This is the second post in the four-part series “Limitations of liability—The Elephant in the Room.”
Waivers of consequential damages have become the industry standard, and these clauses are found in most industry templates. Let’s pick on the AIA form, since it’s still the most commonly used on commercial construction projects. The AIA A201 General Conditions, § 15.1.6, states:
§ 15.1.6 CLAIMS FOR CONSEQUENTIAL DAMAGES
The Contractor and Owner 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 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
.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 15.1.6 shall be deemed to preclude an award of liquidated damages, when applicable, in accordance with the requirements of the Contract Documents.
The origins of this clause in the construction setting are often traced back to a New Jersey case called Perini Corporation v. Great Bay Hotel and Casino, Inc., involving the construction of a casino in Atlantic City. The casino owner won $14.5 million in lost profits in an arbitration against the contractor on what was originally a $16.8 million GMP project. The New Jersey Supreme Court affirmed the arbitrator’s decision. The AIA and other industry groups reacted almost immediately by adding a clause to their contract forms, like the one above, purporting to waive “consequential damages” that may be claimed by either party arising out of the contract.
Although the clause is identified as a “mutual waiver,” the waiver as it applies to the contractor is extremely limited and the clause is clearly intended to protect contractors against claims such as those raised by the owner in the Perini matter. It’s a noble concept. No contractor wants to accept the risk that any one breach could lead to the financial ruin of its company. But does this clause, and others like it, go too far in the other direction? Let’s play out the typical conversation when an owner client sends me the AIA form:
Owner: “The contractor sent me this AIA contract. He tells me it’s industry standard and doesn’t need any changes.”
Attorney: “The AIA forms are certainly good starting points, and have been well-vetted by the industry. But there are a couple of standard terms that you should review carefully before signing. For instance, have you considered what ability you have to recover your losses if the contractor delays the project?”
Owner: “Well, I assume we would have the right to recover from the contractor for losses caused by his delay.”
Attorney: “Maybe not. The AIA General Conditions bar an owner from recovering “rental expenses, for losses of use, income, profit, financing, business and reputation, and for loss of management or employee productivity” in that scenario, even if the contractor caused those losses. That’s a pretty broad waiver, and it includes most, if not all, damages you would likely suffer if the project falls behind schedule.”
Owner: “Who pays for those losses if the contractor is behind schedule?”
Attorney: “If it’s not the contractor, I assume that it’s you.”
Owner: “That’s not what I intended. How do we address this?”
Attorney: “Have you considered liquidated damages? They would add back some of what this this clause takes away, and allows the parties to fix the per diem damages that the contractor would owe for failing to meet the project schedule. You could even cap the amount if you want.”
Owner: “The Contractor will never agree to liquidated damages at this point. They didn’t account for liquidated damages in their bid.”
Attorney: “I’m sure the contractor didn’t specifically plan for a delay, but I don’t think the contractor bid the project on the assumption that he would have no exposure to you if he failed to perform. We can strike the waiver clause, or customize it in some fashion, like selecting certain delay damages that you could recover for a contractor delay, such as extra rent or added financing costs. And if the contractor is insured for any of your losses from the delay, or if they result from intentional or other egregious misconduct, I doubt he would argue that he shouldn’t be responsible. It is usually easier to approximate those losses up front through a liquidated damages clause, so that everyone understands their exposure. Also, once liquidated damages are set, the contractor can pass this particular exposure through to his subcontractors, to the extent that they cause the delay.”
Owner: “I guess we need to have a conversation. This won’t be easy.”
The owner is right. These are hard conversations, but they are made all the more difficult if these issues do not arise until the eve of contract signing. The owner and the construction team need to understand the extent of the exposure if the project is late due to circumstances in which the contractor is responsible. The contractor needs some motivation and should have some responsibility if it fails to deliver the project on time, but the owner can’t reasonably expect a contractor to take on a project that could lead to financial ruin over common negligence.
Neither party should rely blindly on standard industry forms to define what losses are recoverable in the event of breach. A project owner should analyze its potential exposures as part of its overall business plan for the project. From there, any RFPs or invitations to bid should include a form of contract that clearly defines the contractor’s exposure in the event that he fails to honor his obligations. Factors such as insurance, the nature of the conduct leading to the loss, and the nature of the damages that may be suffered should all be taken into account. Not an easy conversation, but better for both parties if these issues are confronted up front.