Whether it is an owner, contractor, or subcontractor, when construction entities enter into contracts their general focus is typically on a few interrelated goals: completing the project on time, within budget, and making a profit. An often-overlooked aspect of contracting, however, relates to potential liability in the event of a breach, more specifically, consequential damages. While it is relatively easy to foresee direct damages resulting from a breach of contract, it is more difficult to foresee, understand, and protect oneself against damages that may not be directly caused by a breach, but nevertheless, result from that breach – more specifically, consequential damages.
This article will provide an overview of consequential damages in the construction industry and why such damages should not be overlooked when contracting, followed by a summary of how parties may choose to confront such damages when contracting. The article will then conclude with a practical summation of tips to consider relating to consequential damages.
Consequential damages, also known as indirect or special damages, are damages that are not directly caused by a breach of contract but are, nonetheless, a result of a breach. In essence, these types of damages provide a mechanism for compensating non-breaching parties for losses that are not directly caused by a breach but still result from said breach. These damages can be significant in construction contracts, as they can include costs related to delays, lost profits, and other financial losses. For example, if a contractor fails to complete a project on time, the owner may suffer consequential damages such as lost profits or increased financing costs. On the other hand, for a contractor, a breach may result in indirect costs such as lost profits due to increased costs from the breach. In short, the definition of consequential damages generally takes an “all-encompassing” view of damages and includes all such damages that may arise out of a breach, including damages that are only indirectly caused by the breach. Because of this, the breadth of liability potentially available as “consequential” damages is substantially more than damages that are solely directly caused by a breach. Therefore, construction entities need to understand the concept of consequential damages in construction agreements.
One of the most prominent reasons the concept of consequential damages is important is that such damages may have a significant impact on (1) the profitability of a project; (2) the construction entity that suffers from those damages; and (3) the construction entity that may be liable for those damages. Below are just some brief examples of consequential damages in the construction context:
Lost Profits: These damages are one of the most prevalent in the construction industry. They relate to profits that would have been earned if the project had been completed on time and according to the contract terms. For example, from the owner’s perspective, if there is a delay to a commercial property that prevents a business from opening on time, the owner may be able to claim lost profits as a result of the delay. On the other hand, from the contractor’s perspective, if there is an owner-caused delay that causes increased costs cutting into the contractor’s estimated profit on the project, the contractor may be able to claim lost profits.
Increased Operations Costs: These damages relate to the additional costs a party may bear as a result of a project delay or breach of contract. While relatively straightforward, they generally refer to additional operation costs, such as increased costs for a contractor to obtain materials.
Loss of Business Opportunities: This type of damage relates to opportunities that are lost as a result of a project delay or breach of contract. For example, if a delay in a commercial construction project causes an owner to miss a key business opportunity, such as a major event, the owner may be able to claim a loss of business opportunities. Likewise, if the breach causes the contractor to be unable to bid on and win some other project/work, the contractor may be able to recover under a claimed loss of business opportunity.
While the above is not an exhaustive list, the different types of consequential damages arising out of a breach of contract is, in essence, infinite. These damages can even include intangible losses that may occur, such as damage to a company’s reputation. Thus, because there are numerous ways in which a non-breaching party may claim that a loss is a “consequential damage” of a breach as well as the boundless potential liability for such damages, it follows that consequential damages can have a major impact on not only a construction project but also on the viability of construction entities.
Because there is a potential for significant loss as a result of consequential damages, it is not surprising that parties often seek to limit their exposure to these damages through the use of waiver of consequential damages clauses or clauses limiting exposure only to certain types of consequential damages. One way in which parties do this is through liquidated damages clauses. While this article will not dive into such clauses, the general idea is that parties will include a liquidated damages clause which sets a fixed amount of damages that will be owed for a specific type of damage. For example, the clause might provide that if a contractor breaches the contract, it will owe a specified amount of liquidated damages for each day the project is delayed beyond the completion date. Such damages represent the owner’s estimated damages for increased costs of financing or other indirect costs. In essence, these clauses (as well as other clauses which specifically set out consequential damages allowed and/or waived) essentially relieve one party (or both parties) from liability for indirect damages that may be incurred as a result of a breach of contract or limit such liability. However, the effectiveness of these clauses can vary depending on the specific language used and the jurisdiction in which the contract is being enforced. Some jurisdictions may not allow for the waiver of consequential damages in certain circumstances, such as when the damages were foreseeable at the time the contract was entered into. In other cases, a court may find that a waiver of the consequential damages clause is overly broad and therefore partially unenforceable. In other words, it may be difficult to determine what damages are actually “consequential” and thereby applicable to a waiver, compared to which damages are direct damages and therefore not subject to the waiver. See, e.g., Chinese Hospital Association v. Jacobs Engineering Group, Inc., No. 18-cv-05403-JSC, 2019 WL 6050758 (N.D. Cal. Nov. 15, 2019).
