ASK AN ATTORNEY Waivers of Consequential Damages – A Key Contract Clause

By: Jeffrey C. Bright, Esq. Saxton & Stump’s Construction Law Group

When a contract is breached, various types of losses can arise, and the lingo used to describe them is quite varied as well: general damages, direct damages, indirect damages, incidental damages, special damages and consequential damages (to name a few oft used terms). Not all parties use these words correctly in their contracts, and not all parties have the same understanding of what they mean. This article focuses on a key contract term dealing with losses that arise from breached contracts or negligence—consequential damages.

Generally, in the law, losses are referred to as “damages” and the general intent of a court award is to place the injured, non-breaching party in the position it would have occupied had there been no breach. General damages are the types of losses that are intuitive and foreseeable from a breach. For example, if an installed HVAC system is defective, the cost to repair or replace the HVAC system would be general damages (and also direct damages). Regardless of the building type or use, one could expect a defective HVAC system to cause losses from costs to fix or replace the defective system.

Consequential damages, on the other hand, are the derivative (“domino effect”) losses that result from the breach, which may be unique, depending on the circumstances. Using that same example of a defective HVAC system—if the building is a residential house, the impact of the defective system will be different than if the building is a hotel. The domino effect losses from a residential house might be rather limited. But the impact of a defective system on a hotel, and the domino effect losses that occur, could be significant. For example, what if due to the defective HVAC system a large convention pulls its booking? The lost income from the pulled convention would be a consequential damage.

Typical examples of significant risk of consequential damages are when the work is performed on a building/ project that is intended to have use of great economic significance, and if a breach in performance could cause the building/project to be hindered in its use. Examples include:

• Work on facilities where a failure to perform could cause shutdown of the facility or severely hinder use of the facility to meet its separate economic productivity goals

• Work on commercial projects where there is an intended immediate use for revenue generating activities; or

• Work on government, healthcare, or infrastructure projects that have significant importance to the community or society; or

• Work on projects that are phased or connected to other related projects, where a failure to perform on the one project causes significant losses tied to other projects.

Because domino effect consequential damages can be unpredictable and excessively large, the typical approach in the construction industry is to waive consequential damages. The general philosophy being that a contractor should only be responsible for the losses that it causes for fixing its defective work, and the owner should bear the risk of derivative losses to its separate business. Thus, standard construction contract forms, including the AIA typically include a mutual waiver of consequential damages. See A201-2017 General Conditions section 15.1.7.

In a notorious example of the potentially drastic effects of consequential damages, the case Perini Corp. v. Greate Bay Hotel & Casino, Inc., 610 A.2d 364 (N.J. 1992) has served as the poster-child example of excessive losses that can be attached to a contractor when there is no waiver of consequential damages in the contract. In Greate Bay Hotel & Casino, the contractor was to perform a renovation on a casino hotel for an original contract price of $16.8 million. The project did not reach final completion on time. The hotel owner and contractor submitted the dispute to arbitration. The arbitration panel awarded the hotel owner $14.5 million in consequential damages for the lost profits the hotel incurred during the delayed final completion.

When negotiating construction contracts and assessing risk, it is important to closely evaluate the impact of consequential damages and negotiate a waiver of consequential damages (and related liquidated damages clause).