purchaser. Maugham L.J. determined that the damages claimed were not consequential in any event and allowed the claim:

… On the question of damages, the word "consequential" had come to mean "not direct," and the damages recovered by the defendants on the counterclaim arose directly from the plaintiffs' breach of the contract under Section 51 (2) of the Sale of Goods Act, 1893. The plaintiffs' machine would not do the work, and the defendants were entitled to get the best substitute they could for it. 13

4. Victoria Laundry (Windsor) Ltd. v. Newman Industries, Ltd. 14

The Hadley v. Baxendale decision was reviewed and modified by the English Court of Appeal in the Victoria Laundry case. The plaintiff was a laundry company to whom the defendants, an engineering company, agreed to sell a boiler. The engineers did not manufacture the boiler, but happened to own it. Given that the laundry company wanted to expand and required a new boiler for greater capacity, it replied to an advertisement by the defendant engineering company in relation to two boilers which appeared to be suitable to the laundry business. The laundry company negotiated for the purchase of one of the boilers and by April 26, 2006, had concluded the contract for its purchase; which included dismantling and transport.

During dismantling in preparation of transport, subcontractors to the engineering company allowed the boiler to fall on its side, causing it damage. On June 5, 1946, four days after the damage occurred, the laundry company declined to take delivery of the damaged boiler and insisted that it be repaired before delivery to the laundry company. The Court agreed that the laundry company was entitled to reject delivery until repair had been made.

The repairs were not completed until October 28, 1946 (due to a lack of availability of contractors) and the plaintiff took delivery of the boiler on November 8, 1946. The laundry company claimed the loss of profits it would have earned if the boiler had been delivered in early June instead of 20 weeks later in November. The laundry company lead evidence at the trial that had the boiler been delivered on time, then during the 20 weeks that it had been delayed before actual delivery, the laundry company could have:

(i)

taken on a very large number of new customers, as the demand for laundry services at the time was "insatiable" and, in fact, did take on extra staff in expectation of the boiler; and

(ii)

accepted a number of highly lucrative dying contracts for the Ministry of Supply.

The defendant knew before, and at the time of, the contract that the plaintiff was a laundry company and required the boiler for the purpose of its business. The defendant also knew that the plaintiff wanted the boiler for immediate use. In that regard, the Court looked heavily at the correspondence between the parties in which the defendant undertook to make the earliest possible arrangements for the dismantling and removal of the boiler and the comments of the

13 Millar's Machinery, supra, page 210

14 Victoria Laundry (Windsor), Ltd. v. Newman Industries, Ltd. (Coulson & Co., Ltd. [third party]), [1949] 2 KB 528 (C.A.)

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plaintiff noting that it was anxious to be in receipt of delivery of the boiler in "the shortest possible space of time" so it could be put into use. The defendant did not know the precise role for which the boiler was to be used in the plaintiff's laundry business and whether it was to be used in substitution of an existing boiler of an inferior capacity or for replacement of an existing boiler of equal capacity, or as an extra unit. It was argued by the defendant that it could have even been used as a spare or stand-by boiler, although this argument was rejected by the Court, given the correspondence indicating that it would be put to use in the shortest possible space of time.

The trial judge found that the claim for loss of profits was too remote and denied the claim.

On appeal, in reversing the trial decision, Asquith L.J. recognized that the second rule in Hadley v. Baxendale was determinative of the measure of recoverable damages and inquired into the information that the defendant possessed at the time the contract was made. In his judgment, Asquith L.J. reviewed the authorities dealing with damages for loss of profits 15 :

The authorities on recovery of loss of profits as a head of damage are not easy to reconcile. At one end of the scale stand cases where there has been non-delivery or delayed delivery of what is on the face of it obviously a profit-earning chattel, for instance, a merchant or passenger ship … or some essential part of such a ship, for instance a propeller … or engines. In such cases loss of profit has rarely been refused. A second and intermediate class of case in which loss of profit has often been awarded is where ordinary mercantile goods have been sold to a merchant with knowledge by the vendor that the purchaser wanted them for re- sale, at all events, where there was no market in which the purchaser could buy similar goods against the contract on the seller's default … At the other end of the scale are cases where the defendant is not a vendor of the goods, but a carrier: see, for instance, Hadley v. Baxendale … In such cases the courts have been slow to allow loss of profit as an item of damage. This was not, it would seem, because a different principle applies in such cases, but because the application of the same principle leads to different results. A carrier commonly knows less than a seller about the purposes for which the buyer or consignee needs the goods or about other "special circumstances" which may cause exceptional loss if due delivery is withheld.

After citing from the Hadley v. Baxendale case and referring to the first rule, Asquith, L.J., discussed the second rule set out in Hadley v. Baxendale 16 :

… In considering the meaning and application of these rules it is essential to bear clearly in mind the facts on which Hadley v. Baxendale proceeded. The head note is definitely misleading insofar as it says that the defendants' clerk, who attended at the office, was told that the mill was stopped and that the shaft must be delivered immediately. The same allegation figures in the statement of facts which are said … to have "appeared" at the trial before Crompton, J. If the Court

15 Victoria Laundry, supra, pages 1000H to 1001B

16 Victoria Laundry, supra, page 1001E

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of Exchequer had accepted these facts as established, the court must, one would suppose, have decided the case the other way round – must, that is, have held the damage claimed was recoverable under the second rule, but it is reasonably plain from the judgement of Alderson, B., that the court rejected this evidence, for he says … :

"… we find that the only circumstances here communicated by the plaintiffs to the defendant at the time the contract was made, were, that the article to be carried was the broken shaft of a mill, and that the plaintiffs were the millers of that mill."

It is on this basis of fact that he proceeds to ask:

"… how do the circumstances show reasonably that the profits of the mill must be stopped by an unreasonable delay in the delivery of the broken shaft by the carrier to the third person?"

After the review of several cases, Asquith, L.J., summarized the authorities in six points 17 :

(1) It is well settled that the governing purpose of damages is to put the party whose rights have been violated in the same position, so far as money can do so, as if his rights had been observed … This purpose, if relentlessly pursued, would provide him with a complete indemnity for all loss de facto resulting from a particular breach, however improbable, however unpredictable. This, in contract at least, is recognized as too harsh a rule.

(2) In cases of breach of contract the aggrieved party is only entitled to recover such part of the loss actually resulting as was at the time of the contract reasonably foreseeable as liable to result from the breach.

(3) What was at that time reasonably foreseeable depends on the knowledge then possessed by the parties, or, at all events, by the party who later commits the breach.

(4) For this purpose, knowledge "possessed" is of two kinds – one imputed, the other actual. Everyone, as a reasonable person, is taken to know the "ordinary course of things" and consequently what loss is liable to result from a breach of that ordinary course. This is the subject matter of the "first rule" in Hadley v. Baxendale, but to this knowledge, which a contract-breaker is assumed to possess whether he actually possesses it or not, there may have to be added in a particular case knowledge which he actually possesses of special circumstances outside the "ordinary course of things" of such a kind that a breach in those special circumstances would be liable to cause more loss. Such a case attracts the operation of the "second rule" so as to make additional loss also recoverable.

17 Victoria Laundry, supra, pages 1002F to 1003C (footnotes omitted)

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(5)

In order to make the contract-breaker liable under either rule it is not necessary that he should actually have asked himself what loss is liable to result from a breach. As has often been pointed out, parties at the time of contracting contemplate, not the breach of the contract, but its performance. It suffices that, if he had considered the question, he would as a reasonable man have concluded that the loss in question was liable to result …

(6)

Nor, finally, to make a particular loss recoverable, need it be proved that on a given state of knowledge the defendant could, as a reasonable man, foresee that a breach must necessarily result in that loss. It is enough if he could foresee it was likely so to result. It is enough, to borrow from the language of LORD DU PARCQ in the same case, if the loss (or some factor without which it would not have occurred) is a "serious possibility" or a "real danger." For short, we have used the word "liable" to result. Possibly the colloquialism "on the cards" indicates the shade of meaning with some approach to accuracy.

In relation to the claim in the Victoria Laundry case, Asquith L.J. found that the defendant knew that the obvious purpose of a boiler in a laundry business was to boil water for the purpose of that business. With some contempt he pointed out that a "laundry might conceivably buy a boiler for some other purpose, for instance, to work radiators or warm bath water for the comfort of its employees or directors, or to use for research or to exhibit in a museum. All these purposes are possible, but the first is the obvious purpose, which, in the case of the laundry, leaps to the average eye." 18

The purpose of the boiler was taken to be for the purpose of increasing the profit of the business which Asquith, L.J., preferred to call "loss of business". Asquith, L.J., agreed with the defendant that it was not aware of particular lucrative contracts for dyeing which the plaintiff was unable to access as a result of not having the boiler. However, the judge found that it did not follow that the plaintiff was precluded from recovering some general sum for loss of business in respect of those dyeing contracts.

The Court distinguished Hadley v. Baxendale and two other cases in which portions of a total unit were delayed resulting in a loss to the whole operation. Asquith, L.J., summed up those cases as follows 19 :

… The cases of Hadley v. Baxendale, British Columbia, etc. Sawmill Co. v. Nettleship and Portman v. Middleton which were so strongly relied on for the defence and by the learned judge, were all cases in which, through want of a part, catastrophic results ensued, in that a whole concern was paralysed or sterilised – a mill stopped, a complex of machinery unable to be assembled, a threshing machine unable to be delivered in time for the harvest, and, therefore, useless. In all three cases the defendants were absolved from liability to compensate the

18 Victoria Laundry, supra, page 103F

19 Victoria Laundry, supra, page 1005E

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plaintiffs for the resulting loss of business, not because what they had failed to deliver was a part, but because there had been nothing to convey to them that want of that part would stultify the whole business of the person for whose benefit the part was contracted for. There is no resemblance between these cases and the present, in which, while there was no question of a total stoppage resulting from non-delivery, yet there were ample means of knowledge on the part of the defendants that business loss of some sort would be likely to result to the plaintiffs from the defendants' default in performing their contract.

In finding the defendant engineering company liable for the laundry company's business loss, Asquith, L.J., determined that the loss claimed was covered under the first rule in Hadley v. Baxendale as it was damage that arose naturally from the breach.

Victoria Laundry modified the rule in Hadley v. Baxendale by narrowing the first rule from all damages that occurred naturally, to only those damages that occurred naturally and were reasonably foreseeable.

5. The Heron II; C. Czarnikow, Ltd. v. Koufos 20

The Heron II dealt with a claim relating to a charter party agreement for a ship which was contracted to deliver sugar from Constanza in the Dominican Republic to Basrah in Iraq. The journey was predicted, with reasonable accuracy, to take approximately 20 days. However, a deliberate breach by the ship owner which involved deviating at 3 other ports so as to make other deals, prolonged the voyage by 10 days. When the ship arrived, the market value of the sugar had dropped on a per tonnage basis and the shipper suffered a loss as a result of the price differential.

