The Construction Industry During a Pandemic—Will there be a shift to focus on consequential damages?
Somewhat counterintuitively, consequential damages are damages which flow indirectly from a breach of contract. In a construction project, these damages are typically related to delays to the performance or completion of a project. By way of example, in the construction of a restaurant, if the project is delayed and not completed on time, the owner will lose the benefit of its expected revenue and the contractor can be subject to liability for the loss of that revenue—these are consequential damages. As can be imagined, these damages can be quite substantial (and attractive to owners looking to protect themselves during the COVID-19 pandemic, whose long-lasting effects are still unknown).
To limit the risk of being hit with a large consequential damages claim, the parties to a construction contract typically agree to a mutual waiver of consequential damages provision. Such language can be found in standard AIA contract documents.
Limiting liability with a cap on consequential damages
During this pandemic, parties may find it difficult to negotiate away the risk of consequential damages entirely. However, owners and contractors must consider the level of debt one party assumes if it bears 100% of the risk of consequential damages. During contract negotiations, the parties should agree to a compromise, whereby the parties will agree to cap consequential damages either at a specific dollar amount or a percentage based upon the contract value. The idea behind a cap is to limit the liability to the contractor’s fee or profit, rather than having the contractor come out of pocket to fund liability for consequential damages—such risks would discourage contractors and negatively impact the construction industry as a whole.
Interplay with liquidated damages
Liquidated damages (“LDs”) are an attempt by contracting parties to estimate and agree upon the amount of damages the owner will suffer in the event the project is not completed on time. LDs can range from hundreds of dollars a day to thousands, but in no event can LDs be so high as to constitute a penalty (which would be unenforceable under the law). LDs must bear some relationship to the damages the owner would suffer from delayed project completion, and are meant to replace consequential damages and thus mitigate this unknown risk. While there tends to be an aversion to LDs, at least it is a known amount in the event of a delay as opposed to an unknown and unlimited consequential damages amount.
Similar to consequential damages, contractors should attempt to negotiate a cap on LDs. Contractors should also be mindful that if LDs are negotiated out of a contract entirely, they are essentially opening themselves up to unknown liability for consequential damages. Contractors need to understand each type of damage and the risks associated with each one.
How does one evaluate these risks?
Many contractors enter into contracts without ever knowing the risks they face with respect to consequential and liquidated damages. In evaluating these risks, it is important to look at the complexity of the project, the project schedule, and the rights of the contractor to obtain time extensions. The experienced construction attorneys at Haber Law can assist clients who are deciding how to manage the risks of these damages.
About the Author: Kristina Puente concentrates her practices in the areas of construction law and complex business and commercial litigation. Kristina has experience representing owners, contractors, subcontractors and sureties in state and federal construction dispute, arbitration and bid protests.