Indirect damage and Consequential damage

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Example of feedback to an indirect damage clause.

 
 
 
 

​What do Indirect Damages, Indirect liability, and Consequential Damage mean?


Indirect damages, indirect liability, or consequential damages can largely be used interchangeably. This interchangeable term can arise from special circumstances that usually cannot be predicted and are the non-immediate consequences that may happen as a consequence of what a party knew or should have known of the circumstances. 
 

What are direct and indirect damages?
 

Direct damages refer to damages that are directly or immediately result from the conduct of the breaching party. Typically, these damages would be intended to compensate the plaintiff for a loss that is foreseeable arising from the wrongful conduct.

Example of Direct Damage
 

In the instance of a company buying transport trucks for €100000, and months later, the purchasing company realizes the trucks are not functional and routinely malfunction. Let’s say the replacement/repair was €125000.
The direct damage in this situation would be the cost incurred by the procuring company in the sum of: 

  • The original amount spent on the transport trucks (€100000); and

  • The amount spent on finding replacements/repairs (€125000) 

 

Read more about reviewing a contract here.

Consequential damage vs liquidated damage

The difference between consequential damage and liquidated damage often gets confused and mixed up, complicating the contract negotiation phase. Liquidated damage is a type of consequential damage, which are clauses in the form of damages measured in specific dollar amounts ahead of time, which will often replace the need for contractors to try and quantify consequential damages. In effect, this saves the partying utilizing liquidated damages time and effort that it may take to prove the damages. These liquidated damages should be a reasonable reflection of the anticipated damages that a party may face as opposed to a penalty. 

Depending on your position, contract negotiators should aim to avoid being liable for consequential damages, however, this may be a heavily contested clause as conflicting interests may arise from contractors wanting to limit their liabilities at their (disadvantage). 
 

What is the difference between Incidental and consequential damage?

Incidental damages are incidental costs that are reasonably incurred in the inspection, receipt, transportation, care, and possession of goods that are not suitable for use. These are costs are incurred against the party that breaches these contractual terms in order to avoid and mitigate further consequential loss.

Example of Incidental Damage

 

Incidental damage can be shown in the example where there is a sale of a transport truck by a third party that sells repaired trucks. In the case where the sale of the transport truck is made under the premise that the truck is functional, and the truck malfunctions weeks or months after the sale. Incidental damage claims can entitle the non-breaching party to expenses such as transporting the truck to a repair shop, repair costs. This could also open the breaching party to costs such as the loss of profits and opportunity costs of having the truck repaired or costs if this was a foreseeable result of a truck that was not properly maintained.

Indirect damage and business interruption

 

When an event causes a delay in operations, Business interruption arises through the costs incurred while operations are halted. This delay in operations can present itself in the form of damages flowing from the loss of income to rebuilding/repair costs. Business Interruption often ties in with indirect damages, as costs such as loss of reputation, damages to client relationships, and loss of business can be the tangible consequences flowing from this.

Examples of consequential damages / Indirect Damages / Indirect Liability
 

For example, A breaches the contract by failing to deliver screws by a certain date which in turn, causes B a loss of customers and revenue.

The differences in contracts and the context in which the contracts are written will inform what a party ‘knew’ or ‘should have known. Review this carefully before signing the contract.

 

Liability for Indirect damages / Indirect liability / Consequential Damage

 

In practice, the most common context in which indirect damages may be seen is in the negotiation of the limitation of liabilities, where clauses seek to exclude liability for “indirect or consequential” loss or damage. Common construction of these clauses includes, “loss or deferment of profit or revenue, loss of business or other specified losses”. These will often cover damages that arise from the unfulfilled value of the contract, loss of business, or even the loss of reputation.

Therefore, by not mentioning or properly addressing indirect damages in your contracts, and in turn, you can open yourself to large amounts of liability, this can potentially be catastrophic to your profitability runway. Closing negotiations without properly stressing this clause or considering other clauses such as caps on liability will have huge impacts in the long run.

What is a waiver?


A ‘waiver’ is a contractual clause that relinquishes an interest or right by making an intentional or unintentional decision to give up the opportunity to not exercise that right. Waivers are typically used in the context of contractual parties choosing or negotiating the waiving of a right and or consequences that stem from a particular action.

In the instance of you being the party that can enforce the right, a waiver may be beneficial as it would ensure that you would not lose your ability to enforce that right. In the case of the contractual partner, the waiver clause would illustrate whether or not you would be expected to strictly follow the clause itself.

Example of Consequential damage waiver

 

Depending on the contracts and the industry, consequential damage waivers may be a heavily contested clause.

Examples of the wording used for these clauses may include:

“Consequential Damages Waiver. IN NO EVENT SHALL EITHER PARTY BE LIABLE FOR ANY LOSS OF PROFIT, INDIRECT, INCIDENTAL, SPECIAL, PUNITIVE, OR CONSEQUENTIAL DAMAGES ARISING OUT OF OR RELATING TO THIS AGREEMENT.“
 

Consequential Damages and Non-Disclosure Agreements (NDAs)
 

NDAs may limit or exclude the parties’ liabilities for damages in certain clauses and generally are commonplace. In the context of confidential information breaches where a party may suffer indirect or consequential damages, loss of profits, Intellectual Property, customer information, or a specific edge, may not be recovered. In these contexts, it is recommended that you check if the agreement is not one-sided, i.e. they expect consequential damages for breaches but wholly exclude themselves from any confidential information breach. Also, make sure to clearly define what “confidential information” actually constitutes. Lastly, be on the lookout for how clauses attempt to limit or exclude liability in the context of confidential obligations, as this could have larger implications in the form of damages.

What is Indemnification?

Indemnification or indemnity is the obligation to restore any loss, damage, or liability that was incurred. In the background of contracts, indemnities arise where there is a possibility of damage that incurs in the day-to-day operations to which the contract is linked. This is largely negotiated and written into contracts to protect a party from the damage and expenses that may arise from the failure of the other counterpart. Therefore, to be indemnified is to have the right to recover costs and be protected in the case of a potential mishap.


Consequential damages and indemnification

The scope of indemnification of consequential damages is often heavily contested during contract review and negotiation. These negotiations may include whether consequential damages should or shouldn’t be included. Consequential damages and indemnification clauses, as a result, are connected during contract negotiations as indemnification seeks to shift the liability from buyer to seller. Therefore, it is important for both sides to define what are losses.

In identifying the scope of losses, indemnification is a point of contention where sellers will try to limit the scope of losses they cover in the form of indemnification. 


When is Indirect Damages / Indirect Liability / Consequential Damage used?


Depending on the context of the commercial agreement, a rule of thumb is that you should limit yourself to the scope of all or most indirect damages. However, in certain situations relating to confidentiality, some exceptions need to be made as excluding Indirect damages in the case of confidentiality, can unfairly limit a party’s right to recourse. 

There are no hard and fast rules when it comes to contract negotiation and Indirect Damages, but if you’re in doubt as to the quality of your contracts and need a faster way of reviewing contracts. Click here to try a contract review with artificial intelligence.

 

 
 
 
 
 
 
 
 
 
 
 

Disclaimer

Please note that this document is not legal advice. Legly, and its representatives, are not responsible for the content herein or the suitability for your company’s business. We recommend you use this in conjunction with legal advice and not as a substitute.