Consequential Damages and Liquidated Damages
One of the biggest risks contractors and subcontractors face on construction projects is liability for consequential and liquidated damages, although many of them may not even know about that risk, much less understand it.
Consequential damages are damages which flow indirectly from a breach of contract and are typically related to delays in performance and delays in completion of a project. The best way to think of such damages is in connection with an income-producing project such as a hotel, convention center, manufacturing facility, etc., from which an owner will derive revenue. If the project is not completed on time, the owner will lose the benefit of that revenue and the contractor and responsible subcontractors can face liability for that loss of revenue, i.e., consequential damages. Such damages can be significant. In fact, it can represent a bet-the-company risk.
Beginning in 1997, A201 included a mutual waiver of consequential damages provisions which today (2017 version) reads as follows:
15.1.7 Waiver of Claims for Consequential Damages
The Contractor and Owner waive Claims against each other for consequential damages arising out of or relating to this Contract. This mutual waiver includes:
.1 damages incurred by the Owner for rental expenses, for losses of use, income, profit, financing, business and reputation, and for loss of management or employee productivity or of the services of such persons; and
.2 damages incurred by the Contractor for principal office expenses including the compensation of personnel stationed there, for losses of financing, business and reputation, and for loss of profit, except anticipated profit arising directly from the Work.
Another modification would be to carve out from the waiver third party claims for indemnity or contribution. Again, this broadens consequential damages liability and perhaps the risk since such third party claims might not be covered by insurance.
Often times it is difficult to negotiate away entirely the risk of consequential damages (or liquidated damages – see below), but in contract negotiations owners, contractors and subcontractors must consider the level of risk one party assumes when it bears 100% of the risk of consequential damages. As a compromise, parties will often agree to cap consequential damages either at a specific dollar amount or a specific percentage based upon the contract value.
Liquidated damages (LDs) generally represent an attempt made at the contracting stage to estimate and then agree (liquidate) upon the amount of damages the owner will suffer in the event the project is not completed on time or certain milestones are not timely met. LDs can be low or they can be high.
While LDs may be known (liquidated), they can still add up such that, again, contractors and subcontractors should attempt to negotiate a cap on LDs. Some contractors are proud to say they negotiated LDs out of a particular contract. However, that contractor does not understand that by removing LDs, a known amount of damages for delay, it, perhaps unwittingly, threw itself into the unknown world of consequential damages. We are not saying one is better than the other, but contractors should understand each and the risks associated with each one.
How do evaluate your risks?
The risk of consequential damages and LDs generally relates to the failure to complete a project or achieve a milestone on time. When our clients are deciding how to manage the risk of incurring these damages, we advise them to look at the complexity of the project, the quality of the documents, the schedule and their contractual right to obtain time extensions. These and other factors can help you evaluate how much consequential or liquidated damages risk to take, if any. As noted at the beginning, many contractors and subcontractors enter contracts every day without even knowing the risks they face with respect to such damages. However, the risk is there and can be a silent killer. You should know, understand, and evaluate this risk on every project.