Hadley v. Baxendale

“In No Event Shall Client Be Responsible for Special, Indirect, or Consequential Damages” – What Are We Talking About Here? 

In the forms files of many business attorneys, a ubiquitous boilerplate clause addresses the dreaded “special, indirect, or consequential” damages. Some companies have adopted a policy that no contract can be signed unless the company is specifically excused, in writing (and sometimes in ALL CAPS), from this scary-sounding exposure.
 
But what, really, is the concern? Think way back to your first year in law school. You’re in contracts class, the issue is damage computations, and the assigned case is the 1854 English appellate decision in Hadley v. Baxendale. The Hadley brothers were in contract with a delivery service to transport a broken crank shaft for repair, and the delivery service breached the contract by improperly delaying the delivery. The Hadleys sued for lost profits due to factory shutdown during the delay.

The appeals court famously split contractual damage computations into two components:

  1. damages that are naturally and ordinarily foreseeable from the breach (general or direct damages) and
  2. damages that arise from special circumstances actually brought to the attention of the defendant at the time the contract was entered (special or consequential damages). 

Because the Hadleys had not informed the delivery service that a delayed delivery would result in a factory shutdown, the delivery service was not liable for the Hadleys’ lost profits.
 
The economic theory behind the court’s decision was that the parties would be able to appropriately allocate risk if both are informed about the amounts at stake in the event of a breach. If the delivery service had been aware that it would have been liable for the Hadleys’ lost profits during any delays, it could have taken extra steps to ensure timely performance and, presumably, would have charged an additional amount for its services to reflect its enhanced risk.  
 
Unfortunately, this decision still leaves us, 163 years later, in search of a reliable and predictable definition for the phrase “special, indirect, or consequential damages.” Careful lawyers working for risk-averse companies will sometimes imagine an extended causation analysis from aggressive plaintiffs’ attorneys, under which, for example, an economic catastrophe might be creatively attributed to faulty soldering in a newly-installed server. While there is a tendency for lawyers to be dogmatic about eliminating all exposure for special damages, a better approach for most practitioners will be to list or otherwise recite the economic stakes in a contract and to be clear that all parties are aware of those stakes.

If your client has informed its commercial counterpart about the issues and needs associated with proper performance under the terms of a contract, your client should have recourse if the counterpart fails to keep up its end of the deal.

This article was originally posted in the ACBA Business Law Section’s quarterly newsletter.