You are inexcusably late with construction of a football stadium, a casino, or similar project that generates large income for the owner. The indirect damages, often referred to as consequential damages, that flow from the delay can be astronomical to the point of breaking your company if it must pay them. As a result, many construction contracts, at every tier, contain a provision that waives consequential damages. By this waiver, a party seeks to limit its risk for these damages.
Over the years, courts have interpreted these provisions in a widely variable and inconsistent manner. The courts typically start with the specific language of the waiver to discern the parties’ intent. Thus, the language of the provision itself is critical. But construction professionals should not overlook other provisions in the contract that may have an impact on a court’s analysis of the parties’ intent. As one of my colleagues likes to say, “the large print giveth and the small print taketh away.”
Consequential damages are typically defined as damages, losses, or injuries that result naturally, but not necessarily directly from the act of the other party on the project. They are the result of special circumstances. Lost profits, lost income, loss of use, lost bonding capacity, loss of business reputation, insolvency, and loss of efficiency can be consequential damages. They are often referred to as expectation damages. Direct damages, on the other hand, are those damages that are a direct and immediate loss caused by a breach and compensate for that loss. Examples of direct damages include costs to repair faulty work or additional work, as well as resulting general conditions expenses and project delay costs. Ultimately, waiving consequential damages can limit uncertainty and allocate risk for losses other than the direct costs of faulty, additional, or delayed work under the contract.
For example, if a project is delayed due to the fault of the contractor and the delay causes the owner to suffer lost income (for example, rental income from a multi-family project), then the contractor’s liability could extend to that lost income. From a contractor’s perspective, delay caused by the owner, through indecision or design changes, may cause the contractor to incur principal office expenses or to lose the ability to perform other projects. These types of damages typically fall into the consequential damages bucket. From the contractor’s perspective, and we suspect the owner’s too, project margins may not be adequate to underwrite the risk of such damages. This leads the parties to the common mutual waiver of consequential damages clause.
In the case of a mutual waiver of consequential damages, a contractor may be under the impression that the risk of consequential damages has been eliminated entirely. However, when a significant dispute arises, a broken relationship can breed more focused contractual analysis, creative contract-language interpretations, and arguments attempting to pierce that waiver. The parties must be mindful of the waiver provision’s language, its specificity, and the impact of other provisions in the contract.
The Language of the Waiver Provision
When contractual language is unclear, the parties will be left with the uncertainty of a court’s ruling (the uncertainty the parties likely sought to avoid in the first place). And while we all have a general understanding of what damages are consequential, special, or expectation damages, those phrases are not given the same definition by everyone. The line between direct and consequential damages is hard to define. What is and what is not often is open to debate. Thus, the parties are well advised to specify what consequential damages are waived, rather than leaving that analysis to a court or arbitration panel. As a Louisiana Federal Judge wrote, the term “consequential damages” is subject to many interpretations and “no two courts or treatises define consequential damages the same way.”[1]
The Houston Fourteenth Court of Appeals faced this task in Tennessee Gas Pipeline Co. v. Technip USA Corp.[2] The waiver of consequential damages left the court to decide whether twelve different types of damages were recoverable or excluded by the parties’ contractual consequential damages waiver provision. The provision read:
Consequential Damages: Notwithstanding any other provisions of this Agreement to the contrary, in no event shall Owner or Contractor be liable to each other for any indirect, special, incidental or consequential loss or damage including, but not limited to, loss of profits or revenue, loss of opportunity or use incurred by either Party to the other, or like items or damage; and each Party hereby releases the other Party therefrom. [Emphasis added].
In another case, the ambiguous consequential damages provision resulted in a court finding lost profits (typically considered a consequential damage) to be direct damages under the contract. There a supplier of natural gas entered into a gas purchase agreement but breached the contract with its purchaser. The purchaser sued and sought damages under the contract for the market value of the gas not received. The supplier argued that the purchaser was seeking consequential damages (which were waived) for any “lost profits” under the contract through it reselling the gas to third parties at a higher rate. The waiver provision read as follows:
The remed[y] specified in Section[]…5.2 above shall be the sole and exclusive remed[y] for…Seller’s failure to deliver gas according to this Agreement. Neither party shall be liable in any event for consequential, incidental, special or punitive damages or losses which may be suffered by the other as a result of the failure to deliver…the required quantities of gas. [Emphasis added].[3]
The court found that lost profits on the contract itself were direct damages because the parties’ contract contemplated purchaser’s ability to profit from rates of the purchased gas at a higher price. Lost profits on other contracts for the sale of electricity produced by the facility were consequential damages.