Historically, the cases in the admiralty court established that the shipper was not entitled to claim for the price differential when the cargo was delivered late. The House of Lords overturned the line of admiralty cases which had been in place since the time that ships were powered by sail. In doing so, the judgments of Diplock, L.J. and Salmon, L.J. reviewed the importance and modification of Hadley v. Baxendale in Victoria Laundry. Lord Diplock laid the ground work for the application of the Hadley v. Baxendale damages rules 21 :

… until Victoria Laundry …, Hadley v. Baxendale was generally regarded as laying down two rules as to the measure of damages for breach of contract. The first was a general rule which did not depend on any knowledge actually possessed by the contract-breaker at the time when he entered into the contract. Under it the injured party was entitled to recover only the loss to him arising naturally according to the usual course of things from the breach. The second rule, which was regarded as an exception to the first, entitled an injured party who owing to circumstances peculiar to himself had sustained as a result of the breach a greater loss than would arise naturally according to the usual course of things from the breach, to recover such loss, but only if the contract-breaker at the time

20 The Heron II; C. Czarnikow, Ltd. v. Koufos, [1966] 2 All E.R. 593 (C.A.); affirmed [1967], 3 All E.R. 686 (H.L.)

21 The Heron II, supra, page 603 B to G (footnotes omitted)

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at which he entered into the contract knew that a breach on his part would lead to an exceptional loss of the kind in fact sustained and entered into the contract in such circumstances as would induce the other party to believe that in the event of breach, he would accept liability for such exceptional loss. The latter part of the second rule, which requires, in addition to knowledge, an acceptance of contractual liability for exceptional loss, was laid down in British Columbia and Vancouver's Island Spar, Lumber and Saw Mill Co., Ltd. v. Nettleship; but except in the case of a person, like a common carrier, who has no right to decline to enter into a contract, it has little application in practice for it requires no more than that the nature of the exceptional loss should be communicated by the party who will sustain it to the other party in the course of negotiations for the contract. If the other party then enters into the contract without disclaiming his responsibility for the exceptional loss, he will be liable for such loss if it occurs as a result of his breach. …"

So long as Hadley v. Baxendale was regarded as laying down two rules, one independent of the knowledge of the contract-breaker and the other dependent on the state of his actual knowledge, there might be room under the first rule for applying to contracts of carriage by sea a different measure of damages for breach of contract by delay in delivery from that applicable to contracts of carriage by land or for sale of goods under a contract of sale involving shipment overseas, although as early as 1902 we have the authority of Dunn v. Bucknall Bros. that there is no such special measure.

Lord Diplock went on to acknowledge that the United States had rejected the old admiralty decisions which refused to provide awards for damages for the differential in price when cargo was delivered late by ship. The United States had found the old case law to be obsolete. Lord Diplock considered that the court had the occasion in a modern era to reconsider the old principles of law and provided the following summary of the principles related to consequential loss: 22

… in the added light of the clear and comprehensive statement of the modern principles governing the measure of damages for breach of contract contained in Victoria Laundry … . This judgement, of ASQUITH, L.J., which owes much to the revolution in legal thinking initiated by Donoghue v. Stevenson, made it clear:

(i)

that there are not two rules formulated in Hadley v. Baxendale but two different instances of the application of a single rule;

(ii)

that the rule as to the measure of damages for breach of contract applies to all kinds of breaches of all kinds of contracts;

(iii)

that the aggrieved party is entitled to recover such part of the loss actually resulting to him as was at the time of the

22 The Heron II, supra, pages 604 D to 605H (footnotes omitted)

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contract reasonably foreseeable by the party who broke it as liable to result from the breach.

I have added to the ipsissima verba of ASQUITH L.J. – the words italicised – "by the party who broke it" – to identify the foreseer. These added words and the two expressions "reasonably foreseeable" and "liable to result from the breach" call for further analysis.

What is "foreseeable" depends on the knowledge of the foreseer: what is "reasonably foreseeable" depends on the knowledge which a reasonable person entering into the contract in question might reasonably be expected to possess as well as any additional information communicated to him by the other party to the contract. The obligation to pay damages for breach of contract is a consensual obligation. When a party enters into a contract with another party the obligations towards the other party which he thereby undertakes to fulfill and the rights against the other party to which he is entitled are those and only those which by his words and conduct at the time of the contract he has reasonably induced the other party to believe that he is accepting a legal obligation to fulfill or asserting a legal right to claim. This is so not only in respect of what may for convenience be called the primary obligations and rights created by the contract, that is, those which are discharged by performance of the contract, but also in respect of the secondary obligations and rights which arise on non-performance of his primary obligations by one of the parties to the contract. Of these the most important is the obligation of the non-performer to make to the other party, and the corresponding right of the other party to claim from the non-performer, reparation in money for any loss sustained by the other party which results from the failure of the non-performer to perform his primary obligation.

The non-performer may, of course, have expressly stipulated what monetary reparation he will make (by a liquidated damage clause) or excluded his liability to make reparation (by an exemption clause) for breach of a particular primary obligation; but if he has not, his conduct in entering into the contract is in itself sufficient to induce the other party to believe that he, the non-performer, undertakes, in the event of non-performance of that primary obligation, a secondary obligation to make monetary reparation for any loss sustained by the other party of a kind which the non-performer has reasonable grounds for assuming that the non-performer knows is liable to result from the breach. The other party is entitled to assume that the non-performer knows of the kinds of loss which are liable to result from the breach in the usual course of things, for instance that in the case of non-delivery of goods he will have lost the value of the goods at the date at which they should have been delivered; but he is not entitled to assume, unless at the time of the contract he has communicated the information to the non-performer, that the non-performer knows of an exceptional kind of loss which is only liable to result because of the existence of special circumstances peculiar to the other party which are outside the usual course of things. For by his own conduct in entering into the contract without communicating such special circumstances to the non-performer the other party reasonably induces the non- performer to believe that he, the other party, is not asserting any right to claim

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reparation for any exceptional kind of loss resulting from non-performance of a primary obligation.

In explaining what was meant by "liable to result from the breach", ASQUITH, L.J. gave effect to the development which had taken place in the common law during the preceding century particularly in the role of "foreseeability" in man's duty towards his neighbour. In both Hadley v. Baxendale and Horne v. Midland Ry. Co. the phrase "the probable result of the breach" had been used without further exegesis. "Probable" no doubt connotes a greater likelihood than "possible" but it is not restricted to an odds-on chance and, unlike MCNAIR, J., in his judgment from which this appeal is brought, I see no conflict between the use of the single adjective "probable" in the earlier cases and ASQUITH, L.J.'S explanation of the degree of probability required to make a particular kind of loss recoverable as being a "serious possibility" or a "real danger" or, more colloquially, "on the cards".

Salmon, L.J., agreeing with Diplock, L.J., that the appeal should be allowed, also weighed in on the application of Hadley v. Baxendale since the Court of Appeal had reviewed that case in the Victoria Laundry decision 23 :

The principles to be applied in solving such questions were stated by this court in Victoria Laundry … Indeed that case and Hadley v. Baxendale, decided some ninety-five years previously, are landmarks in our law. Both clarified and developed the law relating to damages. There are difficulties, however, in adjusting thought to change – difficulties which are not invariably surmounted with success. Although the judgment in Hadley v. Baxendale has now long been regarded almost as holy writ, there were eminent judges who expressed considerable doubt about it for some years after it was pronounced; see for example the observations of Wilde, B., in Gee v. Lancashire and Yorkshire Ry. Co. and of SIR BALIOL BRETT, M.R., in The Notting Hill. And so today evidently the learned trial judge, a most eminent commercial lawyer, has not yet become fully reconciled to the judgment in the Victoria Laundry case. This case shows that in reality Hadley v. Baxendale did not lay down two different rules, as had been supposed, but only one rule with two different facets. The rule is that any damage actually caused by a breach of any kind of contract is recoverable providing that when the contract was made such damage was reasonably foreseeable as liable to result from its breach. Foreseeability may be established by showing that on facts presumably within the knowledge of the parties at the date of the contract, such damage was, in the ordinary course of things, liable to occur as a result of the breach. That is one facet of the rule. Foreseeability may also be established by showing that special facts which would not be presumed to be within the knowledge of the parties were in fact drawn to the attention of the contract-breaker when the contract was made from which it could reasonably be foreseen that such damage was liable to occur as a result of the breach. That is the other facet of the rule. In all cases within the rule, the law will presume (in

23 The Heron II, supra, page 609D to 610E (footnotes omitted)

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the absence of any contrary intention expressed in the contract) that both parties entered into the contract on the basis that he who broke it should be liable for the damage which he could reasonably foresee was liable to occur as a result of his breach – British Columbia and Vancouver's Island Spar, Lumber and Saw Mill

Co., Ltd. v. Nettleship. This is entirely appropriate, for the risk or loss caused by

a breach of contract should not fall on the shoulders of the innocent party but on

those of the party whose breach caused the loss and who could reasonably foresee that a serious risk of that loss would be incurred by his breach. This is particularly true where, as in this case, the party in breach deliberately chose to break the contract and run the risk in order to make money. In Hadley v.

Baxendale ALDERSON, B., spoke of the, damages which

"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 of it."

He did not explain the sense in which he was using the word " probable ". There are many degrees of probability. I entirely agree with DIPLOCK, L.J., that the word "probable" does not necessarily connote an odds-on chance. In the Victoria Laundry case ASQUITH, L.J., who delivered the judgment of this court, clarified the meaning of the word "probable" in its context in ALDERSON, B.'S judgment. ASQUITH, L.J., said that it need not be

"proved that on a given state of knowledge the defendant could, as a reasonable man, foresee that a breach must necessarily result in

loss. It is enough if he could foresee it was likely so to result. It is

enough

if the loss (or some factor without which it would not

have occurred) is 'a serious possibility' or a 'real danger'. For short,

we have used the word 'liable ' to result."

I have used the words "liable to result" in the same sense in this judgment. I do

not agree with the trial judge that there is anything in ASQUITH, L.J.'S, judgment

which is inconsistent with what was said in Hadley v. Baxendale. As I have

already indicated, I regard the Victoria Laundry case as a clarification of the law.

It is thus that the common law develops. It is not static and inert but a living and

growing thing, ready to meet and adapt itself to the changing needs of time.

In the Heron II, the House of Lords went to great lengths to describe the Hadley v. Baxendale decisions as setting out one rule with two branches for determining whether rules of foreseeability would allow recovery. In relation to the claim in the lost value of the sugar delivered 10 days late, the House of Lords allowed it finding that the damages were foreseeable.

6. Croudace Construction Ltd. v. Cawoods Concrete Products Ltd. 24

The English Court of Appeal considered what is included in the term "consequential damages" in Croudace Construction. The plaintiff, Croudace Construction, was the general contractor

24 Croudace Construction Ltd. v. Cawoods Concrete Products Ltd., [1978] 2 Lloyd's Rep. 55 (C.A.)

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building a school in London. The tender documents stated that concrete masonry blocks would be obtained from the defendant, Cawoods Concrete Products.

Croudace Construction brought an action against Cawoods Concrete Products for damages for breach of contract, in part for late delivery and in part for failure to meet the specifications.

The supply contract between Croudace Construction and Cawoods Concrete Products provided as follows in Clause 4 25 :

No complaint of any kind can be entertained (except in special circumstances justifying delay) unless it is made in writing within 24 hours after the time of supply of the materials or goods of which complaint is made. … if any materials or goods supplied by us should be defective or not of the correct quality or specification ordered our liability shall be limited to free replacement of any materials or goods shown to be unsatisfactory. We are not under any circumstances to be liable for any consequential loss or damage caused or arising by reason of late supply or any fault, failure or defect in any materials or goods supplied by us or by reason of the same not being of the quality or specification ordered or by reason of any other matter whatsoever.

