Consequential damages clauses can be difficult to negotiate in a contract. They are even tougher to litigate over since a lot of lawyers struggle with the definition, how to categorize the damage type, and proving the link between the breach and the calculation of damages. The distinctions can be mind-numbingly miniscule; but the outcomes that flow from claims for consequential damages are potentially catastrophic if you are on the losing side.
Consequential damages lawsuits are rare but can be devastating to the future of your company
References to consequential damages often appear in contract clauses attempting to limit the liability of a party. Limitation of liability clauses, which can be one-sided or mutual, often address indirect damages, liquidated damages, delay damages, consequential damages or other forms of damage. Because the law starts from the basic premise that any damage flowing from a breach is recoverable, these clauses generally limit (hence, the name of the clause) the amount or type of damages a party can recover.
The consequential damage category varies by type of project and how the contract defines it. A claim for one or more of these can result in a large unforeseen legal exposure.
Direct damages are the damages that result directly from the other side’s breach. This is most often the amount that has not been paid for the work performed or the amount paid for defective work. The term indirect damages is a loose term that covers all other forms of damage that lawyers refer to as consequential damages. While these damages can be traced back to the breach of contract, they were not part of the original benefit of the bargain. Stated differently, consequential damages are those that don’t represent direct reimbursement for the failure to meet the promises under the contract.
The disconnect relates to the large number of possible consequential losses that can occur and the difficulty parties have in both defining and quantifying them. Lost revenue or profits for late delivery of a project is a common example of a consequential damage. But if the contract made time of the essence, emphasized scheduling as part of the deal, put in place penalties for late delivery, and clearly shows that the parties contemplated project completion by a date certain for the owner to begin collecting revenue, the resulting damage may be more direct than consequential. Calculating lost revenue or profit and attributing it to the consequential damage in this example is also difficult since there are multiple forces in the market that could cause the same damage. For example, lost revenue at a manufacturing facility could be traced to increased material costs instead of late delivery of the project.
By way of additional examples, here are some other forms of consequential damages: loss of anticipated savings, excess carrying costs on loans, injury to reputation, lost business opportunity, loss of bonding capacity, business interruption, additional principal office expenses or rent, third party claims of breach and diminution in property value. The consequential damage category varies by type of project and how the contract defines it. A claim for one or more of these can result in a large unforeseen legal exposure. Even worse, the cost of litigating over such claims can be excessively high because of the difficulty of the proofs in this area.
Construction companies and their lawyers should consider practical ways to deal with these exposures before they start projects. Carefully review waivers of consequential damages before signing contracts. Making the waivers mutual to avoid one side having too much bargaining power at a later date is a good idea. Insurance coverages should also be reviewed to understand what is covered and what is not.
Next, be thoughtful and realistic about what consequential damages might result on a project and specifically call them out in the contract. In some cases, you might want to list them as being waived; and in others, you might want to specify that the parties do not consider them consequential damages and/or waived. This helps avoid the problems that arise from a generic waiver of consequential damages.
If and when you are in suit and the claim involves consequential damages, be realistic about the nature of the claim, the reality of proving causation and the challenges of computing the actual damages. This prevents the cost of making or defending a consequential damages claim from far exceeding any actual damages that might be awarded.
Consequential damages are often low on the priority list in contract negotiations. This is slightly understandable since they are hard to understand and rarely come into play when a dispute arises. The problem, however, is that the amounts in dispute are usually extremely high when they do become an issue. So, while the odds of a company being involved in such a claim are low, the odds of such a claim destroying a company if it is made are significantly higher. For this reason, move them up in your priority list when you are reviewing your contracts and evaluating claims.
Josh Quinter is a commercial litigation attorney, with a focus on construction law. He is also a member of the board of directors and a department chair at his law firm, Offit Kurman. Active in a number of construction trade and business organizations, he presently serves as the president of the Mid-Atlantic Chapter of the Metal Building Contractors & Erectors Association (MBCEA), serves on the MBCEA national board and is the organization’s general counsel. Contact him at jquinter@offitkurman.com or for more information, go to www.offitkurman.com/attorney/joshua-quinter.
