Consequential damages: often negotiated, rarely understood

Gloucester, England, 1854. At the City Flour Mills, the crankshaft of the steam engine breaks, and the mill stands still. The proprietors, Joseph and Jonah Hadley, have no spare part: the broken shaft must travel to the manufacturer as a model for the replacement. They hire the carrier firm of Joseph Baxendale, which promises to ship the shaft on the second day. It ships days late. The mill stays idle, the Hadleys sue for the profits lost in the extra days of standstill, and a jury awards them more than twenty times the carriage fee. On appeal, the Court of Exchequer reverses — and in doing so writes one of the most famous judgments in the common-law world.¹

Every waiver of “consequential damages” in use today descends from that broken crankshaft. Which makes it all the more remarkable that after 170 years of case law across the common-law world, nobody can say with confidence what the term covers. My position after two decades of negotiating these clauses: the naked term “consequential damages” is a liability in itself. Whoever writes it into a contract is buying a dispute about words instead of an allocation of risk.

One case, two limbs

The rule of Hadley v. Baxendale is a limitation of liability built into the common law itself. A breaching party is not liable for every consequence of the breach; damages are limited to what is reasonably foreseeable, on one of two grounds: (a) the loss flows naturally from such a breach “in the great multitude of such cases,” or (b) it arises from special circumstances that were communicated to the breaching party when the contract was made.² The Hadleys failed to recover their lost profits because they had never told Baxendale that the entire mill stood still without the shaft.

The first limb became known as “direct” or “general” damages, the second as “special” or “consequential” damages — even though none of those four terms appears anywhere in the judgment.³ Two consequences follow, and both are routinely overlooked.

First: damages that are remote, speculative, or unforeseeable are recoverable under neither limb. They are off the table by law, waiver or no waiver.

Second: lost profits are not automatically consequential. Profits that any party would obviously lose from this kind of breach are direct damages under the first limb — and survive a consequential damages waiver.

What everyone gets wrong

Glenn West, who has studied these waivers more thoroughly than anyone, calls the exclusion “alien vomit,” after the nickname of an invasive sea squirt that overruns whole colonies: the boilerplate attaches itself to contracts on both sides of the Atlantic and crowds out the provisions next to it that someone actually thought about.³ The misconception catalogue is long. Deal professionals equate consequential damages with remote losses (wrong: never recoverable anyway), with lost profits (wrong: see above), with “indirect” damages, with everything beyond replacement cost — and there is case law loosely supporting each version, which is precisely the problem.

Two decisions show what the confusion costs.

In 2 Entertain Video v. Sony DADC, vandals set fire to a warehouse holding the entire home-entertainment stock of a BBC Studios subsidiary. The storage contract excluded “indirect or consequential loss,” including loss of profits — but only, said the clause, to the extent such losses were indirect or consequential to begin with. The court held: the lost profits and business interruption were the direct and natural result of the fire, first limb, not excluded. The waiver failed at the very moment it was written for.⁴

In New York, Biotronik had waived “consequential damages” in an exclusive distribution agreement and assumed its lost resale profits were gone. The Court of Appeals held those profits were general damages — recoverable despite the waiver — and surprised a good part of the New York bar.⁵

Ken Adams collected what such clauses actually list in practice and arrived at 31 items: consequential, special, direct, general, indirect, incidental, punitive, exemplary, collateral, and delay damages; plus loss of profits, loss of anticipated revenues, loss of savings, loss of goodwill, loss of data, loss of use, loss of production, loss of contracts, loss of business reputation, lost opportunities, cost of capital, increased operating costs, downtime costs, substitute goods, substitute services, substitute facilities, and claims of customers.⁶

The madness is not the length, it is the construction. These lists mix items describing how a loss is characterized (consequential damages) with items describing what the loss arose from (damage to equipment). They stack synonyms, because consequential and special damages are the same thing. They contradict themselves, because excluding both direct and indirect damages excludes everything. And they invent categories that do not exist: someone brought “collateral damages” home from the movies.

The cause is not malice, it is self-protection. Almost nobody drafts such a clause from scratch. It is carried over from the last contract, from the trade-association template, from the other side’s draft, and every hand that touches it adds one more item, because one more item cannot hurt and nobody will ever criticize them for it. Cover-your-back, in clause form. The result is the opposite: the longer the list, the more synonyms and contradictions a court can use to construe the whole clause, or strike it. Adams calls it negotiation theater — precision work on the wrong front. And here is my bet: most of the people writing the waiver into their contracts today have never heard of Hadley v. Baxendale.

Drafting that works

Three rules cover most of the ground.

Name the losses, don’t label them

If you want to exclude loss of profit, loss of production, or loss of data, exclude them by name, as standalone exclusions — not as illustrations of “consequential damages.” The moment the list becomes a subset of the label, a court reads the label, and you are back in the two-limbs lottery (that is exactly how the clause in 2 Entertain Video died).

