Client Alerts
January 23, 2007

Could You Be Held Responsible for Consequential Damages?

Stites & Harbison Client Alert, January 23, 2007

In a recent case a subcontractor thought that it was insulated from liability for any costs suffered by a general contractor beyond the bare, direct cost of correcting any defects with the subcontractor's work. It was not.

Construction owners often find themselves on the other side of the same coin . . . they are held liable for damages suffered by a contractor that don't seem at all related to the owner's project.

Could this happen to you?

What we are talking about here is something called "consequential damages" — not a direct cost over-run on a job-gone-wrong — but a cost that is a down-the-road, off-the-job consequence of that job having gone wrong.

Whether an owner or a contractor can recover its consequential damages is a function of the factual tie between the action that caused the job to go wrong and the consequential damages suffered and the precise wording of the written agreement between the owner and the contractor.

In the recent case referenced above, Dynamic Air, Inc. v. Downey, Inc., 2006 U.S. Dist. Lexis 54766, Dynamic Air, a subcontractor, thought that it was protected from all consequential damages that might be incurred by the general contractor and owner as a result of any defective performance on its part. It relied upon restrictive language barring recovery of consequential damages in a contract warranty provision.

In this particular instance, the project general contractor alleged that the warranty provision took effect only after the work was completed; but that the general contractor and owner suffered consequential damages before completion of the project. The judge reviewing a motion by Dynamic Air to throw out the general contractor's law suit, agreed that the language barring all consequential damages, restrictive as it was, only applied after work was completed, and ruled for the general contractor and against the subcontractor as to consequential damages incurred before contract completion.

So, in this instance, even though the subcontractor thought that it was protected it was not; and it may well have to pay.

If nothing in the contract addresses the possibility of recovery of consequential damages, then, under an ugly set of facts, both the owner and the contractor are both potentially at risk to pay the other such legitimate consequential damages as can be proven in court.

The Dynamic Air case is only the latest in a long line of cases that address consequential damages in a construction setting.

The law books are full of examples where contractors have recovered from owners for the consequences of job site delays that are not of the contractor's making. Examples of this variety of consequential damages include loss on the contractor's bonding capacity and decrease in the absorption of the contractor's home office overhead. To combat this species of consequential damages, owners often insert "no damage for delay" clauses in their contracts. The enforceability of these clauses varies from state to state depending upon the exact factual scenario that gave rise to the project delay.

On the other side of the coin we find Perini v. Great Bay Casino, Inc., 129 N.J. 479 (1992). Delay in opening an Atlantic City casino (actually, delay in completing a connector bridge linking the casino to the Board Walk) allegedly caused the casino owner to lose $14,500,000 in revenue (consequential damages — many times the value of the underlying construction contract — $600,000). A court in New Jersey affirmed an arbitration award holding the contractor liable to the owner for this sum.

The Perini case led the American Institute of Architects to enact a standard form "Mutual Waiver of Consequentical Damages" clause [Section 4.3.10] in its family of construction contract documents in an attempt to insulate future contractors and owners from liability for these sorts of recoveries. However, in our practice we have seen many contracts in which this clause has been significantly modified . . . modified in a manner that may place the protection and/or enforcement of the underlying intent of the AIA drafters in doubt.

What lessons are to be learned from all this? There are at least three:

  • Make sure that you understand what your contract says. If you don't understand it, don't sign it.
  • If your company can't live with what the contract says, don't sign the contract.
  • In most instances be certain that your contracts contain provisions that protect you from consequential damages. The one notable exception to this policy arises where an owner absolutely has to have its project up and running by a particular date and wants monetary assurance from the contractor that this date is met. This assurance is most frequently provided through a liquidated damages provision and not by a blanket indemnity for all consequential damages.
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Health Care - Construction