Construction Contracts from a Surety’s Perspective: Limiting Your Exposure for Consequential and Liquidated Damages

by Jase Hamilton, AFSB, Cavignac & Associates
Jase Hamilton-resized A common provision in construction contracts allows for the “upstream” party to be entitled to damages if the contracting party doesn’t perform to the agreed contract terms. These recoverable damages are often referred to as consequential and liquidated damages. There are big differences between consequential and liquidated damages. Watch out: sureties are very sensitive to both. Consequential Damages Consequential damages in a contract are additional damages which compensate for losses that don’t result from the ordinary course of events in performing the contracted work, but were “foreseeable by the party in breach because of special circumstances that he had reason to know when he made the contract.”1
While consequential damage claims on construction projects typically arise out of delayed completion of the project, they can also arise because of other contractual breaches.From an obligee’s perspective (i.e. owner, GC or upper tier subcontractor), consequential damages may include:

  • loss of use damages
  • lost profits
  • increased interest expense
  • diminution in value
  • lost rent income

From contractor’s perspective, consequential damages may include:

  • extended home office overhead
  • lost profits
  • loss of bonding capacity
  • professional reputation

Taking into consideration both the obligee’s and the contractor’s perspectives, it’s easy to understand why consequential damages can, and often do, exceed the direct damages suffered.

Waiving Consequential Damages

Sureties will often advise their principal contractors to limit the consequential damage exposures by incorporating a “mutual waiver” of the consequential damages clause in their contact. An example of such a clause is found in AIA Document A201-1997, General Conditions, Article 4.3.10:

§4.3.10 Claims for Consequential Damages. The Contractor and Obligee 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 Obligee 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.

This mutual waiver is applicable, without limitation, to all consequential damages due to either party’s termination in accordance with Article 14. Nothing contained in this Section 4.3.10 shall be deemed to preclude an award of liquidated direct damages, when applicable, in accordance with the requirements of the Contract Documents.

Although this is a standard mutual waiver of consequential damages clause, the addition of such a clause could result in partial or even no reimbursement to the contractor in the event the obligee defaults. Therefore, in order to avoid any misinterpretation of the clause it is extremely important that the contractor consider limiting the scope of the waiver by describing exactly the types of consequential damages being waived.

It is often times easier to obtain a partial waiver from the obligee. Therefore, an alternative approach to consider is limiting the waiver so that the obligee only waives their right to recover consequential damages to the extent those damages are not covered by insurance. If the obligee is unwilling to waive consequential damages entirely, another option is to negotiate a dollar cap on the total consequential damages exposure.

Liquidated Damages

A more commonly used method for assessing damages on construction projects is to incorporate a liquidated damages clause into the contract. Typically, a liquidated damages clause sets a defined, previously agreed upon dollar amount that the aggrieved party may collect for each day of delay. The advantage of a liquidated damages clause is that it alleviates the need for an analysis of which damages are reasonably foreseeable.

Although liquidated damages are preferable to consequential damages, sureties strongly recommend negotiating a cap on the total amount of delay damages recoverable under a contract. On some projects, the daily amount recoverable as liquidated damages is so substantial that the continued viability of the contractor could be in jeopardy if significant delays occurred for which the contractor is responsible.

Summary

The most effective way for a contractor to limit their exposure for consequential and liquidated damages is to incorporate a “Mutual Waiver of Consequential Damages and Liquidated Damages” clause in their contract. It is also recommended that the contractor negotiate for a reasonable cap on the total amount of delays and consequential damages recoverable from the principal contractor in the event it breaches its contract. This cap should be an amount that the contractor can financially absorb without putting the contractors entire company at risk. As always, when evaluating legal contracts it is recommended to review all terms & conditions with the appropriate legal counsel.

1Restatement (Second) of Contracts §§ 351(1), (2) (b) (1979) – U.S Common law