by Niharika Dhall FCI arb, Legal Counsel
In EPC contracts, parties generally seek to limit liabilities by excluding certain kinds of damages. It is very common to see clauses excluding loss of profit, loss of opportunity, consequential losses, indirect losses, etc. In fact, these terms have become so commonly used and accepted, that it is rare to see contractual clauses defining these terms. However, there are nuanced differences in their scope which can have a significant impact on a party’s liabilities. The purpose of this article is to look at some different ways of drafting the clause to reach the outcome most suitable for a project.
We begin by looking at one of the most basic kinds of exclusion clauses which simply states that, “Neither party shall be liable to the other party for indirect or consequential losses”. The effect of this clause is that in the event of breach of contract neither party can recover losses which are consequential or indirect in nature. The terms ‘consequential loss’ or ‘indirect loss’ in contractual exclusion clauses refer to losses that are covered by the second limb of Hadley v Baxendale1 , which classifies losses arising from breach of contract into two limbs:
- First limb: which comprises losses that are a natural and necessary consequence of breach, within the reasonable contemplation of the parties, colloquially referred to as direct losses; and
- Second limb: which comprises losses that arose on account of special circumstances and can be claimed only if their likelihood was communicated and within the reasonable contemplation of the parties, colloquially referred to as consequential or indirect losses.
In EPC contracts, certain kinds of consequential losses (for instance, lost profits, loss of opportunity, loss of anticipated profits, or lost savings) may be considered foreseeable and within reasonable contemplation of the parties since contracts usually specify the project’s capacity and planned use. Moreover, claims for consequential losses can be quite significant. Therefore, it is important to exclude these losses specifically.
In certain cases, parties may wish to exclude additional categories of losses like lost profits or loss of opportunity. To exclude these additional categories, the clause above is not always appropriate because it only excludes consequential losses. Therefore, the clause above will only exclude parts of lost profits or loss of opportunity which are consequential in nature.
It is important to keep in mind that lost profits or loss of opportunity could very well be covered by the first limb of Hadley v Baxendale if these losses are a natural and necessary consequence of breach. For instance, if the breach involved destruction of a project, the owner of the project may be able to recover the cost of re-building the project and loss of production during the said period as direct losses. In another example, a breach involving the supply of a defective ship’s engines, loss of profit during the time the owners were deprived of the use of the ship, is a direct loss2. Therefore, if loss of profit or loss of production is to be excluded completely, the exclusion clause should be drafted differently.
To exclude lost profits entirely, in addition to consequential losses, the clause should ideally state that, “Neither party shall be liable to the other party for indirect or consequential losses or for lost profits, loss of opportunity, loss of anticipated profits, or lost savings”. The effect of this clause would be that in the event of breach of contract, the entire category of lost profits, loss of opportunity, loss of anticipated profits, or lost savings (whether direct or consequential) would be excluded, along with all consequential losses3.
The interpretation and scope of exclusion clauses has been discussed in a number of common law judgments where the language of the clause makes it unclear whether or not direct lost profits are excluded4. For instance, if the clause provides that, “Neither party will be liable to the other for any indirect or consequential loss, (both of which include, without limitation, pure economic loss, loss of profit, loss of business, depletion of goodwill and like loss) howsoever caused”, the above clause does not exclude a claim for loss of profit where such a claim was a direct loss5. This kind of clause may be appropriate for certain EPC projects, but it is important that parties understand the scope of the clause and account for the associated risks.
Therefore, the kind of exclusion clause most suitable for an EPC project will depend on the circumstances of each case. In a contract which already contains liquidated damages for delay and breach of performance guarantees, parties may want a wider exclusion clause. In other cases, parties may wish to exclude only consequential losses. In any event, it is important to draft this clause carefully and duly consider alternative approaches.
