The Alberta Court of Appeal has released a decision that provides much needed guidance as to how to distinguish between direct losses, which are generally recoverable, and indirect or consequential damages, which are often excluded from recovery by contractual agreement.
Dow Chemical Canada ULC v NOVA Chemical Corporation involved allegations of breach of contract in the context of the production of ethylene at the parties' jointly owned plant. Among the issues under consideration was whether an exclusion of liability clause limited the recovery of indirect and consequential damages, and if so, what did that exclusion really cover. The decision provides insight into the applicability and interpretation of exclusion clauses and clarity on the distinction between direct and indirect or consequential damages.
Central to this aspect of the decision was the exclusion of liability clause contained within the Operating and Services Agreement (the "Agreement") which governed the operation and management of the subject ethylene plant. Pursuant to the Agreement, liability for damages was restricted to instances of "gross negligence or wilful misconduct". The contract specifically excluded "indirect or consequential damage (including without limitation loss of profits and damages arising from loss of production)". As part of its analysis, the Court rejected the trial judge's reasoning which, according to the Court of Appeal, involved the strict interpretation of exclusion clauses against the party claiming the exclusion from liability. In so doing, the Court of appeal rejected the notion that the moving party must show that the damages were "clearly and unambiguously" excluded. Instead the Court applied the Supreme Court's reasoning in Tercon and in Sattva, and held that exclusion clauses should be interpreted like all other contractual clauses: not in isolation, but by giving the words their ordinary and grammatical meaning, considered in harmony with the rest of the contract and in light of their purpose and commercial context.
The Court noted that there was nothing inherently unreasonable or sinister about an exclusion clause in a freely negotiated contract, particularly between sophisticated parties. Exclusion clauses are often used by parties to "provide greater certainty and to order their commercial affairs by allocating risk in a manner different from that which would otherwise be provided by law." The Court further noted that the objective of an exclusion clause was for the parties to arrive at a mutually agreed upon risk and liability sharing regime, having regard to the sometimes conflicting notions of fairness (or perceived fairness), industry standards, practicality, availability of insurance/risk mitigation measures, and business efficacy. The Court of Appeal's rejection of the clear and unambiguous test for the interpretation of exclusion clauses was not surprising as the law has been relatively clear since Tercon, supra. However, the strong language used by the Court of Appeal shows support for the practical objectives of exclusion clauses and highlights the utility of considering their inclusion in a variety of agreements.
In addition to signifying its support for the use of exclusion clauses, the Court of Appeal provided some clarification on how damages are determined to be either direct or consequential when specifically referenced in exclusion clauses. Of note, the Court of Appeal rejected the trial judge's use of the "reasonably foreseeable" test as set out in Hadley v Baxendale for determining whether damages were "indirect or consequential." It held that that relying on whether it was reasonably foreseeable that the damages were direct and subject to recovery or consequential and therefore excluded, would render the terms of the exclusion clause meaningless. At common law, damages that were not reasonably foreseeable were already excluded from recovery so when applied this test would be inconsistent with the parties clear intention to deliberately exclude something to which they might otherwise be entitled.
Instead, the Court held that the correct approach was to consider the intention of the parties as reflected in the specific language of the contract including the related commercial realities. Important to the Court's analysis was:
a) Whether the damages in question were recoverable pursuant to the common law. If the damages in question were already excluded by the common law then those damages could not be the subject of the exclusion clause;
b) Whether the damages sought to be excluded as indirect or consequential damages were ancillary to the primary focus of the commercial arrangement (downstream losses); and
c) Whether the inclusion of the damages sought would be commercially reasonable in light of the purpose of the contract and the risks agreed to be assumed by the parties. Generally speaking, indirect or consequential damages typically relate to the assumption of risks that are disproportionate to the interests the party in question agreed to accept.
In this case, the Court of Appeal noted that: [i]n a contract like this for the delivery of a product, the loss of the value of the product is the direct damage." The exclusion clause would have been agreed to in contemplation of the downstream polyethylene profits because those losses were reasonably foreseeable and therefore recoverable under the common law. As the Agreement at issue was about the delivery of ethylene, losses associated with ethylene were direct while those associated with polyethylene, which was not otherwise the subject of the Agreement, were intended by the parties to be excluded as indirect or consequential.
Where claims arise for breach of contract, careful attention should be given to the existence of any clause restricting the scope of liability and the potential impact on the scope of damages that may be recoverable. In resolving any disputes as to the meaning of exclusionary provisions, Courts are likely to consider the particular meaning of the contractual terms having regard to commercial realties of the arrangement and the intention of the parties. Further, in drafting and adding such clauses to agreements, there may be value in carefully considering the risk allocation process and how exclusion of damages as indirect or consequential can assist in both identification and mitigation of risk.
 Tercon Contractors Ltd v British Columbia (Transportation and Highways), 2010 SCC 4 at paras. 62, 127,  1 SCR 69 and Sattva Capital Corp v Creston Moly Corp, 2014 SCC 53 at para. 47,  2 SCR 633.
 (1854), 9 Exch 341, 156 ER 145.