The plaintiff's claim for damages relating to delay included:

(i)

"damages by reason of men and materials being kept on the site without work, or without full work, to do because of the absence of the materials which the defendants ought to have delivered and had failed to deliver in time" 26 ;

(ii)

"inflation costs - the extra cost of doing the work due to the fact that the carrying out of the work had been delayed by reason of the delay in the delivery of the blocks" 27 ;

(iii)

an indemnification and claim with respect to a "claim which had been made against them [Croudace] by sub-contractors in respect of delay in the sub- contractors' work which was said to have been caused by the absence of the materials which the defendants [Cawoods] ought to have delivered." 28 .

In answering the above question, Parker J., tried to distil the meaning of "consequential" 29 :

The second issue is more difficult, for the word "consequential" has no well defined meaning and may have different meanings according to the context in which it is used. The plaintiffs relied on two cases, Millars Machinery Co. Ltd. v. Way … and Saint Line Ltd. v. Richardsons Westgarth & Co. Ltd. … where in similar clauses the exclusion of consequential damages was held to exclude such

25 Croudace Construction, supra, pages 56 to 57

26 Croudace Construction, supra, page 60

27 Croudace Construction, supra, page 60

28 Croudace Construction, supra, page 60

29 Croudace Construction, supra, pages 58 to 59

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damages only as did not fall within the expression directly and naturally resulting from the breach or which would be recoverable only on proof of special circumstances or were contributed to by some supervening cause. Neither party was able to find any other direct authority.

I was referred by Mr. Keating to a number of textbooks and authorities in which the word "consequential" is given a much wider meaning, but I did not find them helpful. What I have to determine is the meaning of the word in the clause before me and wider meanings in other contexts and for other purposes do not assist.

In approaching this question, I do so on the basis that the clause, being an exclusion clause, will only exclude what can be brought clearly within the words used. … This is a commercial contract between commercial men of like status. There is no reason why, if the defendants chose to do so, they should not limit their liability very severely indeed. The sole question is as to the extent to which the words used have so limited it.

It is in my judgment clearly intended that the defendants should be under some

liability for delay … [O]n the plain wording of cl. 4 itself, there is no intention to relieve from liability all loss and damage only for such loss or damage which is properly described as "consequential".

The problem is, therefore, to determine, in effect, what it was which was intended to survive the exclusion. The rival contentions of the parties may be shortly stated. For the defendants, it is submitted that only damage which survives the exclusion is the difference, if any, between the value of the materials when they should have been delivered and when they were in fact delivered. For the plaintiffs, it is contended that all loss and damage survives save only such damage as, in the absence of the clause, would only have been recoverable on proof of special circumstances. Put another way, it is submitted that nothing is within the word "consequential" if it directly and naturally results in the ordinary course of events from the late delivery. …

It is in my judgement clear that the word "consequential" is, in the present

context, used to describe or indicate a type of loss or damage which is in some way less direct or more remote than that loss or damage which is to remain recoverable despite the exclusion. This appears to me to follow from the ordinary use of the words and from the fact that it would be commercial nonsense to give it any other meaning.

Was it then intended to cover any other than the difference in value, if any? I find this commercially unreal. When selling building materials to a contractor for delivery on a building site, the difference in the value of the materials is, as a matter of common sense, wholly irrelevant. If between the date when the goods should have been delivered and the date when they were in fact delivered, there is

a fall in the value, this is, as a matter of commercial reality, of supreme

indifference to the contractor and in no real sense does he suffer any loss or damage as a result of the fall. If he does, however, it appears to me to be more

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remote and less direct than that which begins to clock up at once, namely the cost of idle men and plant, etc.

To take an example, suppose that a load of steel work is due on May 1, and the contractor has on site ready to install it a work force, scaffolding and lifting plant. The steel is however 14 days late. The most direct, immediate and natural damage caused by the delay is the expense of the work force, scaffolding and plant. If when the steel arrives 14 days later it is worth the same as, less than, or more than it was worth on May 1 makes not the slightest difference to the contractor. Yet it is said that if it is worth the same or more than it was on May 1 the only damage which the contractor has suffered is consequential damage and that therefore he can recover nothing, but that if it happens to be worth less than it was on May 1 the difference in value is not consequential and is recoverable whereas the really direct damage is consequential and irrecoverable.

I cannot accept that this was the intention of commercial men or what they must be taken to have meant. If the defendants did so intend, this clause certainly does not clearly and unambiguously express their intention, and they have therefore failed in their objective.

Parker J., continued by referring to the judgment of Atkinson J. in the Saint Line 30 case, in which Atkinson J. referred to the Millar's case 31 :

He then refers to Millars, and at p. 104 he continues:

In my judgment, the words, "indirect or consequential" do not exclude liability for damages which are the direct and natural result of the breaches complained of. … I do not think "intermediate" adds anything to the word "direct" and I do not think "consequential" adds anything to the word "indirect". What the clause does do is to protect the respondents from claims for special damages which would be recoverable only on proof of special circumstances and for damages contributed to by some supervening cause. I am satisfied that it does not protect them from the claims which are made in this case.

That passage appears to me to equate "consequential" with "indirect" and to treat them as interchangeable.

30 Saint Line Limited v. Richardsons Westgarth & Co., Limited, [1940] 2 K.B. 99; In this case, Saint Line purchased a set of ship engines from Richardsons. The engines were unsatisfactory and Saint Line claimed against Richardsons for (1) loss of profit; (2) wages etc.; and (3) superintendent’s fees. The contract between the parties contained an exclusion clause as to "indirect" and "consequential damages". The Court found that the claims were not precluded by the clause because the claims arose "directly and naturally from the breach".

31 Croudace Construction, supra, page 59

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Parker, J., found that the damages claimed were direct and not excluded by the consequential damages clause. The matter was taken to the Court of Appeal and judgment was given by Megaw, L.J. In upholding Parker J.'s decision, Megaw, L.J. stated 32 :

…it is clear that the word "consequential" can be used in various senses. It may be difficult to be sure in some contexts precisely what it does mean. But I think that the meaning given to the word in the Millars' case is applicable to the present case. It is binding on us in this case. Even if strictly it were not binding, we ought to follow it. That case was decided in the year 1934. It has stood, therefore, now for more than 43 years. So far as I know it has never been adversely commented upon. …

Notwithstanding that he followed it, Megaw, L.J. recognised that the Millar's case was fairly light on its reasoning as to the definition of consequential damages 33 :

… It is true also that the report in Commercial Cases of the Court of Appeal decision is not set out at length or in detail and does not, I think, purport to give the precise words used, but merely a summary of what was said, by Lords Justices Greer, Maugham and Roche, who constituted the Court. Lord Justice Maugham is reported as saying

On the question of damages, the word "consequential" had come to mean "not direct", and the damages recovered by the defendants on the counterclaim arose directly from the plaintiffs' breach of contract under Section 51(2) of the Sale of Goods Act, 1893.

I have already quoted what Lord Justice Roche said:

Lord Justice Roche agreed that the damages recovered by the defendants on the counterclaim were not merely "consequential", but resulted directly and naturally from the plaintiffs' breach of contract.

7. British Sugar plc v. NEI Power Projects Ltd. 34

The English Court of Appeal again considered an exclusion clause for liability for damages in relation to consequential loss in British Sugar. The contract at issue was for the design, supply, delivery, testing and commissioning of electrical equipment by the defendant, NEI. British Sugar alleged that the equipment was poorly designed and badly installed, which resulted in breakdowns in the power supply. The damages claimed were 47 times the amount of the contract price and consisted mainly of increased production costs and lost profits due to breakdowns. The relevant clause in the contract stated 35 :

32 Croudace Construction, supra, page 62

33 Croudace Construction, supra, page 62

34 British Sugar plc v. NEI Power Projects Ltd., [1997] EWJ No. 1127

35 British Sugar, supra, paragraph 7

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The Seller will be liable for any loss, damage, cost or expense incurred by the Purchaser arising from the supply by the Seller of any such faulty goods or materials or any goods or materials not being suitable for the purposes for which they are required [,] save that the Seller's liability for consequential loss is limited to the value of the contracts.

This clause had been negotiated by the parties. NEI had insisted upon a liability cap and had negotiated the cap on consequential loss being limited to the value of the contracts. On this point, Waller L.J., stated 36 :

… But in the result what is clear is that the Court is dealing with a contract negotiated between businessmen and not a contract simply on standard terms. Secondly, it can also be seen that the effect of amending Clause 6(iv) would appear to reflect the negotiation, that is to say the plaintiffs were not prepared to accept an overall limit on all damages, but were drawing a distinction between consequential damages and others and were prepared to accept a limit on consequential loss only.

The clause accordingly as amended seems on its face to place on the defendants an obligation to pay any damages which would normally be recoverable for breach of contract, but provides for some limitation only so far as consequential losses are concerned. The question is what limitation is placed upon the damages by use of the words "consequential loss", and that obviously depends on the meaning of the word "consequential".

The appellants suggest that any reasonable businessman would understand that, for example, loss of profits would be "consequential". They rely on those authorities which suggest that it is important to ascertain in the context of a commercial contract what reasonable businessmen would have intended placed in the situation of the parties. They then rely on MacGregor on Damages (15 th Edition) paras 25 to 27 and say that the analysis of the editor there coincides with what a reasonable businessman would understand …

The key passage in MacGregor is again set out in the judge's judgment at page 57:

"… in contract, where pecuniary losses are nearly ubiquitous, another distinction is taken and built upon. This is the useful and important division between normal and consequential losses. The normal loss is that loss which every Plaintiff in a like situation will suffer, the consequential loss is that loss which is special to the circumstances of the particular Plaintiff. In a contract the normal loss can generally be stated as the market value of the property, money or services that the Plaintiff should have received under the contract less either the market value of what he does receive or the market value of what he would have transferred but for the breach. Consequential losses are anything beyond this normal measure,

36 British Sugar, supra, paragraphs 8 to 11

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such as profits lost or expenses incurred through the breach, and are recoverable if not too remote."

Waller L.J. then referred to the Millar's Machinery, Croudace Construction and Saint Line cases and concluded that the interpretation to be applied to the contract was that the parties simply agreed to limit the defendants' liability for loss and damage not directly and naturally resulting from the defendants' breach of contract to an amount equal to the value of the contract. In expressing this view Waller L.J. states as follows 37 :

… Thirdly and finally, the construction suggested by the appellants, in my view,

gives very little effect to the words at the commencement of Clause 6(iv). On a proper reading of that clause, an obligation was being placed on the defendants to pay such damages as flowed naturally and directly from any supply by the defendants of faulty goods or materials, with the limitation being imposed in relation to some other type of loss which did not flow so directly, for example, damage which might flow from special circumstances and come within the second limb in Hadley v. Baxendale.

The Court of Appeal found that the parties only agreed to limit NEI's liability for consequential loss and damage and not loss or damage arising directly from NEI's breach of contract and therefore the exclusion clause did not assist NEI in its defence of the claim.

8. Deepak Fertilisers and Petrochemical Corporation v. Davey McKee (London) Ltd. 38

The English Court of Appeal again considered consequential damages when an explosion destroyed a low pressure methanol plant. In the Deepak Fertilisers case, the process was licensed to the owner by the designer and constructor of the plant (referred to as the "Design- builder"). The exclusion clause in the contract between the owner and the Design-builder provided as follows 39 :

… and in no event shall [the Design-builder], by reason of its performance or

obligation under this contract, be liable … for loss of anticipated profits, catalyst, raw material and products or for indirect or consequential damages.

