Waiver of Consequential Damages
Construction agreements can be lengthy. They often include terms covering everything from logistics for working on the project site to complicated provisions regarding intellectual property. Many provisions in a construction agreement deal with risk and who is going to pay for damage claims if or when they occur.
Because the waiver of consequential damages can significantly control the amount of damages for which a contractor is assuming risk and greatly limit the owner’s ability to recoup many damages, it is arguably the most important provision in a construction contract. Therefore, it is essential for contractors and owners to carefully consider the waiver of consequential damages before entering into any construction agreement.
What are Consequential Damages?
Generally, when the contactor has breached the construction agreement, the owner will have direct losses (e.g., cost to fix the work) and will have other indirect or consequential losses (e.g., lost revenue incurred during project down time). Whether or not a loss is consequential or direct is determined by state law, and unfortunately, there is no uniform approach among the state cases and statutes. What is a consequential loss to one judge may be a direct loss to another judge evaluating similar facts.
Historical Inclusion of Waiver of Consequential Damages
For the last 20 years, the most widely used construction general conditions (the AIA A201) have included a broad waiver of consequential damages where the owner waives its right to claim lost profits or loss of use damages caused by the contractor’s failure to perform. Contractors argue the AIA document’s approach is equitable because contractors’ fees are not sufficient enough to allow them to assume the risk of millions in lost owner profits if an unexpected event were to occur and the owner was damaged by delayed or defective contractor work. On the other hand, owners argue against this provision, noting that if a contractor fails to honor the agreement, the contractor should be responsible for all losses, including direct and consequential damages.
Modern Treatment – Proposed Owner Carve-Outs
Recently, many owners and their counsel have started proposing carve-outs to the waiver of consequential damages during contract negotiation. Owners say they will agree to the waiver of consequential damages, but not in connection with claims asserted against the contractor based on the contractor’s promises to indemnify in the agreement, the contractor’s gross negligence or willful misconduct, the contractor’s failure to pay taxes or liens, or the contractor’s breaches of the provisions relating to intellectual property and confidentiality. Some owners even try to limit the waiver of consequential damages so it does not apply to claims arising from breaches of warranty.
Agreeing to pay consequential damages for a narrow group of claims like those arising out of failure to satisfy liens or pay taxes (and arguably even claims arising from breach of confidentiality or intellectual property agreements) is tolerable because a contractor has more control over whether those claims occur (and the consequential damages flowing from those clams would presumably be less). Contractor delays and mistakes, however, including those leading to accidents or defective work, are more difficult to control.
In recent contracts, some owners have agreed to broadly waive consequential damages, but not for claims covered by insurance. Contractors can significantly control their risk, of course, by agreeing to limit recoverable consequential damages to those that are otherwise covered by insurance.
Detailed compromises vis-à-vis the waiver of consequential damages are likely to be commonplace in future construction agreements. Contractors and owners’ counsel are becoming increasingly wary of the risks assumed and transferred in the waiver of consequential damages, and have recognized its importance. Indeed, many counselors believe it is the most important provision, requiring a great deal of attention from all parties