Consequential damages deserve some time in the spotlight as an important issue to consider in construction project risk mitigation. Construction project participants frequently come across language addressing consequential damages in their contracts. However, consequential damages do not get top billing like some other equally critical issues such as liquidated damages, or there is lack of understanding about what consequential damages are. This article aims to provide a basic understanding of what consequential damages are. This understanding can assist contracting parties in their approach to common contract language concerning consequential damages.
What are consequential damages?
In straightforward terms, consequential damages are damages that a contract party incurs as the indirect result of a breach by the other party to the contract. To begin to understand what consequential damages are, it is helpful to understand what they are not. Consequential damages are beyond the direct damages resulting from a breach. Direct damages are those that naturally flow from a breach, like a project owner’s costs to complete work after a project has been abandoned by a contractor. Consequential damages often come from outside the contract parties’ relationship. They typically stem from a contract party’s dealings with another party outside the contract that are impacted by a party’s breach of the contract. For example, a contractor may lose out on other projects that it cannot pursue because an owner has delayed the contractor’s work on an existing project. The contractor’s lost profits on another project for a third party are not increased costs for the contractor to perform the project, but they are a damage that resulted indirectly from the owner’s breach. In the same situation, the contractor’s increased general conditions costs on the delayed project would be a direct damage and not a consequential one. A good rule of thumb is that consequential damages stem from a party’s dealings outside the contract.
Most construction contracts address consequential damages, usually in the form of consequential damages waivers. These waivers may be one-sided, where only one party to the contract is waiving its rights to recover consequential damages in the event the other party breaches. These waivers can also be mutual such that both parties waive their rights to pursue these damages. Sometimes the contract does not address consequential damages at all, in which case either party may have rights to pursue consequential damages in the event of a breach (subject to other legal requirements per each state’s case law on consequential damages that are beyond the scope of this article). When faced with such waiver language in negotiating a construction contract, analyzing and negotiating the waiver depends on whether a party is an owner or contractor or, alternatively, a contractor or subcontractor.
For a project owner, consequential damages can come in many forms, largely dependent on the project’s ultimate use. If the project is a multifamily development, one of the owner’s consequential damages could be lost rent income if the project is delayed by the contractor. If the project is a power generation facility, the owner’s consequential damages in the event of a contractor-caused delay could be lost revenue since the facility cannot produce electricity to be sold. An owner could also incur consequential damages in the form of increased carrying costs, such as interest if the owner has borrowed money to finance its project. The project circumstances will largely inform the owner’s potential consequential damages. If the owner stands to lose significant profit from the use of the finished project, then the owner should carefully consider before signing any contract agreeing to waive consequential damages. Sometimes it is easy to default to agreeing to make a waiver of consequential damages mutual, but an owner should consider the potential consequences of doing so.
Potential consequential damages for contractors and subcontractors may stem largely from how breaches can affect other projects. As mentioned above, owner-caused delays on one project can prevent a contractor or subcontractor from pursuing other projects and earning profits on those projects. Those lost profits can be a consequential damage resulting from owner delays. If a contractor relies heavily on government projects for its income and is improperly terminated, that termination could affect its ability to win future government projects. As a result, the potential decreased income could be a consequential damage to that contractor from the improper termination. A similar scenario could also affect a contractor’s or subcontractor’s ability to obtain bonding or cause increases to future bonding costs. Those financial impacts could be consequential damages to a contractor or subcontractor. Before waiving consequential damages, a contractor or subcontractor should assess the potential to incur consequential damages and whether that risk is acceptable.
Consequential damages play an important role in risk management for all participants on any project. A carefully considered waiver can significantly reduce the risk of having to pay for an opposing party’s consequential damages. Conversely, insisting on an allowance of consequential damages can protect a non-breaching party. If not carefully considered, the consequential damages clause can unwittingly waive the ability to pursue damages that might make or break a project’s success or impact a company’s future ability to do business. Experienced counsel can assist in assessing these risks and proposed waivers and crafting language that works for an organization.
Smith Currie Oles provides comprehensive legal services to all parts of the construction industry across the nation. Smith Currie lawyers have decades of demonstrated success representing construction and federal government contracting clients “From the Ground Up,” including procurement matters, contract formation and negotiation, project administration, claims prosecution and, when necessary, in litigation and other forms of dispute resolution.
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