As a result of the plant exploding, the owner suffered a number of losses in addition to the cost to reconstruct the plant. In particular, the owner claimed for:

(i)

fixed costs and overheads incurred during the period from the explosion to the resumption of commercial production (referred to as "overheads"); and

(ii)

increased costs due to the re-constructed plant requiring more catalysts to operate than the original plant configuration (referred to as the "catalyst cost").

37 British Sugar plc v. NEI Power Projects Ltd., supra, paragraph 20

38 Deepak Fertilisers and Petrochemical Corporation v. Davey McKee (London) Ltd., [1998] EWJ No. 3092

39 Deepak Fertilisers, supra, paragraph 31

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The English Court of Appeal concluded that losses which "clock up at once" 40 (namely the cost of idle workers and plant etc.) are direct losses and not consequential losses. 41 Since the overhead started to accrue as soon as the explosion occurred, they were considered direct and not consequential damages. The result was that the owner was entitled to pursue the claim for overheads against the Design-builder, notwithstanding the exclusion clause. The Court stated that 42 :

… The direct and natural result of the destruction of the plant was that Deepak was left without a Methanol plant, the reconstruction of which would cost money and take time, losing for Deepak any methanol production in the meantime. Wasted overheads incurred during the reconstruction of the plant, as well as profits lost during that period, are no more remote as losses than the cost of reconstruction. Lost profits cannot be recovered because they are excluded in terms, not because they are too remote.

The English Court of Appeal made it clear that overheads were not consequential damages and therefore not excluded from the damages available by the wording of the clause in the contract. It is also to be noted that the English Court of Appeal would have allowed the claim for lost profits during the reconstruction period, except for the express exclusion in the clause. This means that the general exclusion of "consequential damages" was not broad enough to cover lost profits.

As for the catalyst cost, the English Court of Appeal found this to be a valid claim for damages. On this point the Court said 43 :

The extra cost claimed is the cost which has now become necessary to ensure and enable the plant safely to produce the methanol in those quantities which the plant was supposed to. In other words, we would hold that this extra cost is akin to any other cost (such as an additional piece of plant or part) which achieved the same result. This could not be categorised as an indirect or consequential loss or damage nor could its cost be categorised as constituting a loss of profit.

9. Hotel Services Ltd. v. Hilton International Hotels (UK) Ltd. 44

It is obvious that the English Courts have been challenged over the years by the comments made in MacGregor on Damages 45 , which is a leading English textbook. This point was dealt with directly in Hotel Services. Sedley, L.J. described the facts that gave rise to the confusion over consequential damages in this case 46 :

40 The Court of Appeal uses the words of Parker J., the trial judge in Croudace Construction, supra

41 Deepak Fertilisers, supra, paragraph 89

42 Deepak Fertilisers, supra, paragraph 90

43 Deepak Fertilisers, supra, paragraph 92

44 Hotel Services Ltd. v. Hilton International Hotels (UK) Ltd., [2000] 1 All E.R. 750 (Comm) (C.A.)

45 H. MacGregor, Q.C., MacGregor on Damages (London: Sweet & Maxwell, various)

46 Hotel Services, supra, paragraph 1

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In the minibar to be found in many hotel bedrooms unimagined problems lurk. The honesty minibar, which depends on guests accounting for what they have used, generates forms of dishonesty ranging from leaving without pay to refilling bottles with water or other suitably coloured fluids. One answer to this problem was the Robobar, a device developed and marketed by [Hotel Services], which electronically registered on the guest's account any incursion into its contents. [Hilton International Hotels], a large hotel chain, between 1986 and 1996 used [Hotel Services'] Robobars in a number of their hotels. But the Robobars themselves proved problematical: their chillers leaked ammonia which both corroded the equipment and created a risk (albeit a very small one) of injury or even fatality to guests. Repeated endeavours to correct the malfunction failed.

The Court of Appeal considered a claim for the cost of removal and storage of the chiller units and cabinets and loss of profit on the mini-bars. The contract between the parties contained an exclusion clause in the rental contract for the Robobars which provided as follows 47 :

SECTION 14: LIABILITY

(1) [Hotel Services] will not in any circumstances be liable for any indirect or consequential loss, damage or liability arising from any defect in or failure of the System or any part thereof or the performance of this Agreement or any breach hereof by [Hotel Services] or its employees.

The Court found that the losses claimed were the direct and natural consequences of the defective Robobars and therefore was not affected by the exclusion clause. However, the Court also addressed the comments made in MacGregor on damages in relation to the definition of "consequential losses" as it relates to exclusion clauses 48 :

It is clear from the evidence that Hilton thereafter rented Robobars in order to sell drink at a profit, and preferably an improved profit. It does not follow, for example, from the fact that most of its Robobars in the event made steady losses that Hilton's aim was simply to increase the hotels' overall profitability by using the Robobars as a loss leader. In this situation we see nothing wrong with the simple conclusion that both the cost of having to get and keep the equipment out of the hotel bedrooms and the loss of any profits which it would otherwise have been earning were direct or natural consequences of the dangerous un- serviceability of the equipment and therefore untouched by an exemption clause which (since all recoverable loss is literally consequential) plainly uses "consequential" as a synonym of "indirect".

But nothing, at least in this area of the law, is so simple. [Counsel for Hilton] contends that a solid body of authority treats "indirect or consequential" damage as loss arising out of mutually known special circumstances, leaving all naturally occurring loss in the category of direct or intermediate damage. [Counsel for Hotel Services] submits that this simplistic allocation of contractual intent

47 Hotel Services, supra, paragraph 4

48 Hotel Services, supra, paragraphs 8 to 11

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between the two limbs of Hadley v. Baxendale is erroneous. He takes his stand on a different taxonomy adopted by Mr. Harvey MacGregor QC in the leading textbook on damages (see McGregor on Damages (16 th edn, 1997)). In his first chapter … MacGregor rejects the distinction between general and special damage in favour … of "normal" and "consequential" losses: the former he describes as those which every claimant in a like situation will suffer, the latter as those peculiar to the particular claimant's circumstances. As an instance of normal damages he gives a net market value of a benefit lost by the breach. Then …:

"Consequential losses are anything beyond this normal measure, such as profits lost or expenses incurred through the breach, and are recoverable if not too remote. The distinction is not the same as that between the first and second rules in Hadley v. Baxendale: a consequential loss may well be within the first rule."

If consequential losses include profits lost or expenses incurred through breach, it is unsurprising that such loss may come within the first rule in Hadley v. Baxendale. What we find more problematical than the conclusion is the premise that such losses cannot be normal losses in the author's own sense of losses which every plaintiff in a like situation will suffer. Whether they do, it seems to us, must depend on the facts and to this extent [counsel for Hotel Services] is right to submit that the question is fact-sensitive. McGregor, by contrast, derives his meaning of "consequential" from the more catholic usage to be found in cases such as Mondel v. Steel … This was an unsuccessful demurrer to an action for damages for consequential loss brought by a plaintiff who had already succeeded in setting off damages for failure to meet the contractual specification in an action against him for the contract price. Parke B. spoke differentially of loss in market value and "any consequential damage". This is of course a legitimate usage which, to the extent that it cuts across the two Hadley v. Baxendale categories, simply requires cases to be decided in a different vocabulary. The difference barely affects the recoverability of damages, since both normal and consequential damages are in Mr McGregor's scheme recoverable so long as they are not too remote; but while in relation to damages this represents a continuum, its effect on exclusion clauses is to require a knife to be inserted between the two kinds of loss. This no doubt is why, in a note contained at present in his supplement, Mr McGregor reflects:

"It may be that there is justification for the courts to construe the term consequential loss more narrowly where exclusion clauses are concerned - exclusion of liability for consequential loss is a common feature of commercial contracts - but the argument in the text as to the term's proper meaning is still adhered to. Ideally one would wish it to be possible to construe consequential loss narrowly where exclusion clauses are concerned but resort to the contra proferentum rule and widely in all other cases; but two competing interpretations of this nature may be difficult to achieve."

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We may perhaps add that we are not convinced by the passage in which Mr McGregor goes on to argue that those authorities which appear to confine the meaning of consequential loss the second limb of Hadley v. Baxendale lack logic. Not only do we have some difficulty in accepting the reasoning (namely that it is contradictory first to communicate special circumstances and then to accept an exclusion of liability for damage arising out of them: all worthwhile exclusions are contradictory), we find difficulty in allowing a substituted meaning of "consequential", even if it is analytically more satisfactory, to colour decisions based on a different and usage-based meaning.

It may be thought, however, that the source of the difficulty is not the need to find

a differential rule for the ascertainment of liability and the construction of

exclusion clauses respectively but the underlying distribution of losses between the normal and the consequential. One would like to say simply that all consequential losses are recoverable provided they were either objectively or

subjectively foreseeable by the parties; but to do this is to restore to the word "consequential" the natural meaning of which commercial and legal usage in exclusion clauses has long since robbed it. Instead one has to go back to the language of the clause in its documentary and factual context and try to see what

it means. In this exercise, we have found no real help in the other parts of the

contract, save its Section 18, dealing with force majeure, excludes liability for

"any direct or indirect loss", thereby emphasising the familiar distinction.

The Court of Appeal in defining the meaning of "consequential loss" gave examples that consequential loss might be injury to the profitability of the hotel itself; but where the contract is a rental agreement, the essence of the contract is the use of equipment, and, if through the breach of the contract it becomes unusable and dangerous, the natural and immediate loss is the profit which the rental equipment would have otherwise yielded and the cost of neutralizing the danger.

After referring to the well known rule in Hadley v. Baxendale, the Court went on to describe it as being one on a continuum 49 :

This is not a dichotomous but a continuous classification, bringing into the region of recoverability all loss which the parties must in the nature of things or for known reasons have anticipated. It is the framing of exclusion clauses which has

made it necessary to divide up its elements in order to keep the contractual effects within acceptable bounds. Thus in Millar's Machinery … a clause excluding "responsibility for consequential damages" was read down by this court so as not

to exclude liability for damage occurring naturally or directly. In an inadequately

reported decision upholding "the Trial Judge", Maugham L.J. is recorded in indirect speech as having held that the "word 'consequential' had come to mean 'not direct'," and Roche L.J. as having applied this reading to the contract. … In the present case, it will be recalled, the phrase is "indirect or consequential" as it was in Saint Line Ltd. v. Richardsons … where Atkinson J, construing a byzantine exclusion clause which included the same phrase as in the present case, said:

49 Hotel Services, supra, paragraph 15

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"Direct damage is that which flows naturally from the breach without other intervening cause and independently of special circumstances, while indirect damage does not so flow. The breach certainly has brought it about, but only because of some supervening event or some special circumstances. The word 'consequential' is not very illuminating, as all damage is in a sense consequential. …"

Sedley L.J. discussed the difficulty of drawing a bright line between damages naturally flowing from a breach and damages that can only be contemplated with the knowledge of special circumstances. With this difficulty in mind, Sedley L.J. is appreciative of the point of view taken by McGregor in his text book 50 :

… One sees readily why McGregor is willing to allow the consequential loss in the sense adopted by him may be within the first limb of Hadley v. Baxendale. But the passage also illustrates the difficulty of allocating loss of profit and removal and storage charges in a case such as the present to the region of indirect loss; and, like Atkinson J [in Saint Line], we would regard consequential loss, where the two are bundled together, as synonymous with it.