Nevertheless, despite the potential limitations on the enforceability of waiver of consequential damages clauses, they can be a useful tool for parties. Specifically, these clauses can help limit the potential exposure to indirect damages and can provide greater clarity and certainty around the potential costs and risks associated with a project. Without a consequential damages clause setting forth what damages are recoverable and/or what damages are expressly waived, it can be difficult to accurately assess the damages suffered by a party in the event of a breach leading to more uncertainty and adding fuel to the already brewing dispute between parties. In addition, the inclusion of such clauses may serve as a deterrent to parties who may be tempted to breach their contract. For example, if a party is aware that it may be held liable for significant consequential damages in the event of a breach (e.g., lost profits) or liquidated damages, that party may be inclined to do everything possible to adhere to the terms of the contract and avoid breaching the contract. All said, including waiver language relating to certain consequential damages provides limits on potential significant liability relating to damages that may arise out of a breach (but which may not be direct damages of a breach).
With this in mind, one example of a mutual waiver of consequential damages can be found in ConsensusDocs200 in Section 6.6. In the relevant part, Section 6.6 provides for a waiver of consequential damages (other than those damages that are determined to be liquidated damages as outlined in other portions of the Agreement). Specifically, in Section 6.6, the Owner waives damages including rental expenses incurred, loss of income, loss of profit, loss of business, loss of financing, and loss of reputation. The contractor waives certain losses including loss of business, loss of financing, loss of profits, loss of bonding capacity, loss of reputation, and insolvency. While this limits the number of damages the non-breaching party may recover, this type of provision provides some relative certainty as to the number of damages that may arise as a result of a breach of contract for all parties.
Overall, in the event of a breach of contract, consequential damages can have a substantial impact on the total extent of liability relating to a breach. Without any “checks” on these damages, the potential damages for things such as lost profits as a result of delays can be massive. Given this uncertainty, parties oftentimes negotiate waivers/limitations on such consequential damages. While the waivers limit potential recovery for a non-breaching party, the waivers provide a more defined scope of damages that may be at issue should a breach occur and a dispute arises. That said, below are some practical considerations relating to consequential damages in the construction industry:
- Definition of Consequential Damages: Clearly define the scope and meaning of “consequential damages” in the contract in specific and unambiguous language to avoid disputes later on.
- Foreseeability of Damages: Consider the foreseeability of the damages at the time the contract is formed. Damages that are direct and foreseeable should not be considered consequential damages.
- Allocation of Risk: Allocate the risk of consequential damages between the parties in a fair and equitable manner. For example, a contractor may agree to bear the risk of certain types of damages while the owner may agree to bear the risk of others.
- Limitation of Liability: Consider limiting the liability of each party for consequential damages in a way that is reasonable and proportional to the parties’ relative needs. For example, utilizing ConsensusDocs200 and its Section 6.6 may address these concerns.
- Notice Requirements: Consider including notice requirements in the contract to ensure that the parties are aware of any potential consequential damages and to provide an opportunity to resolve any disputes before escalation.
By carefully considering the above, construction entities can ensure they have a comprehensive understanding of the potential “consequences” of “consequential damages,” and that they are taking steps to protect themselves from the substantial impact such damages may have on a construction dispute.
Watt Tieder is one of the largest construction boutique law firms in the United States, with a diverse and experienced team of attorneys representing many of the world’s leading corporations, developers and contractors on both domestic and international projects. We represent more than half of the Top 30 Engineering News Record contractors and most of the nation’s top sureties. With offices in six cities in the United States, the firm is a dynamic, mid-size boutique that provides knowledgeable and practical legal representation to the construction, surety, government contracts and bankruptcy industries world-wide.
The views expressed in this article are not necessarily those of ConsensusDocs. Readers should not take or refrain from taking any action based on any information without first seeking legal advice