Contractors: To Waive Or Not To Waive Consequential Damages?

A waiver of consequential damages is contained in many construction contracts. The American Institute of Architects (AIA), for example, has included a mutual waiver of consequential damages between the owner and contractor since at least 1997 and continues to do so today. (See, e.g., AIA A201-2007, at § 15.1.6). But what does such a waiver mean and is it a good thing for contractors to give up a right to recover consequential damages?

A little background on contract law is necessary. Generally, a party breaching a contract is only liable for damages that naturally or ordinarily flow from the breach. These damages are called "direct damages." For example, if a contractor installs a roof on a commercial building incorrectly such that the roof leaks and requires repair, the cost of investigating the leak and repairing it would be damages that naturally flow from the breach and would constitute direct damages.

Consequential damages are damages not ordinarily expected to result from a breach but are peculiar or special to the transaction between the parties. Courts award compensation for consequential damages only if both parties to the contract were aware of or contemplated these "special circumstances" at the time of the contract. Now, assume using the example above that the owner of the commercial building had a contract to sell the building at the time the leaking roof was discovered and lost the sale as a result. Any damages resulting from the loss of the sale would not be direct damages but would be special or particular to this business transaction and therefore consequential in nature and not recoverable unless the contractor and the owner contemplated a sale of the business at the time they entered the construction contract.

While I hope this example demonstrates the difference between direct and consequential damages, courts often struggle with determining whether a particular damage is direct or consequential. The AIA waiver of consequential damages provision is helpful because it gives examples of consequential damages for an owner and a contractor. Owner consequential damages under the AIA waiver include rental expenses, losses of use, profit, financing, business or reputation, and loss of management or employee productivity. Examples of consequential damages for a contractor include principal office expenses, losses of financing, business, and profit, except for anticipated profit arising directly from the contractor's work (which would be a direct damage). A well-drafted waiver of consequential damages should not be a generic waiver of "consequential damages" but should include descriptions or clarifications to avoid leaving a court to decide whether a particular type of damage is direct or consequential. As a rule, courts will enforce these waivers.

So, is it a good thing for contractors to waive their right to recover consequential damages? Consequential damages can be severe and substantial, often far outweighing any direct damages caused by a breach. And an owner's consequential losses often may be greater in magnitude than a contractor's on a given project. Because of this risk, in negotiating a contract, contractors should request that the owner waive recovery of consequential damages and should resist any effort to delete a waiver from the contract. By using a mutual waiver, each party is giving up a right to recover what might be substantial damages in the event of a breach, but in doing so, a contractor can put itself in the best position to control and manage risk and avoid potential substantial liability.