Notwithstanding the comments of McGregor, the Court of Appeal rejected that analysis and reverted to the Hadley v. Baxendale first principles to find that each case requires a fact finding analysis to determine whether or not in each particular case special circumstances were required to know that the damages would accrue. Specifically, if equipment is rented out for selling drinks and turns out to be unusable and possibly dangerous, it requires no special mutually known fact to establish that the damages will include the consequent cost of putting it where it can do no harm and that there will be a loss of profit as a result of those defects. As these claims were found to be understood without knowledge of special circumstances, they were considered to be direct damages and as such they were not losses that were governed by the exclusion clause and were losses available to Hilton International in its claim against Hotel Services.

10. Farley v. Skinner 51

The House of Lords recently revisited the calculation of consequential loss in its decision in Farley v. Skinner. In this case, a property owner brought an action against the surveyor (building inspector) due to the fact that the surveyor had been asked to consider whether or not the property was seriously affected by aircraft noise. The property was located 15 miles from Gatwick International Airport. While the House of Lords was unanimous in its conclusion, each of the law Lords wrote an opinion. Only Lord Scott of Foscote specifically referred to the principle in Hadley v. Baxendale: 52

In my opinion, the issue can and should be resolved by applying the well known principles laid down in Hadley v. Baxendale … as restated in Victoria Laundry

50 Hotel Services, supra, paragraph 16

51 Farley v. Skinner, [2001] H.L.J. No. 49

52 Farley v. Skinner, supra, paragraphs 75 to 76

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in the light of the recent guidance provided by Bingham L.J. in Watts v. Morrow … and by this House in Ruxley Electronics and Construction Ltd. v. Forsythe

The basic principle of damages for breach of contract is that the injured parties entitled, so far as money can do it, to be put in the position he would have been in if the contractual obligation had been properly performed. He is entitled, that is to say, to the benefit of his bargain …

11. Caledonia North Sea Limited v. British Telecommunications PLC 53

Another recent House of Lords decision arose out of a tragic explosion on the Piper Alpha Oil Platform on July 6, 1988 which killed 165 workers, injured 61 workers and killed 2 rescuers. The operator operated the platform on behalf of a consortium of owners. At the time of the explosion, 37 of the operator's employees were on the platform and the remaining 189 people were employees of a number of different contractors hired to carry out specific tasks on the platform.

The case raised a number legal issues relating to the allocation of the losses between the operator and the contractors. One of the issues raised was whether or not a claim could be made for consequential losses. Article 21 of the contract provided as follows 54 :

21 Consequential Loss

Notwithstanding any other provision of this contract, in no event shall either the contractor or the company be liable to the other for any indirect or consequential losses suffered, including but not limited to, loss of use, loss of profits, loss of production or business interruption.

The court found that the claims made were fatal injury damages not relating to "indirect or consequential losses suffered, including but not limited to, loss of use, loss of profits, loss of production or business interruption." It was argued that the losses were indirect or consequential, but that claim was rejected by the court. The claims in issue were those relating to the payments made to the families of the killed workers which were in excess of the amount of recovery that would have been allowed by Scot's Law but were paid because the claims could have been brought in Texas. What is most interesting about this case is the questioning comment and the decision of Lord Hoffmann in relation to the decision of the Court of Appeal in Hotel Services: 55

My Lords, I would wish to reserve the question of whether, in the context of the contracts in the Hotel Services and similar cases, the construction adopted by the Court of Appeal was correct. But I do not think they have any application to this case. Clause 21 limits the liability of the parties for losses caused by breach of contract. Certain kinds of losses are excluded. But this is not a claim for breach

53 Caledonia North Sea Limited v. British Telecommunications PLC (Scotland) and Others, [2002] UKHL 4

54 Caledonia North Sea, supra, paragraph 68

55 Caledonia North Sea, supra, paragraph 100

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of contract. It is a claim to an indemnity for a liability incurred by the operator outside the contract. In my opinion, clause 21 has no application to such a claim.

This case raises the interesting question whether a clause excluding liability for damages excludes liability under an indemnity clause in the contract.

12. Simkins Partnership (A Firm) v. Reeves Lund & Co. Ltd. 56

Consequential losses were also considered in the Simpkins Partnership case. This case dealt with a claim by a law firm against the installer and maintainer of telephone systems. The law firm had contracted with the telephone system installer for a new voice-mail system. Some time after it had been installed, a hacker was able to access the system and make significant international long distance calls at the expense of the law firm. The law firm claimed against the telephone system installer for the losses it incurred in paying those telephone charges. The defendants relied on an exclusion clause and the Justice reviewed the English law in relation to an exclusion for consequential loss: 57

Finally, Mr Challenger relied upon a provision in the contract whereby the Defendants were not to be responsible for the loss of "any business or profits or any other consequential loss whatsoever or howsoever arising". Mr Daly however submitted that the loss claimed here should not be categorised as "consequential", but flowed directly from the breach.

Mr Daly cited a decision of Mr Blunt Q.C. in the Technology & Construction Court, on 8th June 2000, Civil and Marine Slag Cement Ltd v Cambrian Stone Ltd in which the learned Deputy Judge said as follows:-

"However, the Court of Appeal's decision in Croudace Construction … is perceived to provide binding authority that in every contract the effect of a clause excluding liability for consequential loss is to exclude liability for losses which would fall under the second rule in Hadley v Baxendale … but not for losses which would fall under the first rule enunciated in that case. (For recent decisions on, and discussions of this topic see Deepak Fertilisers …, BHP Petroleum Ltd v British Steel plc … and Hotel Services …). Thus I am constrained to consider whether the loss assumed to have occurred in the present case is one which, to use the words of Alderson B in Hadley v Baxendale:

"may fairly and reasonably be considered

naturally, ie according to the usual course of things

from

arising

(the) breach of contract itself"

Alderson B's famous dictum in Hadley v Baxendale and its treatment by Adquith LJ [sic] in his judgement in Victoria Laundry

56 The Simkins Partnership (A Firm) v. Reeves Lund & Co. Ltd., [2003] EWHC 1946 (QB)

57 The Simkins Partnership, supra, paragraphs 20 to 22

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… were considered by the House of Lords in … The Heron II … In my judgement, the effect of the speeches in that case is that a kind of loss falls within the first rule in Hadley v Baxendale if it is one which the Denfendant [sic] when he made the contract, ought to have realised was not unlikely to result from the breach even though he was not given any express intimation to that effect by the Claimant … "

I adopt this as a correct statement of principle. The Defendants accept here that they knew an unbarred system would be a fraud/security risk if left unbarred. In view of this the Defendants cannot avoid the conclusion that this sort of loss is a kind of loss which falls within the first rule in Hadley v Baxendale, and is direct rather than consequential.

In finding that the damage claimed was direct damage, the court determined that the exclusion clause did not apply and telephone installers were liable for the damage claimed.

C. Canadian Authorities

1. General Securities Ltd. v. Don Ingram Ltd. 58

Don Ingram entered into an agreement with General Securities, pursuant to which General Securities undertook to advance credit that was required from time to time to finance Don Ingram's business. Pursuant to this agreement, General Securities advanced credit to the respondent from 1934 to 1937. In 1937, General Securities agreed unconditionally to finance the purchase of 26 vehicles by Don Ingram. Relying on this agreement, Don Ingram contracted with Studebaker to purchase these vehicles. However, when the vehicles were delivered to Don Ingram, the appellant refused to provide the funds. Don Ingram was obliged to discontinue its business and sell its assets at a loss.

Given the knowledge of the parties, the Supreme Court of Canada held damages could be awarded based on the fact that General Securities knew of all "material circumstances": 59

This case presents none of the difficulties that sometimes arise, touching the application of the second branch of the rule in Hadley v. Baxendale

[General Securities was] fully aware of the material circumstances. In October when they agreed to finance the proposed purchase, pursuant to the existing agreement of 1934, they must have realized with the knowledge they had, if they gave a thought to the matter, that, if they refused to make the necessary advance on the arrival of the goods in Vancouver and the presentation of the draft, [Don Ingram] would be unable to take it up and that the Studebaker Corp. would (probably, if not certainly) sever their relations with [Don Ingram], and that in consequence of such a severance it was highly probable that [Don Ingram] would be forced out of business and would suffer the pecuniary loss naturally resulting

58 General Securities Ltd. v. Don Ingram Ltd., [1940] 3 D.L.R. 641 (S.C.C.)

59 General Securities, supra, page 643

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therefrom.

The appeal is hardly an arguable one and should be dismissed with

costs.

The Supreme Court of Canada upheld Don Ingram's claim for consequential damages because the damages incurred by it with respect to loss of profits, loss of business, and loss on realization of assets were within the contemplation of General Securities based on the knowledge of the "material circumstances" of the transaction.

2. Munroe Equipment Sales Ltd. v. Canadian Forest Products Ltd. 60

The defendant, Canadian Forest Products, was urgently seeking a tractor to assist it in the removal of cut logs prior to the winter season and arranged to rent a second-hand tractor from the plaintiff, Munroe. The trial judge found that Munroe's salesman had been made aware of the intended use for the tractor and was told when the contract was entered into that the tractor was required to open roads, that time was short and that the frost had recently set in. However, the tractor proved to be defective and broke down shortly after it was delivered to the site. As a result, Canadian Forest Products abandoned the tractor and refused to make the monthly payments. Munroe sought recovery of the payments and, in response, Canadian Forest Products counterclaimed for loss of profits.

The Manitoba Court of Appeal was divided on whether the defendant should succeed in its counterclaim. In light of the principles of Hadley v. Baxendale, the majority of the Court found that insufficient information had been made available to Munroe concerning the amount of wood and the fact that the removal was urgent. In particular, the majority of the Court stated: 61

In my opinion it is unreasonable to expect that such a burden of responsibility for damages as now claimed by the defendant should be assumed from the rental of a second-hand unit. Surely no reasonable person could contemplate, under the circumstances of the renting of this machine, that the lessor of one second-hand tractor was underwriting and virtually insuring the removal of all this pulpwood from the bush.

However, in the minority view, sufficient information to engage the second rule in Hadley v. Baxendale had been communicated to Munroe. According to the minority, Canadian Forest Product's counterclaim should have been allowed.

3. Scyrup v. Economy Tractor Parts Ltd. 62

Just two years later, the same court reached the opposite conclusion on similar facts. In Scyrup, the plaintiff acquired a second-hand attachment for his tractor from the defendant. The defendant was aware that the plaintiff required the attachment in order to fulfil a contract with a third party. The attachment was defective and the plaintiff lost his contract with the third party. The plaintiff commenced an action against the defendant for damages for loss of profits.

60 Munroe Equipment Sales Ltd. v. Canadian Forest Products Ltd (1961), 29 D.L.R. (2d) 730 (Man. C.A.)

61 Munroe Equipment, supra, page 740

62 Scyrup v. Economy Tractor Parts Ltd. (1963), 40 D.L.R. (2d) 1026 (Man. C.A.)

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The Manitoba Court of Appeal was once again divided. The majority of the Court allowed the plaintiff's action because it was apparent to the defendant that the delivery of a defective attachment would lead to a loss of profits by the plaintiff.

