Risk Transfer: Understanding Potential Damages Due to Unexcused Construction Project Delays
In the event of an unexcused delay in the timely completion of a project, contractors may incorrectly assume that they can only be liable to the owner for one of three types of damages – actual, consequential or liquidated. However, a recent trend in construction contracts involves project owners attempting to transfer risk for delays to the general contractor through a combination of damages, carve-outs and creative definitions. Accordingly, it is as important as ever for contractors to understand the different types of damages that may be recoverable by an owner as a result of an unexcused delay and what contractors can do to identify and minimize their liability from these damages during contract formation.
From a contractor's perspective, the most recognizable and perhaps most straightforward type of damages for delay is liquidated damages. “LDs,” as they are colloquially referred to, are simply an agreement between the parties that predetermines or liquidates the amount of damages an owner can recover from the contractor if the project is late. Liquidated damages provisions generally allocate a fixed sum for each day that the contractor, without excuse, fails to achieve major milestones such as substantial completion, final completion or different phases of a project.
In order to be enforceable, liquidated damages must be specifically stated in the contract and must reasonably estimate the actual or anticipated damages contemplated by the parties at the time of contracting. If the stipulated amount is later determined by a court to have been unreasonable at the time of contracting, it will be viewed as a penalty and be considered unenforceable.
One of the common misconceptions about a liquidated damages clause is that, if included in a contract, it will render the owner unable to also recover actual damages from the contractor for an unexcused delay. Whether the owner is entitled to recover additional types of damages for delay above and beyond liquidated damages (e.g., actual, consequential or otherwise) is dependent on the scope of the liquidated damages provision.
What to Watch For:
A sophisticated owner may include a liquidated damages provision that carves out the assessment of other damages for delay or states that the stipulated liquidated damages are in addition to other types of delay damages. For example:
“The amount recoverable as liquidated damages hereunder is intended to compensate Owner solely for loss of use during the period of delay. Such liquidated damages shall be in addition to other consequential losses or damages that the Owner may incur by reason of such delays, such as, but not limited to, the cost of additional architectural and construction management services resulting from the delay, additional costs to the Owner for payments to other Contractors resulting from the delay, including acceleration costs by other Contractors to recover from the defaulting Contractor's delay.”
A less straightforward, more unpredictable and exponentially riskier form of damages is consequential damages. Consequential or special damages can best be described as indirect damages; i.e., damages that are not naturally linked to the breach of contract, but foreseeable at the time of contracting. Some of the more common examples of consequential damages include loss of use, lost rent, lost profits, loss of income, loss of reputation, loss of business and increased financing costs.
Given their expansive and unpredictable nature, it is entirely possible that consequential damages may far exceed an owner's direct or actual damages and, in some cases, the value of the contract itself. In the seminal consequential damages case, Perini Corp. v. Greate Bay Hotel & Casino, Inc.,1 an arbitration panel awarded a casino owner $14.5 million for lost profits against a contractor for its delay in the construction of a casino.
While the contract itself was for only $600,000, it did not contain a waiver of consequential damages provision (or a liquidated damages provision). The award was subsequently upheld by the Supreme Court of New Jersey concluding that based on the evidence submitted to them, the arbitrators could have concluded that the damages [lost profits] were reasonably foreseeable.
As mentioned above, consequential damages must be reasonably foreseeable or contemplated by the parties at the time of contracting.2 However, whether something is reasonable is entirely subjective (both as to the parties and to courts) and therefore contributes to the unexpected and unpredictable nature of consequential damages.
What to Watch For:
What makes consequential damages so concerning is that the absence of a consequential damages provision in a contract does not prevent an owner from seeking them. In other words, just because your contract may not specifically address or reference consequential damages does not mean that the owner is precluded from seeking and potentially being awarded significant consequential damages in the event of a breach.
Given the unique risks posed by consequential damages claims, it is imperative that a contractor understand at the time of contracting how the contract treats consequential damages.
Limiting Exposure During Contract Formation
In light of the different types of damages that can result from delay, it is important that contractors strive to limit their exposure to these types of damages during contract formation.
Establishing Modest Liquidated Damages Provisions
In an attempt to avoid the assessment of liquidated damages, a contractor's initial response may be to remove any liquidated damages provisions from their contract entirely. While seemingly a good idea, the removal of a liquidated damages provision is not without risk as it can leave a contractor liable for an unknown and potentially significant amount of delay damages in the form of actual and/or consequential damages.
Instead, a contractor may want to include a modest liquidated damages provision so that the specific dollar amount and overall risk factor from an unexcused delay is known. In addition, contractors can ensure that there is no ambiguity or carve-outs in the liquidated damages provision by including a clear and unambiguous statement that the liquidated damages are the owners sole and exclusive remedy for delay. For example:
“Notwithstanding any language to the contrary contained herein, Owner agrees that the liquidated damages setforth in this Section shall be the only damages recoverable by the Owner as a result of the Contractor’s failure to achieve Substantial Completion and/or Final Completion of the Work by the dates required by this Agreement.”
A further “belt-and-suspenders” approach is to state that the liquidated damages provision is in lieu of any other damages that may flow directly or indirectly from delay and that no other damages are recoverable. Finally, a well-drafted liquidated damages provision should make clear that the contractor will only be responsible for delays proximately caused by the contractor (and its subcontractors).
Creating a Mutual Waiver of Consequential Damages
Since the absence of a consequential damages provision does not necessarily protect a contractor from their assessment, contractors should always attempt to include a mutual waiver of claims for consequential damages in all their contracts. The importance of utilizing a mutual waiver of consequential damages cannot be understated. As mentioned above, consequential damages can be significant and, in some cases, may result in an award of damages well in excess of the value of the contract.
Moreover, since consequential damages are highly subjective, it is important to define what exactly may be considered consequential damages. Otherwise, an owner may try to recategorize certain damages as direct or actual damages and therefore not within the scope of a waiver of consequential damages provision. A good example is contained in Article 15 of the AIA A201-2017 General Conditions of the Contract for Construction:
The Contractor and Owner waive Claims against each other for consequential damages arising out of or relating to this Contract. This mutual waiver includes:
- 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
- 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.
Given the subjectivity of these types of damages, and the inconsistent rulings by courts, it is extremely helpful to include a definition of consequential damages to assist the parties (and the court) in any potential contract interpretation issues.
Limitation of Liability
During contract negotiations, consider adding a reasonable absolute cap on the maximum amount of damages recoverable by the owner as an additional provision. Such a provision is helpful to a contractor where an owner will not agree to a waiver of consequential damages and/or a modest per diem liquidated damages provision. These caps can be specific as to the type of damages (consequential or liquidated) or can even be stated as a cap on any and all damages in the aggregate. The following is an example of a damages cap provision:
“Contractor shall be liable for delay damages sustained and proven by Owner as a result of any unexcused delay caused by any action of Contractor, provided, however, that Contractor’s liability for all delay damages, actual, liquidated and/or consequential, shall in no event exceed $________ in the aggregate.
The importance of risk management during contract formation cannot be understated, particularly when it comes to damages for delay. The failure to consider this risk and to include language that mitigates the potential damages can prove to be disastrous for an unsuspecting contractor.
1Perini Corp. v. Greate Bay Hotel & Casino, Inc., 129 N.J. 479, 610 A.2d 364 (1992)
2 24 Willistonon Contracts § 64:12 (4th ed.).
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