What are consequential damages?
What does it legally mean in contracts?
What’s the difference between consequential damages and incidental damages?
In this article, we will break down the notion of consequential damages so you know all there is to know about it.
We will look at what is a consequential loss, its legal definition, how the legal theory started in case law, we’ll look at different types of consequential damages, compare it with direct damages, incidental damages, indirect damages and go over concrete examples so you can better understand the concept.
Are you ready to dive in?
Let’s get started!
What are consequential damages
Consequential damages, also known as special damages or indirect damages, can be awarded to a party due to the contractual breach of another party in addition to direct damages to compensate for foreseeable damages or losses and traceable to the breach and known to the parties upon the signing of the contract.
Consequential damages go beyond the compensation for direct damages suffered by a party due to the breach of another but are other damages that were foreseeably caused as a consequence of the breach of contract.
Typically, when a party breaches a contract, the non-breaching party will claim direct damages (also called actual damages or compensatory damages) directly resulting from the breach, negligence, misconduct or the prejudicial act.
In addition to compensatory damages, the non-breaching party can also claim consequential damages resulting from losses that are not “direct damages” but intimately resulting from the breach due to the circumstances of the non-breaching party.
Consequential damages defined
To better understand the notion of consequential damage, let’s first look at the consequential damages definition and how it was developed in case law.
So how do we legally define consequential damages?
According to Cornell Law School’s Legal Information Institute, consequential damages is defined as follows:
Damages suffered because of the injured party’s particular circumstances. Also called special damages, since they result from a breach of contract and yet would not necessarily be incurred by every injured party experiencing that breach.
What’s notable in this definition is that “consequential damages” are damages resulting from the injured party’s circumstances.
This means that the factual circumstances surrounding the breach are highly relevant to the award of consequential damages.
Consequential damages are a type of damage not directly and naturally linked to the breach of contract but foreseeable at the moment of contracting and directly traceable to the breach.
You can look at the legal definition of consequential damages in a different angle.
Consequential damages are not direct damages but are damages that necessarily arise from the specific nature of the breach of contract.
The legal theory of consequential damages is attributed to the English case Hadley v Baxendale in the 19th century.
The Hadley case is studied in virtually all law schools in the common law world and is the foundation of the notion of consequential damages.
In this case, a miller entered into a shipping contract to send a broken crankshaft of a steam engine to be repaired.
Baxendale does not deliver the crankshaft on time for the repairs to be done within the expected timeline.
As a result of this failure, Hadley files suit to recover costs but also losses resulting from the shutdown of the mill operations.
The jury awards Hadley an award for its losses due to the shutdown of the mill.
On appeal, the court reverses the jury’s award because the court considered that the special circumstances of Hadley and the special losses it suffered as a result of the late delivery of the crankshaft was not known to Baxendale at the moment the contract was signed.
The courts considered that “consequential damages” are recoverable when there is a breach of contract and when the breaching party knows or is imputed to know that the non-breaching party may suffer losses beyond ordinary expectancy or restitution damages.
As a result, Baxendale could not be accountable to pay for consequential damages that he was unable to assess Hadley’s risk exposure nor was he informed of it.
The court considered that if Baxendale would have known the important risks for this transaction, maybe he would have refused to sign the contract, charged a much higher price, specifically limited liability his obligations or even took other measures to execute the contract.
Consequential damages in contract law
Many contracts refer to consequential damages where parties attempt to exclude it, waive it, maintain it, carve it out, disclaim it or what have you.
In this section, we’ll look at how consequential damages should be considered from a contract law perspective.
Consequential damages clause
The parties to a contract can define the meaning of consequential damages in a consequential damages clause.
Depending on the contract language used by the parties, certain events may be qualified as direct damage or consequential damage.
The courts will assess whether damages suffered are “actual” or “consequential” by looking at the circumstances, the consequential damages clause, the sophistication of the parties, the foreseeability of the damage and so on.
It’s important to draft the consequential damages clause in such a way that it does not interfere with the interpretation of the indemnification clause, disclaimers and limitation of liability clause.
Consequential damages breach of contract
Parties to a contract can suffer damages of a different kind should there be a breach of its terms.
A breach will generally lead to direct damages to the non-breaching party.
Direct damages are all the costs, expenses, damages or injuries suffered due to the negligence, poor services, defectiveness of a good or other breach committed by the breaching party.
Typically, this can include costs to perform urgent repair expenses, medical expenses or transportation expenses.
In addition to the direct damages, a party may also suffer consequential damages resulting from the breach of contract.
Consequential damages are damages that are not directly linked to the breach but were obvious and foreseeable when the parties contract or related to the special circumstances of the non-breaching party and known to the other upon entering into the contract.