Cap first, but not only the cap

A monetary cap is the one limitation instrument whose meaning no court has to guess. Adams long argued for stopping there — and retracted that in 2022: the bare cap is a cop-out, and the concern behind the exclusion is legitimate. His current answer is the more interesting one. Instead of anchoring on the effect (“consequential damages”), he anchors on the cause: the special circumstances communicated to the obligor at the time of contracting. That is simply Hadley’s second limb, spelled out rather than labeled. Practitioners in plant engineering and software pull in the same direction: a cap alone is too blunt where a single defective component can trigger revenue losses that dwarf the price, and it fails if the cap itself is held invalid. So in practice: cap plus named exclusions, each doing its own work.⁶

Mind the carve-outs

In an NDA, never waive consequential damages: the loss from a leaked trade secret almost by definition consists of consequential damages, so the waiver guts the very agreement it is meant to protect. Worse, excluding both direct and consequential damages in an NDA removes the consideration for the duty of confidence and can make the whole agreement fail. The market standard is the opposite carve-out. In M&A, where remedies run through indemnification, say expressly that recoverable losses are limited to what contract law would allow under the foreseeability rule; otherwise a broad “Losses” definition can quietly override Hadley.⁷

What that looks like assembled — a clause I use in export contracts, here in generalized form:

Note the technique: the critical losses in paragraph 2 are excluded by name, each standing on its own; “consequential damages” appears only as a residual category at the end, where it can do no harm to the rest of the list. Paragraphs 1 and 3 keep the mandatory minimums intact. What the clause deliberately does not do is rely on the label to carry the load.

The German twist

Now the part that surprises international counsel: under German law, this clause — like virtually any liability limitation — is invalid the moment it qualifies as a standard term, which in practice it almost always does. German standard-terms law prohibits limiting liability for gross fault and for injury to life, body, and health even between businesses (Section 309 No. 7 BGB). And for simple negligence, the cardinal-duties case law requires liability for foreseeable, contract-typical damages to remain intact (BGH, judgment of 18 July 2012 – VIII ZR 337/11) — which is precisely the category a consequential damages exclusion targets, because in commercial dealings lost profits and production losses are the typical, foreseeable damages (Leuschner, NJW 2016, 1222). The savings clause in paragraph 3 rescues nothing: German law does not trim an overreaching standard term down to the permissible maximum; it strikes it.

So the honest advice under German law runs on three other tracks. Negotiate the liability clause individually, genuinely and documentably. Do the limiting work one level earlier, in the statement of work: what is not owed cannot be breached — the most powerful limitation instrument that content review cannot touch. Or change the benchmark altogether: under the CISG, limitation clauses are measured against the Convention’s flexible framework rather than the strict BGB model, which is one of the strongest reasons for German exporters to keep the CISG — and for a belt-and-braces setup, pair it with a supplementary law such as Swiss law plus arbitration.

The takeaway

The Hadleys lost out because of what they had not said. Most parties fighting over a consequential damages waiver today lose for the same reason: they wrote a label where they should have written a list, and each side filled the label with its own hopes. Exclude losses by name, cap the total, keep the carve-outs honest — and if you stay with German law, accept that the real limitation work happens in the statement of work, not in the liability clause. If that is not enough for you, move up a level and negotiate the choice of law itself.

Notes

1. Hadley v. Baxendale (1854) 9 Ex. 341, 156 Eng. Rep. 145 ([1854] EWHC Exch J70). Facts as reconstructed in Glenn D. West & Sara G. Duran, Reassessing the “Consequences” of Consequential Damage Waivers in Acquisition Agreements, 63 Bus. Law. 777, 784 f. (2008). ↩

2. Hadley v. Baxendale (1854) 9 Ex. 341, 355: damages “should be such as may fairly and reasonably be considered either arising naturally … from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it.” ↩

3. Glenn D. West, Do You Really Know What “Consequential Damages” Means?, Weil Global Private Equity Watch, 18 May 2020: “In the thousands of cases considering this rule in the ensuing 166 years across the common-law world, it does not appear that anyone has really nailed this down.” ↩ ↩²

4. 2 Entertain Video Ltd v Sony DADC Europe Ltd [2020] EWHC 972 (TCC). ↩

5. Biotronik A.G. v. Conor Medsystems Ireland, Ltd., 11 N.E.3d 676 (N.Y. 2014). ↩

6. Kenneth A. Adams developed the critique over years: Excluding Consequential Damages Is a Bad Idea, 15 February 2010; Limitation-of-Liability Overkill, 5 March 2020; the reversal and his proposed solution, anchoring on the “special circumstances” rather than on “consequential damages”, in Here’s an Alternative to the Usual “Consequential Damages” Randomness, 20 June 2022, and in the Consequential Damages rider to MSCD5 (as of 7 November 2022). Each including the practitioner counterpoints in the comment sections. ↩ ↩²

7. On NDAs: Kenneth A. Adams, Excluding Consequential Damages in a Confidentiality Agreement?, 18 October 2011. On M&A: West & Duran (fn. 1), 786 ff.; Glenn D. West, Consequential Damages Redux: An Updated Study of the Ubiquitous and Problematic “Excluded Losses” Provision in Private Company Acquisition Agreements, 70 Bus. Law. 971 (2015). ↩

Reference: Poleacov, P. (2026). Consequential damages: often negotiated, rarely understood. INN.LAW. https://inn.law/en/perspectives/consequential-damages/

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