Consequential Damages: The Hidden Costs of Breach
What Are Consequential Damages?
Consequential damages (also called indirect or special damages) are losses that do not result directly from a breach but are a foreseeable consequence of it. They represent the ripple effects that flow from a contract failure.
Examples
- A supplier delivers defective components. The direct damage is the cost to replace them. The consequential damage is the lost revenue from products you could not sell while waiting for replacements.
- A software vendor's system goes down for a week. The direct damage is the cost of the outage. The consequential damage is the business you lost to competitors during the downtime.
- A contractor delays a building project by three months. The direct damage is the additional construction costs. The consequential damage is the rental income the owner lost during the delay.
Why Contracts Often Exclude Them
Consequential damages can vastly exceed the value of the contract itself. A $50,000 software contract could lead to millions in lost business. Because of this unpredictable exposure, many commercial contracts include a mutual exclusion of consequential damages.
Typical language reads: "In no event shall either party be liable for any indirect, incidental, consequential, or special damages, including lost profits, regardless of the form of action."
The Hadley v. Baxendale Rule
The foundational case Hadley v. Baxendale (1854) established that consequential damages are recoverable only if they were reasonably foreseeable at the time the contract was formed. This means the breaching party must have known or should have known about the potential downstream losses.
What to Watch For
- One-sided exclusions. If only your consequential damages are excluded while the other party retains the right to claim theirs, the clause is unbalanced.
- Broad waivers that include all damages. Ensure the exclusion does not inadvertently waive your right to direct damages or other essential remedies.
- Carve-outs. Well-drafted exclusions often carve out exceptions for confidentiality breaches, IP infringement, or willful misconduct.
When to Consult a Lawyer
Consider consulting an attorney before agreeing to a consequential damages exclusion, especially if a breach of the contract could cause significant downstream losses to your business.
This article is for informational purposes only and does not constitute legal advice. Consult a licensed attorney for guidance specific to your situation.