Key Takeaways

1. Consequential damages—also known as special damages—are compensation for indirect losses that arise from a breach of contract or tort, extending beyond direct damages.
2. The recoverability of consequential damages depends on foreseeability and whether the losses were contemplated by both parties at the time the contract was formed.
3. Excluding or limiting consequential damages in contracts is common practice, but doing so carries risks, especially if unforeseen losses occur that are not directly covered by other remedies.

Understanding Consequential Damages

Definition and Legal Basis

Consequential damages are a category of compensatory damages awarded for harm that does not flow directly and immediately from a wrongful act, but arises as a secondary result. In contract law, these are losses that occur as a consequence of a breach, but are not the immediate and direct result. According to the Wex Legal Dictionary from Cornell Law School, consequential damages are “damages that can be recovered in a lawsuit for breach of contract, as compensation for losses that result indirectly from the breach.”

The concept is rooted in the principle that a party injured by a breach should be made whole, not just for immediate losses but also for those that were reasonably foreseeable at the time of contracting. This principle was famously articulated in the English case of Hadley v. Baxendale (1854), which established that damages are recoverable if they are either the natural consequence of the breach or were within the contemplation of both parties when the contract was made.

Direct vs. Consequential Damages

It is essential to distinguish between direct (actual or general) damages and consequential (special) damages. Direct damages are the immediate result of a breach—such as the cost to repair defective goods. Consequential damages, on the other hand, are the secondary losses that occur due to special circumstances, such as lost profits or reputational harm, which result from the breach but are not the breach itself. For more, see BrewerLong’s explanation.

For example, if a supplier fails to deliver machinery to a manufacturer, direct damages might be the cost of the replacement machine. Consequential damages could include the manufacturer’s lost profits due to halted production, but only if these losses were foreseeable and contemplated by both parties.

Foreseeability and the Contemplation of the Parties

The Foreseeability Test

A central limitation on the recovery of consequential damages is the foreseeability requirement. The losses must have been reasonably foreseeable and within the contemplation of both parties at the time of contract formation. If a loss is too remote or speculative, it is generally not recoverable.

Courts often look at whether the breaching party was aware of the special circumstances that could lead to consequential losses. If the non-breaching party communicated specific needs or risks, and the breaching party accepted the contract with that knowledge, consequential damages are more likely to be awarded. This is explained in more detail by Silberman Law Firm.

Types of Consequential Damages

Consequential damages can take many forms, including:

• Lost profits: Revenue that would have been earned but for the breach.
• Loss of business opportunities: Missed contracts or deals resulting from the breach.
• Reputational harm: Damage to a business’s standing or customer relationships.
• Additional expenses: Costs incurred as a result of the breach, such as expedited shipping or alternative sourcing.

Not every lost profit is a consequential damage; the classification depends on the circumstances and whether the loss was foreseeable. For more on this distinction, see Weil’s discussion.

Contractual Approaches to Consequential Damages

Exclusion and Limitation Clauses

Given the potentially significant exposure to consequential damages, many contracts include clauses that exclude or limit liability for such losses. This is particularly common in complex transactions, such as mergers and acquisitions, or in industries where the ripple effects of a breach can be substantial. For example, a software vendor may exclude liability for lost profits or data losses caused by a software failure.

According to Goulston & Storrs, exclusion clauses are often heavily negotiated, as they can shift significant risk from one party to another. However, waiving consequential damages can leave a party exposed if indirect losses are not otherwise covered.

Risks of Waiving Consequential Damages

While excluding consequential damages can provide certainty and limit exposure, it is not without risks. If a party waives the right to recover consequential damages, it may be unable to recover for significant losses that arise indirectly from a breach. This can be particularly problematic in industries where indirect losses can far exceed direct damages. For a discussion on the risks, see Peckar & Abramson’s client alert.

Careful contract drafting is essential. Parties should clearly define what constitutes consequential damages and consider carve-outs for certain types of losses (such as fraud or willful misconduct) that should remain recoverable.

Consequential Damages in Construction and Commercial Contexts

Construction Industry

Consequential damages are especially significant in the construction industry. Delays or failures in performance can result in substantial indirect losses, such as lost rental income, increased financing costs, or penalties under other contracts. These damages are sometimes called the “silent killer” because they can far exceed the direct costs of a construction defect or delay. For more, see Maynard Nexsen’s article.

To mitigate these risks, architects, contractors, and owners should pay careful attention to contract language regarding consequential damages. The American Institute of Architects provides guidance on how to address these issues in construction contracts.

Commercial Transactions

In commercial contracts, consequential damages often arise from supply chain disruptions, product defects, or service failures. Lost profits and business opportunities are common claims. The Uniform Commercial Code (UCC) recognizes the distinction between incidental and consequential damages, with the former covering expenses to prevent further loss and the latter addressing broader financial impacts. See Metz Lewis’s analysis for more information.

Proving and Recovering Consequential Damages

Burden of Proof

The party seeking consequential damages bears the burden of proof. They must demonstrate:

1. The damages were caused by the breach.
2. The damages were foreseeable and within the contemplation of the parties.
3. The amount of damages can be established with reasonable certainty.

Courts are wary of awarding damages that are speculative or remote, so clear documentation and evidence are critical. Parties should keep detailed records of losses and be prepared to show how the breach led to those indirect consequences.

Limitations and Defenses

Defendants can challenge claims for consequential damages by arguing:

• The losses were not foreseeable.
• The damages were not caused by the breach.
• The amount claimed is speculative or not supported by evidence.
• The contract includes a valid exclusion of consequential damages.

Practical Tips for Managing Consequential Damages

• Communicate special circumstances: If your business is particularly vulnerable to certain losses, make this clear during contract negotiations.
• Draft clear contract terms: Define what constitutes consequential damages and whether they are excluded or limited.
• Consider insurance: In some cases, insurance may help cover indirect losses that are not recoverable under the contract.
• Document losses: Keep thorough records to support any future claims for consequential damages.

Conclusion

Consequential damages play a critical role in contract law and commercial litigation. They provide a mechanism for recovering losses that extend beyond the immediate impact of a breach, but their recoverability depends on foreseeability and careful contract drafting. Whether you are negotiating a contract, litigating a dispute, or seeking to manage business risks, understanding the nuances of consequential damages is essential.

For more in-depth legal research and tools, visit Counsel Stack.

Disclaimer: This guide is for informational purposes only and provides a general overview of consequential damages. Legal outcomes depend on specific facts and jurisdictions. For advice on your particular situation, consult a qualified attorney.