Last edited 25 Jun 2014

Direct loss in construction contracts

In the event that there are problems with a development, it is possible that losses will be incurred by the injured party. For example, the cost of repairs, loss of rent, loss of profit and so on. The party that suffers the loss may then try to recover it from the party that caused it. Under the common law of negligence, losses that are purely economic (such as loss of profit) are generally not recoverable, but under contract law they may be, depending on the wording of the contract.

The general position regarding losses resulting from a breach of contract was established by the case of Hadley v Baxendale (1854) where the court held that the injured party could recover losses that could be reasonably considered to arise naturally from the breach of contract in the usual course of things (direct losses), or losses that whilst they may not arise naturally from the breach, could have been reasonably contemplated by the parties to the contract at the time that they entered into that contract (indirect or consequential losses).

Losses that are unusual, special or unlikely are generally considered too ‘remote’ to be recoverable unless the special circumstances were known at the time that the contract was entered into, whether or not they were caused by the breach. If this were not the case, an almost unlimited liability could arise for losses that were entirely unforseable.

This position however remains fairly open-ended and leaves a great deal of uncertainty as to whether a loss could have been ‘reasonably contemplated’ at the time that a contract was entered into. As a result, in order that both parties can understand specifically those losses that will be recoverable, it is very important that they are set out explicitly and very clearly in the contract.

Very broadly, contracts often allow direct losses to be recovered (such as the cost of repairs), but may exclude indirect or consequential losses (such as loss of profit).

However, it is not always this straight forward. For example, profit can be held by the courts to be a direct loss (British Sugar plc v NEI Power Projects Ltd and Another (1997)) or it may be considered that some component of profit is a direct loss. It cannot be assumed therefore that profit is excluded just because consequential losses are excluded.

The exact wording of the contract must be studied and requires very careful drafting. The FIDIC form of contract for example allows overheads, preliminaries, loss of productivity, interest and finance charges and claims preparation, but excludes profit, inflation or exchange rate fluctuations and lost commercial operation.

It is generally in the interest of the client that recoverable losses are unlimited, but for the contractor (or consultant) to try to restrict recoverable losses by excluding indirect or consequential losses.

This is also the case with regards liability to third parties, and so a similar situation is found within collateral warranties.

Contractors and consultants are likely to wish to restrict recoverable losses in collateral warranties to the cost of repairs. Clients on the other hand (or purchasers or tenants) may argue that contractors and consultants should be able to anticipate the consequences of a breach of contract and so should allow recovery of consequential losses. A compromise position is likely, for example the BPF form of collateral warranty allows consequential losses, but includes a requirement for the injured party to mitigate those losses and sets a cap for liability in respect of each breach.

It can be worth assessing what losses might occur before drafting a contract, and also defining clearly within the contract what constitutes a breach.

NB The Unfair Contract Terms Act can apply under certain circumstances and so any contractual provisions should be ‘reasonable’.