However, the minority was of the view that insufficient information had been provided. According to the minority, the defendant should not be responsible for damages for loss of profits "unless it was clearly indicated to the defendant at the time the equipment was purchased exactly what kind of contract was being entered into by the plaintiff, the type of work that was to be done and the magnitude of the operation." 63

4. Cornwall Gravel Co. Limited v. Purolator Courier Limited 64

Cornwall Gravel brought an action against Purolator for damages for breach of contract and negligence due to the late delivery of a tender prepared by Cornwall Gravel for submission to the Ontario Ministry of Environment. Purolator's employee was told that the item to be transported was a tender submission which had to be delivered by a certain date and time. However, the delivery was late and Cornwall Gravel argued that if the tender had been delivered on time Cornwall Gravel would have been awarded a $700,000.00 contract and would have made approximately $70,000.00 profit. 65 The Court dealt with whether the claimed loss of profit was recoverable.

The relevant provisions in the bill of landing stated 66 :

SCHEDULE A

.

.

.

5. The carrier is not liable for loss, damage or delay to any of the goods

described in the bill of lading caused by an act of God, the Queen's or public enemies, riots, strikes, defect or inherent vice in the goods, the act or default of the shipper or owner, the authority of law, quarantine or differences in weights of

grain, seed, live stock or other commodities caused by natural shrinkage.

.

.

.

9. Subject to paragraph 10, the amount of any loss, damage or injury for

which the carrier is liable, whether or not the loss, damage or injury results from

negligence, shall be computed on the basis of,

63 Scyrup, supra, page 1029

64 Cornwall Gravel Co. Limited v. Purolator Courier Limited (1978), 83 D.L.R. (3d) 267 (Ont. H.C.); aff’d without significant reasons (1979), 115 D.LR. (3d) 511 (Ont. C.A.); aff’d without significant reasons, [1980] 2 S.C.R. 118

65 It was admitted that the plaintiff would have been awarded the contract if the tender was delivered on time.

66 Cornwall Gravel, supra, pages 272 and 273

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(a) the value of the goods at the place and time of shipment including

the freight and other charges if paid; or

(b) where a value lower than that referred to in clause a has been

represented in writing by the consignor or has been agreed upon, such

lower value.

10. Subject to paragraph 11, the amount of any loss or damage computed

under clause a or b of paragraph 9 shall not exceed $1.50 per pound unless a higher value is declared on the face of the bill of lading by the consignor.

The Ontario High Court of Justice held paragraph 5 did not assist Purolator as none of the specified events took place and that the limitation of liability described in paragraph 9 only applied to a situation where there is loss, damage or injury to the goods during transport and did not cover consequential losses due to delay. 67 Purolator, through its employee, was aware of the importance of the tender document and the fact that the tender had to be delivered by a certain date and time. Given these circumstances, the Court found that Purolator must have realised that a contract could be lost if the delivery of the tender was late. Accordingly, Cornwall Gravel was awarded damages for loss of profits.

5. McCain Produce Co. Ltd. et. al. v. Canadian Pacific Limited 68

The plaintiffs (collectively the "Producers") claimed losses, including consequential damages, against Canadian Pacific Railway ("CPR") and Canadian National Railway for delay in shipping the Producer's potatoes.

Some of the heating equipment provided in the CPR railcars proved to be inadequate allowing some of the shipments of potatoes to freeze in transit and while at the port. As a result, some potatoes were detained by federal officials for inspection for frost damage. The detention of the potatoes for inspection created severe congestion in the sheds where the potatoes were kept prior to unloading for transport by ship.

Only CPR appealed the award of damages resulting from the loss of potatoes and increased expenses in relation to the export of the salvageable potatoes. CPR's bill of lading for each of the railcars indicated the quantity of potatoes carried, that they were consigned to a shipping agent in St. John, New Brunswick, and that their final destination was for export to a named country on a named vessel. In particular, damages payable were limited by the language found in clause 4 69 :

The amount of any loss or damage for which any carrier is liable shall be computed on the basis of the value of the goods at the place and time of shipment under this bill of lading (including the freight and other charges if paid, and duty if paid or payable and not refunded), unless a lower value has been represented in writing …

67 On appeal, neither the Ontario Court of Appeal nor the Supreme Court of Canada gave substantive reasons.

68 McCain Produce Co. Ltd. v. Canadian Pacific Limited (1980), 30 N.B.R. (2d) 476 (C.A.); aff'd (1981), 123 D.L.R. (3d) 764 (S.C.C.)

69 McCain Produce, supra, paragraph 22

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[italics in the judgment of Richard J.A.]

In light of the principles in Hadley v. Baxendale, the New Brunswick Court of Appeal held that the claim for consequential damages will be dependent on whether the defendant can be held to have been sufficiently aware of the plaintiffs' business practices and requirements. 70 Given the long history of similar dealings between the parties, the Court held that CPR must have been aware that the contents of the various railcars were the subject of export contracts and that damage would accrue to the Producers as a result of delays in shipment. Accordingly, the Producers were allowed to recover damages for the loss of the potatoes and the loss of certain contracts for the sale of those potatoes.

6. Cathcart Inspection Services Limited v. Purolator Courier Limited 71

Purolator failed to deliver a tender submission for a construction contract which was contained in an envelope which included the words "tender due date" together with the requisite date on the face of it. 72 The plaintiff, Cathcart, was not awarded the contract and claimed for lost profit of $37,000.00. The bill of lading contained an exclusion of liability: 73

DELAY & LIMITATION OF VALUE

Unless specifically agreed to in writing the carrier will not: (1) be liable for any special, consequential or other damages for any reason whatever including delay in delivery, (2) transport any goods declared to have a value in excess of $250. …

Purolator claimed that the limitation clause excluded liability for the claim of loss of profit. At trial, it was found that the loss of profit claimed was not too remote, for the damages were a natural consequence of failure to deliver a tender and was within the reasonable contemplation of the parties. The Court of Appeal found that Hadley v. Baxendale applied as the special circumstances of the delivery was known and communicated to Purolator which meant the damages were reasonably contemplated by the parties.

The Ontario Court of Appeal found that the failure of Purolator to deliver the tender submission was a fundamental breach of the contract, a breach going to the root of the contract. The Court of Appeal also found that such a breach does not necessarily invalidate an exception or

70 McCain Produce, supra, paragraph 92, where the Court of Appeal quotes from Monarch Steamship Co. v. A/B Karlshamns Oljefabriker, [1949] 1 All E.R. 1 (H.L.): "[T]he question in a case like the present must always be what reasonable businessmen must be taken to have contemplated as the natural or probable result if the contract was broken. As reasonable businessmen each must be taken to understand the ordinary practices and exigencies of the other’s trade or business. That need not generally be the subject of special discussion or communication. …"

71 Cathcart Inspection Services Ltd. v. Purolator Courier Ltd. (1981), 128 D.L.R. (3d) 227 (Ont. H.C.); aff’d (1982), 139 D.L.R. (3d) 371 (Ont. C.A.)

72 The Court of Appeal described the "special circumstances" as follows, at page 373: "The envelope in the case at bar clearly indicated not only that it contained a tender but also the due date thereof. The trial judge … found that the defendant 'knew or ought to have known on February 19, 1979, it was to deliver a tender and that failure to do so could result in a substantial loss of profits to the plaintiff'."

73 Cathcart, supra, pages 373 and 374

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exclusionary clause such as the one found in this case. 74 Instead, the question of the effect of the limitation clause was considered according to the true construction of the contract and the Ontario Court of Appeal applied the following test: 75

… whether it was fair and reasonable to attribute to the parties the intention that the exclusionary clause should survive notwithstanding a fundamental breach by the party in whose favour it was drawn …

In applying this test the Court of Appeal, relying on the British Columbia Court of Appeal in Hofstrand 76 , looked at two factors to determine the nature of the contract involved. Firstly, the nature of the service being provided was a courier service which is employed typically for speed and certainty of delivery. Secondly, the "vast majority" of communications typically sent by courier "involve financial considerations". In this case it was known that this was a tender submission being sent and the Court of Appeal found that it must have been in the contemplation of the parties that if the tender was not delivered Purolator would be liable for any damages flowing from its failure to deliver.

The Court of Appeal determined it was reasonable for Cathcart to conclude that whatever is excluded by the limitation clause, it does not exclude non-delivery. The Court of Appeal pointed out that there was a serious difference between delay and non-delivery, especially as the party calling for bids was prepared to consider Cathcart's tender if it had been found and delivered late, but, due to concerns of fraud, was not willing to have the tender re-submitted.

7. B.D.C. Ltd. v. Hofstrand Farms Ltd. 77

On December 29, 1976, the defendant courier contracted with the Province of British Columbia to deliver an envelope from a government office in Victoria to the Land Registry Office in Prince George. Unknown to the courier, the envelope contained a Crown grant of land in favour of Hofstrand Farms that needed to be registered by December 31, 1976. The registration of the grant was important to Hofstrand Farms because Hofstrand Farms had agreed to sell the land to a third party. The sale contract allowed the third party not proceed with the purchase if the grant was not registered by December 31, 1976. The courier failed to deliver the envelope on time and the third party refused to complete the transaction. Hofstrand Farms sued the courier for consequential damages for loss of profits.

The Supreme Court of Canada dismissed Hofstrand Farms' action because the losses claimed arose from special circumstances unknown to the courier company and thereby were excluded by the second rule in Hadley v. Baxendale 78 . The Court distinguished the Cornwall Gravel case as

74 The Court of Appeal, at page 374, relied on the decisions in Photo Production Ltd. v. Securicor Transport Ltd., [1980] 1 All E.R. 556 (H.L.); and Beaufort Realties (1964) Inc. v. Chomedey Aluminum Co. Ltd., [1980] 2 S.C.R. 718

75 Cathcart, supra, page 374

76 Hofstrand (1982), 131 D.L.R. (3d) 464 (B.C.C.A.), but note this decision was overturned by the Supreme Court of Canada, see infra, note 74

77 B.D.C. Ltd. v. Hofstrand Farms Ltd., [1986] 1 S.C.R. 228

78 Hofstrand Farms, supra, paragraph 25: The Supreme Court of Canada clearly stated that the rule in Hadley v. Baxendale is the proper test by which remoteness of damages should be measured.

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the courier in this case had no knowledge of the existence of Hofstrand Farms and could not reasonably have known of the existence of a class of persons whose interests depended upon timely delivery of the envelope. The courier had no actual or imputed knowledge that the rights of a third party could in any way be affected by the late delivery of the envelope. As a result, Hofstrand Farms could not recover for loss of profits because the resulting damages were not foreseeable. 79

8. Kempling v. Hearthstone Manor Corp. 80

The plaintiffs, the Kemplings, were the intended purchasers of a residential condominium that would house them and Mrs. Kempling's elderly father. For a variety of reasons the transaction was never concluded and the purchasers sued for breach of contract and mental suffering.

On appeal, the court was unanimous in its conclusion to dismiss the appeal, but issued three separate judgements. In considering the claim for damages for mental suffering, Picard J.A. discussed the Hadley v. Baxendale case and then continued with an analysis of how the rules in that case are to be applied to a claim for mental distress arising from a breach of contract: 81

Professor Fridman discusses the rule set out in Hadley v. Baxendale in his text … and points out that there are two components to the rule, one objective and one subjective. He says, … "The application of the first branch of the Hadley v. Baxendale rule, the objective test, depends upon the nature of the transaction that is involved in any individual case." By contrast, he says … that the foundation for the application of the second aspect, the subjective test:

is the defendant's knowledge of some special circumstances which would lead him to realize, as a reasonable man seized of that knowledge, that the plaintiff might suffer some extra, extraordinary, or normally unforeseeable damage, beyond or different from the kind or extent of damage which would otherwise be within the 'reasonable contemplation' of the parties.

