There is some confusion in construction about the terms “liquidated damages” and “consequential damages,” so brief definitions are in order:
- “Liquidated damages” (sometimes called “stipulated damages”) are damage amounts the parties designate in the contract for the injured party (Owner) to collect as compensation for breach of contract, and are sometimes tied to project completion or milestone dates.
- “Consequential damages” are losses that do not flow directly and immediately from the breach of contract, but result indirectly from the breach. For example, in hotel construction, if the hotel does not open on time, consequential damages could be the revenue lost by the hotel operator.
A contractor should be aware of the relationship between liquidated damages and consequential damages.[i] These concepts are mutually exclusive. Owners should provide for one or the other, but not both. Liquidated damages are essentially a type of consequential damages, but are intended to provide certainty by removing the difficulty of proving damages. Generally, liquidated damages should replace consequential damages, not supplement them.
From a contractor’s point of view, liquidated damages are preferred over consequential damages because its exposure to liquidated damages is limited to a known amount, whereas “the sky is the limit” with consequential damages. For more, read Another “New” Building Bites the Dust / Consequential Damages. For example, if a hotel or casino’s opening is delayed due to construction impacts on a project and the profits are lost for an indefinite period of time, the contractor’s exposure to consequential damages can be astronomical. Generally, from the contractor’s point of view, it would be best to have a waiver of consequential damages and preclude liquidated damages in their entirety. However, when faced with a choice of whether to take liquidated damages or consequential damages, the contractor in some cases should opt in favor of liquidated damages.
- 1. Waiver of Consequential Damages
- Section 15.1.6 of American Institute of Architects (“AIA”) A201 – 2007 form contains a mutual waiver of liquidated damages as follows:
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 [specific waiver of damages listed]. 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 should be deemed to preclude an award of liquidated damages, when applicable, in accordance with the requirements of the Contract Documents.
This mutual waiver makes sense since all parties are giving up something substantial. For owners, it is the loss of use of the property, profits that might have been earned, carrying costs, etc. For contractors, it is the office overhead expenses, financing, loss of profits on other jobs a contractor might have been awarded, etc.
It should be noted that some courts fail to give the AIA waiver language full effect. Accordingly, it is good practice to modify the clause as follows:
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 [specific waiver of damages listed]. This mutual waiver is applicable without limitation, to all consequential, indirect, special, punitive or exemplary damages of any kind, whether due to or based upon delay, contract, tort, negligence, strict liability, warranty, indemnity, error and omission or any other cause whatsoever whether the contract is terminated or not, due to either party’s termination in accordance with Article 14. Nothing contained in this Section 15.1.6 should be deemed to preclude an award of liquidated damages, when applicable, in accordance with the requirements of the Contract Documents.”
The AGC ConsensusDocs Fixed Price contract, Form 200, contains a similar waiver of consequential damages. For subcontractors, where the general contractor has been unable to secure a mutual waiver of consequential damages, it typically still makes sense for the general contractors and subcontractors to include waivers of consequential damages each might claim against the other.
- 2. Liquidated Damages
- Liquidated damages can be a contractor’s friend. However, most contractors’ initial reaction to the notion of including liquidated damages in a contract is negative. From a legal standpoint, however, if a project does go wrong and comes in substantially later than anticipated, a well-drafted liquidated damages clause limits the contractor’s exposure. For more, read Limiting Contractors’ Exposure to Delay Damages – Part 1. A liquidated damages clause should accomplish the following:
- Limit the liquidated damages to a reasonable amount;
- Set a cap on the amount of liquidated damages, e.g. 50% of the general contractor’s fee; and
- Make the liquidated damages the “sole and exclusive” remedy for late completion.
Comment: Although Contractors are typically sensitive to liquidated damages provisions, including a reasonable liquidated damages amount and waiver of consequential damages can actually limit the Contractor’s exposure.
[i] Thank you to Dan McLennon for bringing this issue to our attention. See “Disarming a Dozen Dangerous Subcontract Clauses,” The Contractor’s Compass, April 2015.