By Jason L. Richey and William D. Wickard – K&L Gates, LLP

Provisions in construction contracts that mutually waive the rights of the owner and contractor to recover consequential damages have become common-place. An effective waiver can save the parties substantial litigation costs if it expressly defines the type of consequential damages the provision is intended to bar, so that a court or arbitration panel can dismiss all or part of a construction case at an early stage. However, an ambiguous clause may cause contractors and owners to expend significant time and money defending claims seeking delay costs, lost profits or other damages commonly thought to be “consequential.”

Consequential Damages Defined

When a party breaches a construction contract, the law generally requires the nonbreaching party be placed in the position that it would have been in absent the breach. The non-breaching party may recover two types of damages – “direct or general” damages and “indirect or consequential” damages. What constitutes direct versus indirect damages, however, is not black and white and has generally been a grey area for courts, arbitration panels and lawyers. The distinction is critical because indirect damages usually can be barred by a contract while direct damages generally cannot.

Direct damages follow naturally from the type of wrong complained of. For example, when a contractor fails to complete a project, the costs incurred by the owner to complete the work are direct damages. Many times, direct damages are also measured by the costs necessary to repair or replace a contractor’s defective work.

Consequential or indirect damages are commonly thought of as losses or injuries that do not flow directly and immediately from the act of the party, but only from some of the consequences or results of such act. To be able to recover consequential damages from the breaching party, the damages must have been reasonably foreseeable at the time the contract was made. Typical examples of consequential damages include, among other things, lost rents, damage to reputation, down or idle time, interest and finance charges, loss of use of goods, additional labor costs, material escalation costs, depreciation, rental costs, additional energy costs, loss of productivity and efficiency and additional home office costs. The most common and perhaps most costly example of consequential damages in a construction dispute are lost profits.

Waivers of Consequential Damages

Contractual waivers of consequential damages between sophisticated parties are generally enforceable. However, a court will not enforce a waiver if it determines the provision is unconscionable, against public policy, or prohibited by statute. Consequential damages have become widespread throughout the construction industry. Indeed, since 1997, the AIA has included a mutual waiver of consequential damages in its standard General Conditions for Construction. However, under the AIA provision, whether a type of damage is consequential depends upon the position of the litigant. From the owner’s point of view, damages for rental expenses, loss of use, income and profit; damages relating to additional financing costs; damages to business and reputation; and damages for loss of management or employee productivity are consequential damages. From the contractor’s point of view, damages for principal office expenses, loss of financing, business and reputation; and loss of profit (other than anticipated profits arising directly from its work under the contract) are consequential damages.

Because the AIA’s waiver is not exclusive or project specific, a court or arbitrator must determine whether a particular damage not listed in the waiver is a consequential or direct damage. This presents a problem because no two courts define consequential damages in the same way. Many courts and arbitration panels have dismissed lawsuits without holding a trial, based on the presence of a consequential damages waiver. These courts and panels generally find that classification of damages is a legal issue for the courts and a trial is unnecessary where consequential damages are excluded by contract. Yet, some courts and arbitration panels take an opposite approach to waivers and hold a trial or hearing to decide whether certain categories of damages are consequential based on the premise that the precise demarcation between direct and consequential damages is a question of fact.

Courts’ Approaches to Consequential Damage Waivers

Courts take different approaches to consequential damage waivers. For instance, some courts, such as the court in Otis Elevator v. Standard Construction, dismiss claims based on waivers, even if the waiver does not define consequential damages. That court found a hospital’s delay damages from the faulty installation of elevators were barred by a waiver even though they were not specifically defined as consequential. 92 F. Supp. 603 (D. Minn. 1950).

The court in Niagara Mohawk Power v. Stone & Webster Engineering took an opposite approach. 1992 WL 121726 (N.D.N.Y. May 23, 1992). That court refused to dismiss any of a power plant’s damages against its piping contractor, leaving the recoverability of much of $88,000,000 in damages to be decided by a jury. Although the parties’ contract included a waiver, it did not define what they meant by consequential.

Moreover, the court in Roneker v. Kenworth Truck, dismissed a trucker’s suit against a manufacturer since the waivers included a detailed definition of consequential damages and the court determined whether the trucker’s damages were consequential without a trial. 977 F. Supp. 237 (W.D.N.Y. 1997).

Negotiating Consequential Damage Waivers

Including a clearly-worded, project-specific waiver of consequential damages in construction contracts has become critically important in today’s construction industry. By defining the scope of consequential damages in the contract itself, parties to a construction contract can increase the likelihood a court or arbitration panel will dismiss a claim or a large portion of a claim without a trial.

When defining the scope of a consequential damages waiver, it is important for both contractors and owners to carefully draft the provision in a way that will increase the odds that (i) the parties will not dispute what types of damages are recoverable under the contract; and (ii) if there is such a dispute, the waiver will be found to be enforceable. Both owners and contractors should avoid general boiler-plate “catch-all” consequential damages waivers that do not define what the parties mean by consequential damages. Waivers should be “project-specific” in that they should anticipate and define the potential types of damages that could arise with this project and ensure theyare clearly waived.  Moreover, the parties should ensure the waiver is mutual, i.e., the list of consequential damages should be the same for the owner and contractor.

While following these recommendations does not guarantee a dispute-free project, following them will minimize the chances of a prolonged litigation regarding what constitutes a consequential damage.

About the Authors

Jason L. Richey is a partner in the Construction and Engineering Practice Group in the Pittsburgh office of K&L Gates, LLP.  Mr. Richey maintains an active and broad litigation and arbitration practice concentrated in the areas of construction, real estate and commercial law.  He can be reached at [email protected].

William D. Wickard is of counsel in the Construction and Engineering Practice Group in the Pittsburgh office of K&L Gates, LLP.  His practice is concentrated in the area of complex commercial litigation with a strong emphasis on construction industry litigation.  He can be reached at  [email protected].

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