The objective part of the rule in Hadley v. Baxendale has undergone some modification through the decisions in Victoria Laundry … and The Heron II … The discussions and disputes that followed those cases highlighted the tension between the criteria and tests for limiting liability in contract law as contrasted with tort law. …

Justice Wilson, writing for the minority in Vorvis, said that she thought the proper approach to take in deciding a claim for damages for mental suffering was to

79 Similarly, a carrier of goods who damages them in breach of contract is not liable for consequential loss unless the carrier knows that such loss is likely to flow from the damages. A trucker who damaged a press roll in the course of transporting it to a pulp mill was found liable for the costs of repairing the roll, but not for the loss of profits incurred by delay in production of the mill caused by an attempt to use the damaged roll. See Scott Maritimes Pulp Ltd. v. B.F. Goodrich Canada Ltd. (1977), 72 D.L.R. (3d) 680 (N.S.S.C. App. Div.)

80 Kempling v. Hearthstone Manor Corp. (1996), 137 D.L.R. (4 th ) 12 (Alta. C.A.)

81 Kempling, supra, paragraphs 26 to 28

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apply the basic principles of contract law relating to remoteness as set out by Baron Alderson in Hadley v. Baxendale.

In his text Professor Fridman noted that Hadley v. Baxendale has been the accepted test. As cited by Justice Wilson [in Vorvis] … :

By intangible loss is meant such consequences as loss of reputation, insult, annoyance, aggravation, nervous shock, inconvenience, mental distress, or other emotional or sentimental suffering. In recent years, in England and Canada, there has been a growing realization that such results of a breach of contract should also be the subject of compensation, as long as the doctrine of Hadley v. Baxendale is applicable. There has been a greater acceptance of the idea that such damages can, and should be awarded in appropriate cases. [Emphasis added.]

Justice Wilson found a "common denominator" in the cases where damages were awarded, that being that the parties should reasonably have foreseen mental suffering as a consequence of a breach of contract at the time the contract was entered into. She concluded … :

It is my view, that the established principles of contract law set out in Hadley v. Baxendale provide the proper test for the recovery of damages for mental suffering. The principles are well-settled and their broad application would appear preferable to decision-making based on a priori and inflexible categories of damages. The issue in assessing damages is not whether the plaintiff got what he bargained for, i.e. pleasure or peace of mind (although this is obviously relevant to whether or not there was a breach), but whether he should be compensated for damage the defendant should reasonably have anticipated that he would suffer as a consequence of the breach.

Justice Wilson applied the Hadley v. Baxendale analysis to the facts before her and concluded, as had the majority, that there was no basis for granting damages for mental suffering.

My conclusion is that the determination of a claim for mental suffering or distress in a breach of contract suit must begin with the application of the rule in Hadley v. Baxendale. The rule has within it the means to test and limit liability where the claim arises through special circumstances, which will be the usual case with mental suffering or distress. The contract must be made on the basis of those special circumstances being known to the parties and the plaintiff having communicated them to the defendant. Also, the plaintiff bears the further burden of having to prove the causal link between the breach and the mental suffering or distress and foreseeability of that injury. Damages would be restricted to those that "would ordinarily follow from a breach under the special circumstances so known and communicated." A breach of contract will often result in

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unhappiness, frustration, inconvenience, anger and even malevolence. The rule is not intended to assure compensation in those cases. The rule allows a court to award damages but does not mandate doing so.

The Court of Appeal found special circumstances had been communicated to the condominium developer and that the Kemplings had "proved the link between the breach of contract and the injuries and that it was foreseeable that mental suffering and distress would result". 82

9. Syncrude Canada Ltd. v. Babcock & Wilcox Canada Ltd. 83

The Alberta Court of Appeal considered the following exclusion clause relating to consequential damages in the Syncrude v. Babcock & Wilcox case:

49 CONSEQUENTIAL DAMAGES: The Subcontractor will not be liable in

any event for loss of anticipated profits, loss by reason of plant shutdown, non- operation or increased expense of operation of other equipment, or other

consequential loss or damage of any nature arising from any cause whatever.

The case dealt with the damages that Syncrude could recover as a result of three defective boilers designed and built by Babcock & Wilcox. The trial judge awarded $6 million in relation to the cost of repairing the boilers. However, the trial judge also awarded $4 million in relation to the extra cost of energy as a result of the boilers being inefficient, from the time of the defect becoming apparent to the date by which Syncrude could have had the boilers repaired. Babcock & Wilcox appealed this decision and argued that the $4 million portion of the award to Syncrude was covered by the exclusion clause and not recoverable by Syncrude.

The Court of Appeal did not agree with the argument that anything beyond the direct cost of repairing the boilers was excluded by clause 49. In upholding the award to Syncrude, the Court of Appeal stated that damages should be calculated based on the difference in value between what was contracted for, and what was delivered. In making this calculation, the capitalized value of the extra energy expenses was taken into account. The court found that the additional cost of energy because the defective boilers were inefficient, was not consequential to the damage incurred and were not excluded by clause 49.

The Court of Appeal discussed the elements of the claim that could be considered as either direct or consequential damages 84 :

It is said that anything beyond the direct cost of strengthening is "consequential", and so excluded by that clause. We do not agree. In the first place, sticking to the words of the clause quoted, is inefficient operation of these boilers, e.g. inability to run them safely in combined mode as contracted for, within the prohibitions in this clause? We doubt that. In the second place, a usual measure of direct damages for supply of defective work or materials is the difference in

82 Kempling, supra, page 28

83 Syncrude Canada Ltd. v. Babcock & Wilcox Canada Ltd., [1997] 7 W.W.R. 343 (Alta. C.A.)

84 Syncrude, supra, page 13

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value between what was contracted for, and what was delivered. None of that is consequential damages. No honest person could sell these boilers without revealing the defect. No informed purchaser would pay as much for them as for ones with the strength and economical combined-cycle capabilities contracted for. Any reasonable calculation of the worth of what was delivered would have to deduct the capitalized value of the extra expense involved in uneconomical but safe simple cycle operation.

And in the third place, the trial judge was not assessing or awarding the plaintiff's actual loss. He was awarding an amount equal to costs of certain mitigation which was improperly not carried out. We do not read this clause as covering that situation. What is the entire boiler problem could have been offset by making a $5,000 adjustment somewhere else in Syncrude' s whole complicated plant and operations? If that should have been seen and done at the time, then failure to mitigate that way would have reduced the entire recovery to $5,000. But could one then call that consequential loss barred by clause 49, and award nothing? The flaw in the logic becomes obvious. This is all an alternative to another direct fix of the boiler problem which would have cost well over

$20,000,000.

10. M.J.B Enterprises Ltd. v. Defence Construction (1951) Ltd. 85

This decision arose in the context of tender law. 86 The second lowest tenderer, MJB Enterprises, claimed that the owner, Defence Construction, had breached the contract (Contract A), that the winning tender should have been disqualified and that MJB Enterprises' bid should have been accepted. The Supreme Court of Canada agreed and awarded MJB Enterprises damages in the amount of the profits it would have realised had it been awarded the contract.

In finding that MJB Enterprises' loss of profits were reasonably foreseeable as a result of a breach of Contract A, the Supreme Court of Canada approved the Hadley v. Baxendale decision as the test regarding remoteness of damages and made reference to the Cornwall Gravel decision: 87

57 Even if the evidence supports that, on a balance of probabilities, Contract B

would have been awarded to [MJB Enterprises], it still must be determined whether the loss of Contract B, although caused by the breach of Contract A, is nonetheless too remote. The classical test regarding the remoteness of damages is

that provided in Hadley v. Baxendale per Alderson B.:

Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and

85 M.J.B Enterprises Ltd. v. Defence Construction (1951) Ltd., [1999] 1 S.C.R. 619

86 In the law of tender, the contract between the owner and each bidder relating to the terms of the tender is referred to as "Contract A" and the contract for the actual construction is referred to as "Contract B".

87 M.J.B Enterprises, supra, paragraphs 57 to 59

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reasonably be considered either arising naturally, i.e., according to the usual course of things, from such breach of contract itself, or such as 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 of it.

58 In this case, [Defence Construction] may be taken to know that if it decided

to award Contract B and awarded it to a non-compliant bid, then one of the tenderers who submitted a compliant bid would suffer the loss of Contract B. In this context it is sufficient that the respondent knew that this tenderer could be

[MJB Enterprises].

59 This finding is consistent with the decision of Cornwall Gravel Co. v.

Purolator Courier Ltd. … In that decision, Cornwall Gravel was awarded damages for breach of contract against Purolator owing to the late delivery of a tender prepared by the plaintiff. It was admitted that had the tender been delivered in time, Cornwall Gravel would have been awarded a contract for which it would have realized a profit of $70,000. R.E. Holland J. held that since Purolator knew that it was delivering a tender which had to be delivered by a particular time, it "must have realized that if delivered late the tender would be worthless and a contract could well be lost" (emphasis added). The lost profits on the contract therefore fell within the rule laid out in Hadley v. Baxendale. Appeal to this Court was dismissed from the bench, with Laskin C.J. stating at p. 118 that "[w]e are not persuaded that there was any error in the disposition made by the

Courts below". If the lost profits were reasonably foreseeable to the courier delivering the tender, then I believe that lost profits must be found to be reasonably foreseeable in the present instance.

In this case, the Supreme Court of Canada found that the lost profits claimed by MJB Enterprises were not too remote and fell squarely within the first rule of Hadley v. Baxendale.

11. D.W. Matheson & Sons Contracting Ltd. v. Canada (Attorney General) 88

Public Works contracted with D.W. Matheson to build a breakwater, but wrongfully removed D.W. Matheson from the project and called on its bonding company to complete the work. D.W. Matheson alleged that it was no longer able to compete on larger projects as a result of Public Works' breach of contract and claimed for a loss of profits.

The Nova Scotia Court of Appeal noted that the issue was one of remoteness. According to the Court, the loss of profits claimed by the plaintiff would only be recoverable if: 89

Matheson's claim for lost profit is, in effect, a claim for the loss of other business opportunities caused by financial stringency resulting from Public Works' breaches of contract. While such losses may be recoverable, they will generally

88 D.W. Matheson & Sons Contracting Ltd. v. Canada (Attorney General), [2000] N.S.J. No. 96 (C.A.)

89 D.W. Matheson, supra, paragraph 72

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be so only when the circumstances of the transaction and dealings between the parties are such that the financial vulnerability of the plaintiff and the likely impact of the breach may be said to be within their reasonable contemplation at the time of contracting. Simply put, the question is whether, in light of all the circumstances, the defendant, by entering into the contract, may justly be considered as having undertaken this risk of breach.

In this case, there was no suggestion that D.W. Matheson would be financially vulnerable in the event of a breach of contract by Public Works. In addition, no special circumstances of the plaintiff's vulnerability were made known to Public Works at the time of contracting. In the absence of special circumstances, the Court held that it would not be fair to find that Public Works had undertaken the risks arising from D.W. Matheson's financial vulnerability in the event of a breach of contract. As a result, damages for loss of profits were considered to be too remote.

