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Review Contracts To Limit Consequential Damages

An award for consequential damages against a contractor can turn a profitable project into a potential for bankruptcy. Consider this example: In 1983 a contractor was hired as construction manager on a project to renovate an Atlantic City casino. The contract stated that the contractor would coordinate with the owner and architect, supervise the trade contractors, and set a guaranteed maximum price for the project in exchange for a fee and expenses.

Although a great deal of the project was completed on time, construction of the façade designed to attract customers passing by the casino was late. The owner terminated the contract because of the delay on the façade, and the contractor brought an action for wrongful termination and the balance of the fee. In turn, the casino sought damages for lost profits and was awarded $14,500,000 in arbitration which was later upheld by the New Jersey Supreme Court. This scenario demonstrates the impact of a consequential damage award and illustrates the importance of contractually managing these risks.

The American Institute of Architects’ (AIA) form contract language pertaining to consequential damages is contained in the general conditions (AIA A201). The A201 general conditions adopted a mutual waiver of consequential damages in reaction to the decision referenced above. The pertinent section reads as follows:

“The Contractor and Owner waive all claims against each other for all consequential damages arising out of or relating to this Contract. This mutual waiver includes:

Damages incurred by the Owner for:

o Rental expenses;

o For losses of use, income, profit, financing, business and reputation; and

o For loss of management or employee productivity or of the services of such persons; and

Damages incurred by the Contractor for:

o Principal office expenses including the compensation of personnel stationed there;

o For losses of financing, business and reputation; and

o For loss of profit except anticipated profit arising directly from the Work.”

This mutual waiver is applicable, without limitation, to all consequential damages due to either party’s termination. Nothing contained in this shall be deemed to preclude an award of liquidated damages, when applicable, in accordance with the requirements of the Contract Documents.

On its face, this language seems to favor contractors because the largest consequential damage claims (like the one referenced above) are those recoverable by owners. Lost profits may be recoverable by contractors, but typically those losses are not comparatively as large.

Contractors should also be aware that the A201 mutual waiver of consequential damages language may not preclude owners from recovering consequential damages for construction delays. Owners may also still recover lost profits, loss of use or other consequential damages as liquidated damages even if the parties agree to the mutual waiver of consequential damages. The A201 document removes “liquidated damages” from the waiver of “consequential damages.”

In Idaho, two requirements must be met for recovery of liquidated damages: (1) an accurate determination of the actual damages that might be incurred upon breach must be difficult or impossible to determine; and (2) the amount of the liquidated damages must bear a reasonable relationship to the actual damages anticipated to be incurred.

Liquidated damages are somewhat beneficial to contractors in that they limit the risk resulting from construction delays. Contractors should discuss what types of costs a liquidated damages provision is intended to cover when negotiating contract terms with an owner and try to limit the recoverable amount to direct damages.

Additionally, contractors should consider including a liquidated damage provision which applies in the case of owner-caused delays and disruptions. This way contractors may recover for those overhead, bonding capacity, and onsite costs which continue to be incurred as a project is delayed. While the drastic results of an award of consequential damages have been addressed by A201. The parties may still choose to include a liquidated damage provision which attempts to address delay damages.

Contractors should consider having their legal consultant periodically review their contracts to manage their risk exposure in the contract’s liquidated damage provisions and in language pertaining to consequential damages.