Indirect damages: Overview, definition and example
What are indirect damages?
Indirect damages are financial losses that don’t happen directly from a breach of contract but are a knock-on effect of it. They’re also called consequential damages because they result from the ripple effects of a problem rather than the immediate issue.
For example, if a supplier fails to deliver materials on time, the direct damage might be the cost of finding a new supplier. The indirect damage could be lost profits because the delay caused production to stop.
Why are indirect damages important?
Indirect damages are important because they highlight the broader impact of a breach, going beyond the immediate losses. In many contracts, indirect damages are excluded through limitation clauses, meaning the breaching party isn’t responsible for these types of losses. For businesses, understanding whether indirect damages are covered or excluded in a contract is crucial to managing risk.
If a contract excludes indirect damages, it means the injured party can only claim for the direct costs caused by the breach. This can significantly limit the amount of compensation available in a dispute, so businesses should pay close attention to these clauses when negotiating agreements.
Understanding indirect damages through an example
Imagine a software company agrees to provide a critical system upgrade for a retail chain. The upgrade is delayed due to the company’s breach, causing the retail chain to miss a major sales event. The direct damage might be the cost of hiring another IT provider to fix the issue. The indirect damage, however, is the lost revenue from the missed sales event.
In this case, whether the retail chain can recover those lost profits depends on whether the contract allows for claims of indirect damages.
An example of an indirect damages clause
Here’s how an indirect damages clause might look in a contract:
“Neither party shall be liable for any indirect, incidental, or consequential damages, including but not limited to loss of profits or revenue, arising out of or related to this Agreement.”
Conclusion
Indirect damages refer to financial losses caused by the ripple effects of a breach, not the immediate problem itself. They can be significant, but many contracts limit or exclude liability for them to protect businesses from excessive claims.
Understanding indirect damages and how they’re handled in a contract helps businesses assess their risks and set clear expectations. Whether you’re drafting or reviewing a contract, knowing the scope of liability is essential for protecting your interests.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.