12. Rio Nevada Energy Inc. (Re) 90

Rio Nevada entered into several agreements with Engage. When Rio Nevada sought protection from its creditors, Engage withheld payments for lost fees under two agreements as a result of their termination.

One agreement contained the following clause: 91

11. Damages Limitations

Neither party is liable to the other in contract or negligence for any economic loss

or other indirect, consequential or special damages of any nature

Justice Romaine considered that the interpretation concerned the meaning of the words "any economic loss". Engage argued that its claim for lost profits was not excluded by the clause because the economic loss excluded by the terms of exclusion clause had to be indirect, consequential and special damages. Engage further argued that its claim was for a direct type of damage.

The trial judge did not accept Engage's interpretation and, without reference to any authorities, interpreted the clause as follows: 92

… The heading of the clause is not "Indirect Damages Limitation" but "Damages Limitations". The plain language of the clause precludes liability for economic loss, and economic loss is not restricted to indirect or consequential loss. The future loss of fees falls within the plain meaning of "any economic loss". In my view, the clause lists a litany of prohibited damages. It is, and is intended to be, a broad prohibition. …

90 Rio Nevada Energy Inc. (Re), [2001] A.J. No. 227 (Q.B.)

91 Rio Nevada, supra, paragraph 18

92 Rio Nevada, supra, paragraph 20

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13. Bank of America Canada v. Mutual Trust Co. 93

The Supreme Court of Canada again revisited and approved of the Hadley v. Baxendale decision in Bank of America. The issue was the rate of interest that could be charged in relation to bank debts. Major, J., writing on behalf of the Court, allowed the claim for compound interest and based his decision on commercial realities. He found that to allow compound interest under an agreement until a breach and then allow only simple interest after the breach would provide incentives to commit a breach of contract. In arriving at this conclusion, Major J. found support in the Hadley v. Baxendale decision that it must have been in the parties' contemplation that there would be a cost of delay if the loan was not repaid.

D. Analysis of the Case Law

The Hadley v. Baxendale case set out two seemingly simply rules. The first rule is that direct damages, being those damages naturally occurring, are recoverable; and the second rule is that those damages foreseeable with knowledge of special circumstances can only be recovered upon disclosure of those special circumstances. The rule was modified by Victoria Laundry making both branches subject to an objective test and by applying the rules to all types of damages arising in contract. In the Heron II, the House of Lords found that Hadley v. Baxendale did not really set out two rules, but characterised the two rules as different facets of one rule dealing with foreseeability. Other cases suggest that Hadley v. Baxendale sets out the test for remoteness in relation to a claim for damages.

Where courts decline to award damages based on the second rule in Hadley v. Baxendale, they often state that it was not the defendant’s role to be the plaintiff’s insurer. However, where courts are inclined to award damages, the decisions typically find that the damages claimed are naturally occurring and, as a result, are valid direct damages. The cases reviewed above are summarised in Appendix A – Summary of Cases.

While the early English cases disallowed claims for loss of profit, by 1935 and the Millar’s Machinery decision, claims for loss of profit were more regularly awarded as falling within the first rule because they were characterised as naturally occurring and direct losses. The Court in Croudace Construction also found that delay damages were direct costs as they “clock up at once”, including idle men and plant. Increased production costs and loss of profits due to breakdown have also been characterised as direct damages as was seen in the British Sugar case. In Deepak Fertilisers, the Court found that overheads incurred during the period of rebuilding the destroyed plant were also direct costs. In Hotel Services the Court characterised the loss of profits and the costs to remove defective equipment as direct damages because the defendant needed no special knowledge to know that if the defective equipment did not work that the hotel would suffer these damages.

In each of Croudace Construction, British Sugar, Deepak Fertilisers and Hotel Services, the contract exclusion clauses were not broad enough to protect the defendant from the economic losses claimed against them.

93 Bank of America Canada v. Mutual Trust Co., [2002] 2 S.C.R. 601

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In Canada, the three significant cases dealing with claims against couriers were resolved on the

basis of whether or not the courier knew of the special circumstances associated with the contents of the packages and the consequences of late delivery.

In General Securities, Munroe, Scyrup, McCain Produce, and Kempling, the respective Courts examined the facts to determine whether or not special circumstances were communicated to the defendant such that the plaintiff could be successful in the claims made.

In Syncrude v. Babcock & Wilcox, the Court awarded the additional cost of energy caused by the

defect in the boilers as that was direct damage flowing from the defective design and construction of the boilers. The exclusion clause did not preclude recovery by Syncrude for the same reason as in the English cases: the exclusion of consequential damages clause was too narrow to exclude economic losses that were direct damages.

A number of cases show that defendants often seek protection from direct economic losses in a

clause excluding consequential damages. These clauses cannot protect from such a claim and, if the exclusion of damages is limited to “consequential damages”, only serves to preclude claims that would otherwise only be available upon the disclosure of special circumstances. Of course, a plaintiff would not be able to obtain damages for claims where special circumstances were not disclosed. So a “consequential damages” exclusion clause only protects the defendant from claims which would require disclosure of special circumstances and only in the case where such special circumstances were, in fact, disclosed.

If the parties truly seek to allocate the risk of lost profits and other economic damages to

insurance, then exclusion clauses must be drafted broadly as they will be interpreted narrowly.

E. Interpretation of Exclusion Clauses

The Supreme Court of Canada has stated that exclusion clauses are subject to special rules of construction 94 :

In construing such a clause, the court will see that the clause is expressed clearly and that it is limited in its effect to the narrow meaning of the words employed and it must clearly cover the exact circumstances which have arisen in order to afford protection to the party claiming benefit. It is generally construed against the party benefiting from the exemption.

In England, Lord Diplock in Photo Production v. Securicor Ltd. 95 set out the following as the

authoritative statement on the court's approach to the construction of exclusion clauses:

Since the presumption is that the parties by entering into the contract intended to accept the implied obligations exclusion clauses are to be construed strictly and the degree of strictness appropriate to be applied to their construction may properly depend upon the extent to which they involve departure from the implied obligations.

94 Bauer v. Bank of Montreal (1980), 110 D.L.R. (3d) 424 (S.C.C.), at page 428

95 Photo Production, supra, page 850E

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In commercial contracts negotiated between businessmen capable of looking after their own interests and of deciding how risks inherent in the performance of various kinds of contracts can be most economically borne (generally by insurance), it is, in my view, wrong to place a strained construction upon words in an exclusion clause which are clear and fairly susceptible of one meaning only even after due allowance has been made for the presumption in favour of the implied primary and secondary obligations.

F. Drafting an Effective Consequential Damages Limitation Clause

Should the parties intend that only damages for physical harm will be recoverable and that claims for lost profits and other economic losses will be not be recoverable, then exclusion clause used by those parties should specifically exclude liability for all indirect, economic, consequential, incidental or special damages, as well as loss of profit and overheads. In addition, to ensure that a party is not liable for more than is contemplated, a cap on liability is recommended. Examples of consequential damages clauses from various standard form construction contracts are reproduced in Appendix B – Selected Contract Clauses.

The following clauses are a further example of a capping liability and excluding all consequential and economic damages. To determine whether this clause suits a particular purpose, the sub-paragraphs of the Exclusion of Economic Damages should be considered individually to assess each sub-paragraph’s applicability to the contract at hand:

Maximum Liability

Notwithstanding any provision in this contract, or elsewhere to the contrary, neither party shall be liable to the other party (or their respective officers, employees, consultants,

agents, subcontractors and suppliers), for more than $

[or reference some

known number like the contract price], whether such liability arises at any time, or from any cause, whether in contract, in tort, or in any other theory of law whatsoever.

Exclusion of Economic Damages

Notwithstanding any other provision of this contract, or elsewhere to the contrary, in no event shall either party be liable to the other party (or their respective officers, employees, consultants, agents, subcontractors and suppliers), whether in contract, in tort, or in any other theory of law whatsoever, for:

(a)

loss of profits;

(b)

loss by reason of plant shutdown, non-operation or service interruption, completely or partially;

(c)

loss by reason of the equipment, parts or materials supplied under this contract not functioning, completely or partially;

(d)

increased expense of operation, energy, overhead or production;

(e)

loss of resource or product;

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(f)

cost of purchased or replacement power, or any incremental amount;

(g)

claims of the other party’s customers, subcontractors or suppliers against the other party;

(h)

loss of any other contract;

(i)

cost of financing;

(j)

loss of use of capital or revenue; or

(k)

any other special, incidental, indirect or consequential loss or damage of any nature arising at any time or from any cause whatsoever.

G. Effect of Contractual Exclusions on Recovery for a Fundamental Breach

If the damages claimed by a plaintiff fall within the realm contemplated by a clause excluding recovery for consequential damages, the exclusion clause may nonetheless be inapplicable to a claim for breach of contract if the plaintiff can establish that one of the contractual breaches constitutes a fundamental breach of contract.

The doctrine of fundamental breach originated from England and was not adopted by the Supreme Court of Canada until 1980. The doctrine states that a clause limiting liability (by an exclusion clause, one framed as a limitation of liability clause or otherwise) will not be construed to apply if a person benefited by the clause creates a situation that is radically different from that contemplated by the agreement as a whole. In essence, depending upon the interpretation given to the clause and the intention of the contracting parties, an exemption clause may not excuse liability for a "fundamental breach" of contract.

In 1989, the Supreme Court of Canada rendered a decision which cast doubt over the doctrine of fundamental breach. In Hunter Engineering Company v. Syncrude Canada Ltd. 96 the Supreme Court of Canada defined a fundamental breach as one:

where the event resulting from the failure by one party to perform a primary obligation has the effect of depriving the other party of substantially the whole benefit which it was the intention of the parties that he should obtain from the contract.

The court in Hunter rejected the traditional approach to fundamental breach. It instead applied an alternative approach that addresses the consequences of the breach as a matter of construction of contract rather than as a categorical rule of law. According to the Supreme Court, the real question is whether the contract, properly interpreted, provides that exclusion clauses shall be enforced in the event of a fundamental breach. If, as a matter of contractual interpretation, the parties intended an exclusion clause to continue to apply in the event of fundamental breach, the courts must enforce the bargain agreed to by the parties. The doctrine of fundamental breach was described as an "exceptional remedy" which "should be available only in circumstances

96 Hunter Engineering, supra

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where the foundation of the contract has been undermined, where the very thing bargained for has not been provided". However, the court said that it would still refuse to enforce an exclusion clause in circumstances where to do so would be "unconscionable" or "unfair, unreasonable or otherwise contrary to public policy".

Therefore, an exclusionary clause will be enforced unless it is unconscionable to do so. The law on this question was recently summarized in Plas-Tex Canada Ltd. v. Dow Chemical of Canada Limited: 97

Whether a breach of contract is a fundamental breach that deprives the breaching party of the benefit of any limitation of liability clause in the contract is a question of construction: Guarantee Co. of North America v. Gordon Capital Corp. …

Alberta Courts have generally held that contracts should be enforced regardless of the stringency of their terms limiting liability because parties require certainty that negotiated provisions in a contract will be legally enforceable: see for example, Catre Industries Ltd. v. Alberta …, Canadian Fracmaster Ltd. v. Grand Prix