Indirect damage and Consequential damage
Understand direct, indirect, incidental, and consequential losses and how exclusions interact with liability caps, indemnities, and remedies.
General information for business contracts. Legal outcomes depend on the agreement, governing law, and circumstances; obtain jurisdiction-specific advice when needed.
On this page
Example of feedback to an indirect damage clause.
Key takeaways
- Direct, indirect, and consequential loss depend on the contract wording and governing law.
- Define excluded loss categories instead of relying only on labels such as consequential loss.
- Read exclusions together with the liability cap, carve-outs, indemnities, and available remedies.
- Examples and waiver language should be reviewed for the agreement's jurisdiction and commercial context.
What do indirect and consequential damages mean?
Indirect and consequential loss are contract-law concepts whose treatment varies by governing law and by the wording of the agreement. They should not be assumed to be universally interchangeable. A well-drafted clause identifies the loss categories the parties intend to exclude or preserve and explains how those exclusions interact with the liability cap, indemnities, and other remedies.
What are direct and indirect damages?
Direct damages are losses that flow directly from a breach. Indirect or consequential loss is a legal and contractual category whose meaning depends on the wording and governing law; the label alone does not decide the outcome.
Illustrative example
A buyer pays €100,000 for equipment and later incurs €25,000 in repair and replacement costs after a failure. Whether the purchase price, repair costs, lost production, or other losses are recoverable depends on the contract, evidence, remoteness rules, exclusions, and governing law.
Consequential loss vs liquidated damages
Consequential-loss clauses allocate or exclude categories of recoverable loss after breach. Liquidated-damages clauses instead agree in advance the amount or method of compensation for a specified breach. Their enforceability and relationship to other remedies depend on the contract and governing law, so the two mechanisms should be reviewed separately.
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 signingthe 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.
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