For example, in the case of personal injury, a person unable to work for a few months will lose salary.
The loss of salary is not necessarily a direct result of the injurious act but obviously results from it.
Another example is if a party purchases a certain good or service but lets the other party know that they cannot miss the deadline if not, they will end up in a breach in another contract and held liable for important sums under another contract.
If this special circumstance is known to the other party and there is a breach resulting in the levy of a penalty clause on the non-breaching party in virtue of another contract, that can be considered consequential damage resulting from the breach.
Consequential damages waiver
To mitigate exposure to consequential damage, you can consider using a consequential damages “waiver” in your contract.
The consequential damages waiver is intended to identify specific consequential risks associated with the contract and have them waived in advance.
To avoid interpretation issues or waivers that are too broad or too restrictive, the wording of the waiver clause is very important.
On the one hand, clients will want to negotiate waivers in such a way that they do not limit the exposure of the service provider unintentionally or too much.
On the other hand, service providers tend to negotiate waivers in such a way as to limit its total liability to what was paid by the client under the contract.
Consequential damages disclaimer
Every contract should be reviewed based on its own merits.
When looking at the concept of consequential damages in a contract, it’s important to consider including an express disclaimer to ensure you are fully disclaiming any liability for consequential damages.
Typically, the following aspects are carved out from consequential damage disclaimers:
For example, if you want to ensure you a contracting party assumes the damages and losses
Recoverability of consequential damages
The recoverability of consequential damages can be impacted by:
- Common law implied warranty
- Indemnity provisions of the contract
- Presence of liquidated damages clause in the contract
- Presence of a waiver of consequential damages clause in the contract
When entering into a contract, it’s important to pay careful attention to how the contract defines actual damages and consequential damages to ensure the scope falls within your risk tolerance and to avoid conflicting interpretations with other contractual clauses.
For example, if you have a liquidated damages clause along with a waiver of consequential damages, you must ensure that you expressly carve out the scope of the liquidated damages provision from the exclusion of consequential damages clause.
Uniform Commercial Code (UCC)
If a contract is subject to UCC, it’s important to nuance direct damages, incidental damages and consequential damages in the contract and not mix them up.
Under UCC, incidental damages are damages suffered by a party in its attempt to limit further losses or additional damages caused by another party’s breach.
On the other hand, consequential damages are damages that the parties could foresee, at the time they entered into the contract, would be suffered by another party due to a breach.
Article 2-715 of UCC, titled Buyer’s Incidental and Consequential Damages, establishes that personal injury and property damage caused and proximate to a breach of warranty is considered consequential damages:
(1) Incidental damages resulting from the seller’s breach include expenses reasonably incurred in inspection, receipt, transportation and care and custody of goods rightfully rejected, any commercially reasonable charges, expenses or commissions in connection with effecting cover and any other reasonable expense incident to the delay or other breach.
(2) Consequential damages resulting from the seller’s breach include
(a) any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise; and
(b) injury to person or property proximately resulting from any breach of warranty.
A buyer should be mindful of the type of damages considered direct, incidental and consequential and ensure that agreeing to disclaimers does not render the warranty ineffective.
Types of consequential damages
There are many types of consequential damages a party can suffer due to the contractual breach of another such as:
- Property damage
- Personal injury
- Attorney fees
- Lost profits
- Loss of use
- Loss of goodwill
- Interest charges
- Third-party claims
- Lost opportunity
- Loss of income
- Loss of value
- Business interruption losses
Let’s look at some of the common types of consequential damages.
Lost profits consequential damages
If a party breaches the terms of a contract, the non-breaching party may claim lost profits as direct damages for the loss of profits resulting in the project at hand but consequential damages for the loss of profits in other projects directly resulting from the breach.
For example, if a software developer had a software development contract to deliver software build by a certain date to then jump on another project, should the client breach the contract resulting in delays the software developer can suffer a direct and consequential loss of profits.
The direct loss of profits results from the client’s breach of contract in the current contract.
The loss of profits from the other project the software developer was unable to start can be considered as consequential damages if it was known to the client upon signing of the contract.
Depending on the context, lost profits can be considered as direct damages, incidental damages or even speculative damages.
Lost opportunity consequential damages
In some cases, a party may claim the “loss of opportunity” as consequential damages.
This may not be an easy argument to make in court as the nature of an “opportunity” is much more speculative than a type of damage that was “foreseeable” and with a high level of “certainty”.
To recover lost profits on other projects, you must prove:
- The lost profits were within the parties’ contemplation at the moment the contract was signed
- The profits on the other project were reasonably certain
- Due to the defendant’s breach, that opportunity has been lost
Loss of income consequential damages
A party to a contract may invoke the loss of income as potential consequential damage resulting from the other party’s breach of contract.