Consider drafting your waiver provisions with clear definitions for consequential damages. In fact, consider defining “consequential damages” because the term itself is ambiguous. Be as specific as possible in defining what is being waived (e.g. lost profits, loss of business reputation, loss of use, etc.). For example:
Except for damages mutually agreed upon by the Parties as liquidated damages in Paragraph 6.5 and excluding losses covered by insurance required by the Contract Documents, the Owner and Contractor agree to waive all claims against each other for any consequential damages that may arise out of or relate to this Agreement. The Owner agrees to waive damages including but not limited to the Owner’s loss of use of the Project, any rental expenses incurred, loss of income, profit, or financing related to the Project, as well as the loss of business, loss of financing, principal office overhead and expenses, loss of profits not related to this Project, loss of use, or insolvency. The Contractor agrees to waive damages including but not limited to loss of business, loss of financing, principal office overhead and expenses, loss of profits not related to this Project, loss of bonding capacity, loss of reputation, or insolvency.[4] [Emphasis added].
When courts interpret the parties’ waiver language, the courts will typically respect the parties’ intent, if the language is clear and unambiguous. Avoid clauses that are contradictory and that contain language that is subject to multiple interpretations.
A Backdoor to Consequential Damages
Not only can an unclear waiver provision wreak havoc, but so can other provisions of a contract.
Indemnity Provisions
Parties typically include indemnity clauses where one party promises to protect the other against all losses related to some incident. Indemnification is the obligation to reimburse a party for the damages they sustain due to the breach of an underlying obligation. It is often limited to third party claims, and sometimes, limited to property damage and personal injury. For example, if a subcontractor fails to pay its supplier due to no fault of the contractor and the supplier files a lien, the contract may require the subcontractor to indemnify the contractor for any costs it incurs in removing the supplier’s lien from the project.
But we often see contract drafts that extend indemnities beyond third party claims to the contractor’s breach of contract. This seems inappropriate because the owner, as a first party, already has remedies for breach. Such an extension of the indemnity clause is problematic because it could become a backdoor route to consequential damages, that are limited by specific contractual waivers.
An example of an indemnity provision may read:
CONTRACTOR shall indemnify, defend and hold harmless OWNER, its directors, officers, employees and agents from and against any and all claims, demands, actions, causes of action, duties, liabilities, losses, damages and other assets and expenses (including, without limitations, the cost of correcting or compensating for injuries to persons, property, the environment and any natural resources, all fines, interest and penalties and CONTRACTOR’s costs and attorney’s fees and disbursements), collectively referred to herein as “indemnified damages”, which are asserted against or incurred by OWNER or such persons and arise out of or in any way relate to the services performed by CONTRACTOR or omissions of CONTRACTOR, its employees, agents and subcontractors hereunder, or the breach by CONTRACTOR of the representations, warranties and obligations on its part contained herein, except to the extent that such indemnifiable damages are caused by the negligence of OWNER, its employees, agents, other contractors or their subcontractors.
On one hand, the parties are limiting recoverable damages, but on the other, they are agreeing that losses “arising out of or in any way related to” a breach are recoverable. Unless one of the provisions has a cutout for the other, there is at a minimum a question as to what the parties intended for consequential damages.
Liquidated Damages
The risk of loss due to delay often fuels an owners’ reluctance to waive all consequential damages for themselves. The owner in that position may argue for a unilateral waiver by the contractor. As a result, it has become common for a contract’s waiver provision to include a cutout or an exception for liquidated damages recoverable by the owner if certain circumstances arise. In our earlier example of an owner who lost rental income due to contractor delay, a contractual waiver would presumably preclude recovery of lost income. However, if the waiver excepted agreed liquidated damages, the owner could recover some damages, and the contractor could assess the risk arising from possible inexcusable project delay.
Incorporation by Reference
Another provision to watch, especially for subcontractors, is a provision where the subcontractor is bound to the contractor in the same way that the contractor is bound to the owner. These provisions typically include language where the prime contract is incorporated by reference into the subcontract, and the obligations the contractor has to the owner trickle down to the subcontractor. If there is a waiver of consequential damages in the prime contract, be mindful and aware that the same waiver provision might pertain to both parties in the subcontract.
Conclusion
Consequential damages can be a break the company event or at least cause serious harm. You need to be aware of this risk and draft waivers of consequential damages using clear and unambiguous terms, recognizing that the term consequential damages by itself may not be interpreted in the same manner by everyone. Carefully review the wording of such clauses and be mindful of potentially conflicting provisions in other contract clauses and their implications.
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[1] Team Contractors, L.L.C. v. Waypoint NOLA, L.L.C., No. CV 16-1131, 2017 WL 4366855, at *4 (E.D. La. Sept. 29, 2017).
[2] No. 01-06-00535-CV, 2008 WL 3876141, at *3 (Tex. App. Aug. 21, 2008). [Emphasis added).
[3] Cherokee County Cogeneration Partners, L.P. v. Dynegy Marketing and Trade, 305 S.W.3d 309 (Tex.App.—Houston [14th Dist.] 2009, no pet.).
[4] § 6.6 Limited Mutual Waiver of Consequential Damages. ConsensusDOCS 200 – Standard Agreement and General Conditions Between Owner and Contractor (Where the Contract Price is a Lump Sum) Copyright © 2007, ConsensusDOCS, LLC. [Emphasis added].