Consequential Damages Provisions in Construction Contracts: Legal Issues (2022)

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NCHRP LRD 88 3 CONSEQUENTIAL DAMAGES PROVISIONS IN CONSTRUCTION CONTRACTS: LEGAL ISSUES Polly Jessen, Riley Cutner-Orrantia, Brandon Rattiner, and Diane Sung, Kaplan Kirsch & Rockwell LLP, Denver, CO; and Adam Giuliano and Emily Eads, Kaplan Kirsch & Rockwell LLP, New York, NY INTRODUCTION When a construction contract is breached or liability is allo- cated in accordance with its terms,1 through an indemnity pro- vision, for example, three types of damages are generally impli- cated: (i) direct or general damages; (ii) punitive damages; and (iii) indirect, special, or consequential damages. Consequential damages are generally dened as reasonably foreseeable indirect losses arising from a breach. Common examples include lost prots, loss of use of a facility, and damages related to third- party claims. Consequential damages oen are dicult to cal- culate in advance, given the unpredictable and idiosyncratic nature of indirect losses. While consequential damages can arise under many types of contracts, they are especially relevant to public transportation construction projects. e nature of required contractual per- formance in these projects, and these projects’ visible and im- portant context, both substantially increase the likelihood and magnitude of potential claims. Accordingly, parties to a public transportation construction project should consider how conse- quential damages may arise in the context of a particular project, and how they should be addressed through the contract’s terms. Parties can seek to limit or assign liability by including a clause to preclude or condition recovery of consequential damages— i.e., indirect losses “fairly and reasonably” arising from the breach of the contract. As a result, consequential damages are oen restricted in public transportation construction contracts in order to limit a state department of transportation’s (DOT)— and sometimes construction contractors’—exposure to poten- tial liability. Draing, negotiating, and applying such consequential damages provisions benets from a broader understanding of the issues involved because potential consequential damages claims are not something that can, or should, be simply toggled “on” or “o”. Instead, parties should consider various legal and commercial issues associated with limiting consequential dam- ages provisions in public transportation construction contracts. Without proper consideration and tailoring to ensure tness for purpose, consequential damages provisions that are too rigid or leave either party too exposed can derail or adversely impact pricing, bids, or negotiations. e objective of this research is to produce a digest of con- sequential damages law and to discuss how that law shapes the draing of provisions in public transportation construc- tion contracts that mitigate the risk of consequential damages awards. e digest discusses both relevant law and emerging 1 For clarity’s sake, this report usually groups both kinds of actions together under the umbrella term “breach.” practices and trends. It concludes with a checklist of consider- ations that parties—particularly state DOTs—should consider when draing or analyzing consequential damages provisions. I. UNDERSTANDING CONSEQUENTIAL DAMAGES is section introduces the distinction between direct and consequential damages in contract law and describes how the types of losses most common in public transportation construc- tion disputes are conventionally categorized. Next, it discusses how industry seeks to mitigate the risk of consequential dam- ages awards through certain provisions in model forms. Finally, it discusses how federal and state law bears on such provisions, and on consequential damages more broadly. A. What Are Consequential Damages? Damages are a legal remedy awarded to redress an injury. In a contract dispute, a party that has breached a contract may be required to pay damages to the non-breaching party. e amount of damages owed, under general principles of contract law, are meant to put the harmed party “in as good a position as he would have been in had the contract been performed, that is, had there been no breach.”2 is amount can be calculated various ways. It may be expressly stipulated in the liquidated damages provision of the breached contract, it may be derived from established statutory or common law principles, or it may be derived from some combination thereof. Regardless of the methodology used, calculating damages can be dicult. e directive to restore a party to the posi- tion they would have been in absent the breach encourages extrapolation and conjecture. Contract law is therefore always striving to further rene what damages are and are not recov- erable. At the most general level, contract law principles set boundaries on recovery that apply to every case equally. For example, damages must be proven with reasonable certainty, they must be the proximate result of the breach (or any other contractually dened event giving rise to a claim for damages, such as an indemnity), and they must be foreseeable.3 Contract law principles also operate on the level of individual cases. Spe- cically, contract law categorizes the damage caused by a breach as either direct or consequential, and in some instances, limits recovery to only certain categories of damages. 2 Restatement (Second) of Contracts § 344 cmt. a, Am. L. Inst. (1981). 3 See, e.g., Hadley v. Baxendale, 156 Eng. Rep. 145, 151 (Ex. Ch. 1854) (establishing the foreseeability doctrine).

2 NCHRP LRD 88 CONTENTS Introduction, 3 I. Understanding Consequential Damages, 3 A. What Are Consequential Damages?, 3 B. Mitigating the Risk of Consequential Damages Awards rough Consequential Damages Provisions, 6 C. Legal Considerations Bearing on Consequential Damages Provisions, 9 II. Consequential Damages Clauses and Draing Issues, 11 A. Benets of Including Consequential Damages Clauses, 11 B. Challenges of Including Consequential Damages Clauses, 11 C. Considerations When Draing Consequential Damages Clauses, 12 III. Consequential Damages Clauses in Practice, 13 A. Examples of Consequential Damages Provisions in DOT Contracts, 13 B. Trends in Consequential Damages Clauses, 14 IV. Conclusions and Future Considerations, 16 Appendix A: Comparison of Consequential Damages Provisions, 17 Appendix B: Terms from Consequential Damages Provisions, 20