The typical example is when a property owner is unable to rent the property due to construction delays or a poorly executed construction project.
The loss of rental income is a “loss of income” type of consequential damages that the property owner may successfully claim.
Loss of value consequential damages
The loss in the resale value of a property or goods can be considered as a form of consequential damage.
For example, if a construction project was delayed due to the breach of contract, the non-breaching party may argue that the difference in the market value of the property at the time when the project was supposed to be finished and the current fair market value to be a loss.
To prove the loss of value, you must prove that:
- It was foreseeable that you were going to sell the property after the original completion date of the project
- The sale was reasonable certain
- Your inability to sell is linked to the breach of contract
Comparing consequential damages
In this section, we’ll compare consequential damages with other types of damages so you can see their nuances and differences.
Consequential damages vs direct damages
In the matter Applied Data Processing, Inc. v. Burroughs Corp, the court defines direct damages vs consequential damages as follows:
The distinction between general and special damages is not that one is and the other is not the direct and proximate consequence of the breach complained of, but that general damages are such as naturally and ordinarily follow the breach, whereas special damages are those that ensue, not necessarily or ordinarily, but because of special circumstances
Direct damages flow directly from a breach whereas consequential damages do not directly flow from a breach but are suffered by a party in consideration of the party’s special circumstances.
Consequential damages vs incidental damages
The terms “consequential damages” and “incidental damages” are often used interchangeably although they have different legal meanings in certain situations and must be dealt with individually.
For example, if the Uniform Commercial Code (UCC) applies in the context of the sale of goods, incidental damages and consequential damages will have their meaning defined by law.
Incidental damages are those damages caused to a party to limit or avoid further direct damages caused by the breach.
For example, you purchase a good that is defective and for security and safety reasons, you must have the good urgently repaired to prevent further damages or the further aggravation of the losses.
Consequential damages are damages that, at the time of signing of the contract, the parties could foreseeably estimate would result due to a contractual breach.
For example, if a transportation company was purchasing a truck to its fleet for a special transportation contract and the truck is not delivered on time, it was foreseeable that the transportation company would not be able to execute its transportation obligations.
Consequential damages vs indirect damages
Consequential damages are also referred to as special damages or indirect damages.
Such indirect damages are damages that do not necessarily flow from the breach of contract but are secondary in nature or indirect to breach.
In other words, indirect damages are damages proximately caused by the breach and were foreseeable at the time the contract was signed.
What’s more, indirect damages are damages suffered by a party due to their special circumstances.
For example, if an airline company purchases an airplane for commercial use, defects in the airplane resulting in the loss of revenues can are foreseeable at the moment the contract is signed and thus can be considered as consequential damages.
Consequential damages vs compensatory damages
Compensatory damages are essentially damages awarded by the court to compensate a party for the damages or injuries suffered due to the breach or injurious act of the other.
The term “compensatory damages” is used interchangeably with “direct damages”.
We say “compensatory” damages to indicate that a party is compensated for the losses suffered from a breach or a violation of some kind.
For example, if the breach of contract directly results in a loss of $20,000, then an award of $20,000 in compensatory damages will compensate the loss in full.
Consequential damages vs liquidated damages
As a way to mitigate risk in contracts, you can consider negotiating liquidated damages to mutually agree and negotiate potential harm caused by the breach of contract.
For liquidated damages to be enforceable, you must:
If liquidated damages are perceived as a form of penalty, the courts will not enforce it.
Liquidated damages are slightly different than consequential damages as they are intended to recover hard to evaluate “direct damages” but where the damages are difficult to quantify such as breach of trade secrets.
Consequential damages go beyond direct damages and are intended to compensate for losses that are linked to the breach and were in the contemplation of the parties when the contract was signed.
Consequential damages example
Consequential damages are those damages that necessarily flow from a party’s breach of contract.
Example 1: Construction contract
In the construction space, different stakeholders can be exposed to consequential damages.
In construction contracts, a party may claim consequential damages for losses resulting from extra financing costs, additional overhead costs, lost bonding costs and more.
If an important construction project is delayed for whatever reason, many stakeholders will not be able to perform their work on time, their resources will not be utilized and they will absorb significant overhead expenses, payroll, potential insurance costs lost profits for being unable to move to the next project.
Example 2: Personal injury
Another good example of consequential damages can be given using a personal injury scenario.
If you are injured in an accident, your medical expenses, hospital expenses and all the immediate damages you suffer are direct damages.
However, if due to the injury, you are unable to work for three months, your loss of wages can be considered as consequential damages.
The loss of wages is not directly linked to the accident itself but results from your special circumstances.
