Contract Essentials: What You Need to Know About Indirect Damages

In contracts, one or more of the parties can ask to exclude various types of damages. Wording to exclude damages means the contract is asking the parties agreeing to exclude the ability to make a claim for specific types of damages in the event of a contractual breach.

Whenever there’s a contract dispute, it’s not enough to think about which side breached the agreement and how. You also need to know what damages are available. Higher potential damages means that the non-breaching party has a lot more to get out of going to court.

Likewise, higher potential damages gives the non-breaching party a lot more leverage over the breaching party in any settlement negotiations. And when potential damages are low, the reverse is true. Even if no one is actually thinking about going to court, these same factors will often determine what sort of dispute settlement you and the other party to a contract may ultimately agree upon.

The question then is, what damages are available under your agreements to you and to the counterparty? And what kinds of damages might be excluded?

Direct Damages vs. Indirect Damages

When lawyers talk about “direct damages” caused by a breach of contract, they specifically mean those damages directly and immediately resulting from one side’s violations of the contract. For instance, if a marketing agency does some work for $50,000 and the client doesn’t pay them, the marketing agency can sue for $50,000 in direct damages.

Indirect damages refers to all the knock-on effects on the contract breach on the non-breaching party – all the non-immediate consequences that might happen. So if a software developer has a contract to repair a broken website by a certain date and fails to do that, the indirect damages to the client would include, for example, the value of all the lost business from visitors to the client’s website who were very unimpressed by the still-broken website.

Indirect damages have all sorts of labels: consequential, incidental, indirect, exemplary, special, enhanced, punitive, etc. While these terms can sometimes have different meanings, they are often used interchangeably (though “punitive” damages does mean something specific: damages that are awarded not because they are compensation for harms suffered but when somebody does something so awful the judge or jury will add a penalty to dissuade them from ever doing the same thing again).

How Big A Difference Does It Make to Exclude Indirect Damages?

The difference can be HUGE. Let’s imagine that you are a service provider of some kind – perhaps a company that does software development or marketing services, for example. Imagine then your business has a contract for $50,000 and for whatever reason, you aren't able to deliver the full value of work. So, in addition to the value of the contract itself, a smart lawyer would add on the damage for any lost business caused by the breach of contract. And perhaps also the impact to reputation.

In the above scenario, instead of suing for just $50,000, your client could try and sue you $500,000. While indirect damages need to have been reasonably foreseeable, when a plaintiff has a smart, creative lawyer, it’s not impossible to come up with enormous numbers. On the other hand, if your contract excludes and all indirect damages, the client might only be able to sue for $50,000.

What Does a Contract Say When It Excludes Indirect Damages?

If your agreement excludes indirect damages, it’s likely to say something like this:

“IN NO EVENT WILL EITHER PARTY BE LIABLE UNDER OR IN CONNECTION WITH THIS AGREEMENT OR ITS SUBJECT MATTER FOR ANY CONSEQUENTIAL, INCIDENTAL, INDIRECT, EXEMPLARY, SPECIAL, ENHANCED OR PUNITIVE DAMAGES, REGARDLESS OF WHETHER SUCH PERSONS WERE ADVISED OF THE POSSIBILITY OF SUCH LOSSES OR DAMAGES OR SUCH LOSSES OR DAMAGES WERE OTHERWISE FORESEEABLE, AND NOTWITHSTANDING THE FAILURE OF ANY AGREED OR OTHER REMEDY OF ITS ESSENTIAL PURPOSE.”

Should indirect damages be excluded or not in your next contract?

Like many legal issues with business agreements, it all depends. If you are providing a service or product, it’s usually good to have the applicable contract exclude all indirect damages. If you’re the client, it’s often preferable to not have any contract language like that – that way, if an issue ever comes up, you might have a much bigger stick to threaten the other guy with.

These sorts of exclusions can also include important nuances. For instance, frequently, an exclusion of indirect damages includes a carveout for breaches of any confidentiality obligations. That’s because it can be incredibly damaging when one party to an agreement discloses or improperly uses the other side’s confidential information, but there are almost no direct damages. Instead, all or almost all the damages there are indirect damages.

When in doubt about what’s best for you in any particular situation, we strongly advise you consult an experienced business attorney (like the team at MGLS!) – they’ll help you review your particular agreement and determine the best options given your specific risk/reward profile in that situation.

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Disclaimer: This article constitutes attorney advertising. Prior results do not guarantee a similar outcome. MGLS publishes this article for information purposes only. Nothing within is intended as legal advice.

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