Example 3: Real estate development contract
A real estate developer has a contract with a contractor to build a new office building by a certain date as it has already signed and committed to renting the premises to an important commercial tenant
The contractor fails to deliver the project on time and the work is not done properly.
The real estate developer is unable to observe the terms of its contract with the important commercial tenant and is responsible for certain penalties.
In this example, the developer suffers both direct damages and consequential damages.
The direct damages are the costs associated with the delays in the project and the costs to have the work reperformed.
The consequential damages are loss of revenue or rental income due to the loss of the commercial tenant and the penalties levied on the developer resulting from its other contractual commitment with the commercial tenant.
If the contractor knew about the developer’s contract with the commercial tenant and was aware that the failure to deliver on time will lead to loss of revenue but also penalties on the developer, such damages will be considered as consequential.
Consequential damages FAQ
What is an example of consequential damages?
A typical example of consequential damage is the loss of profits.
However, lost profits can be considered consequential damages in some situations, direct damages in some other situations and even speculative damages as well.
The circumstances of the case will have an impact on how the court qualifies loss of profits.
Here are other examples of potential consequential damages:
- Property damage
- Personal injury
- Attorney fees
- Lost profits
- Loss of use
- Loss of goodwill
- Interest charges
- Third-party claims
- Lost opportunity
- Loss of income
- Loss of value
- Business interruption losses
Are consequential damages recoverable?
Consequential damages are recoverable provided that the damages flow naturally from the breach of contract or from special circumstances specifically communicated to the other contracting party at the moment the contract was signed making the special circumstance foreseeable.
In other words, the following damages can be recovered:
- damages that naturally flow from the breach of contract and are obvious
- less obvious damages due to special circumstances if those special circumstances were made known to the other contracting party when the contract was signed
If the consequential damages were not in the contemplation of both contracting parties at the moment the contract was signed, consequential damages are not recoverable.
What are incidental or consequential damages?
Incidental damages can have a different meaning under common law or under UCC (Uniform Commercial Code).
Under UCC, so in the context of the sale of goods, incidental damages are damages suffered by a party in its attempt to limit further losses or additional direct damages caused by another party’s breach.
On the other hand, consequential damages are damages that, at the time of signing of the contract, the parties could foreseeably estimate may be suffered due to breach of contract.
Outside the sale of goods, incidental damages are those costs and expenses incurred to avoid other direct damages while consequential damages are neither incidental nor direct but normally and naturally arise from the specific situation of a party.
What is the difference between direct and consequential damages?
Direct damages are damages resulting directly from a breach of the contract whereas consequential damages are damages that are not directly caused by the breach but normally and naturally arise from the circumstances of the non-breaching party.
For example, consequential damages in construction can be an owner’s inability to use a property due to major renovation project delays or an increase in financing costs or even loss of income due to the owner’s inability to rent the premises.
Why do we waive consequential damages?
In many contracts, parties attempt to negotiate a waiver of consequential damages.
This is done to minimize the risk of being held liable to pay consequential losses to the other party.
In certain contracts, the consequential losses can be much higher than direct losses.
For example, in an important construction contract, the consequential loss of a property owner or a client can include lost profits, financing costs, financial costs and more.
The consequential loss can end up representing an amount much greater than the value of the construction contract itself and the possible direct damages resulting from a delayed project or work not performed in a workmanlike manner.
How do you prove consequential damages?
To be awarded consequential damages, the plaintiff must prove that the damages were reasonably foreseeable or within the contemplation of the parties when the contract was signed and it did what was possible to mitigate the loss or damages.
The courts will expect the plaintiff to be specific as to the nature of the consequential loss so that it can be demonstrated that the damages were not just a proximate consequence of the breach of contract but really foreseeable damage when the parties entered into the contract.
How do you prove the amount of consequential damages?
Once you’ve demonstrated to the court that you are entitled to an award for consequential damages, the next step is to prove the amount that you are entitled to.
To get an award for consequential damages, a party must demonstrate the quantum of the loss or damage with reasonable certainty.
The amount cannot be based on hypothetical grounds but clear and relatively certain amounts resulting from the breach of contract.
Just like special damages, under the Federal Rules of Civil Procedure, a party must specifically plead consequential damages.
Why limit consequential damages?
In contracts, a service provider has the interest to limit consequential damages while a client as an interest to maintain it.
In a sale of goods contract or supply agreement, a supplier will significantly mitigate risk by limiting consequential damages.
Essentially, a client’s only obligation is the payment for the goods.
The supplier must assume the obligation of providing the goods of good quality and deliver it on time.
If the supplier is able to limit the consequential liability, it will limit its exposure to the possible consequential losses a client may invoke against it.