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

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NCHRP LRD 88 13 deciding whether to include a consequential damages carveout, draers should consider whether the contract’s indemnication provision wholly or partially invalidates the potential waiver. If there is a breach of contract where the indemnication provi- sion allows for a party to recover indirect and direct damages, and the consequential damages waiver excludes the indem- nication provision, then the recovering party may be able to successfully seek indirect damages for claims under the indem- nication provision (including non-third-party claims). When considering whether to include an exclusion for an indemnica- tion provision, it is best practice to (i) limit the indemnication to third-party claims, and (ii) exclude indirect damages relating to direct damages claims when the indemnication includes direct damages claims. Similarly, there is no practical benet in an owner requiring, and paying for, a contractor’s insurance coverage to have a policy that covers consequential damages that are waived. It is therefore necessary to ensure that costs recoverable by insurance are carved out of the denition of consequential damages to the extent con- sequential damages are waived by contract. If they are not, an owner should consider lowering the required coverage, condi- tional on this not diminishing the owner’s own coverage. 5. Liquidated Damages to Recover Consequential Damages Liquidated damages provisions are common to construction contracts. ey authorize compensation payable to a contracting party, typically the owner, for the cost associated with delay of project completion. Liquidated damages are quantied and set out in the contract at the outset and must represent a true cost of the delay to the owner, measured in units of time, which in some way serves as a substitute for actual damages. Oen, a liquidated damages clause provides that the damages described therein are the exclusive remedy to breach or other liability-arising events. Accordingly, these provisions oen encompass consequential damages or limit their recovery, thereby rendering other conse- quential damages provisions superuous. Although this might be advantageous to an owner who can then avoid litigating a consequential damages claim, it may result in the owner’s recov- ery being limited if they anticipated further recovery. III. CONSEQUENTIAL DAMAGES CLAUSES IN PRACTICE is section provides an overview of dierent kinds of conse- quential damages provisions in major transportation construc- tion projects, based on a comparative analysis of those most oen used by dierent state DOTs. Specically, it examines and contrasts the draing practices of several state and federal enti- ties with regard to consequential damages. A. Examples of Consequential Damages Provisions in DOT Contracts Including consequential damages provisions in construction contracts is a recommended practice for the reasons described above. Still, how state DOTs approach consequential damages right-to-contract by voiding terms deemed against public policy or unconscionable. Waivers of consequential damages that limit liability too severely are susceptible to arguments that they run afoul of public policy. erefore, an eective consequential damages provision should not only provide a clear denition of consequential dam- ages but should also specify what is excluded from the waiver. Having express exceptions can help ensure that the waiver will be enforceable. Such express exceptions oen include dam- ages arising from third-party claims that are covered by an indemnication or arising from fraud, intentional or reckless misconduct, or breach of condentiality on the part of the third party.86 For example, a party may seek to exclude remedies to redress breaches of condentiality from a waiver because redressing such harm is almost impossible to do through direct damages—monetary damages are oen inadequate compensa- tion for a condentiality breach. Failing to carve this out of a mutual waiver, therefore, essentially prevents the party that suf- fered the breach from being made whole. 3. Overbroad Clauses Given the diculty of distinguishing direct from conse- quential damages, draers should aim to create a bright line between the two categories by clearly dening consequential damages within the contract. Overbroad clauses, such as com- plete waivers, may limit the recovery of certain direct damages, whether intentionally or unintentionally. For example, contract breaches oen cause lost prots, but as discussed above, those losses could be classied as either direct or consequential.87 In Imaging Systems International, Inc. v. Magnetic Resonance Plus, the contract at issue included a mutual limitation of liability provision preventing either party from re- covering “any lost prots,” with no exceptions provided.88 e court explained that there can be two types of lost prots, stating that consequential damages may include “prots which might accrue collaterally as a result of the contract’s performance,” and that direct damages may include “prots necessarily inherent in the contract.”89 As a result, the court concluded that no lost prots, whether consequential or direct, were recoverable under the contract.90 4. Interplay with Limitations on Liability Caps and Insurance Indemnication clauses can invalidate limitations on conse- quential damages or vice versa. erefore, parties must consider the interplay between these provisions. For example, when 86 Understanding Damages Waivers: Consequential, Incidental, Lost Prots and More, Practical Law Commercial Transactions (July 8, 2014). 87 Viastar Energy, LLC v. Motorola, Inc., 2006 U.S. Dist. LEXIS 78331, at *7 (S.D. Ind. Oct. 26, 2006). 88 Imaging Sys. Int’l v. Magnetic Resonance Plus, 227 Ga. App. 641, 644, 490 S.E.2d 124, 127 (1997). 89 Id. at 643-644 (quoting Franklin v. Demico,179 Ga. App. 775, 779, 347 S.E.2d 718, 721 (1986)). 90 Id. at 644.

14 NCHRP LRD 88 developer for the construction and operation of the US36 man- aged roadway lanes: Except as expressly provided in this Contract to the contrary, neither party shall be liable to the other for any punitive, indirect, inciden- tal or consequential damages of any nature, whether arising out of a breach of this Contract, tort (including negligence) or other legal theory of liability.91 is waiver seeks to minimize the risk to the parties of con- tracting for the potential of unknown and unlimited damages. e waiver may prevent a party from seeking all costs owing from breach, but this risk is counterbalanced by the increased certainty that the counterparty cannot recover consequential damages of an unknown—and potentially large—amount. Parties will commonly include mutual waivers in contracts to avoid exposure to these unknown potential costs. b. Trends e tables in the appendices also reveal important trends in the use of mutual waivers. First, many state DOTs waive conse- quential damages only in contracts relating to a specic project. None of the standard specications packages contain mutual or single party waivers. Of the ten project-specic contracts that waive entitlement to consequential damages, seven do not expressly dene consequential damages. All but one includes carve outs to ensure that particular losses remain recoverable. ese carve outs are common across all: (i) losses that are cov- ered by insurance proceeds; and (ii) losses arising from fraud, recklessness, or extreme negligence. Notwithstanding this trend, failing to dene consequential damages could be costly in instances where the court or a jury determines a disputed cost was direct and therefore not subject to the waiver of consequential damages. e courts have sug- gested as much in noting that a “laundry list of precluded dam- ages” can be put in a contract to avoid such a situation.92 Carving out losses covered by insurance proceeds, however, ensures that the owner does not lose the benet of the contractor’s insurance, oen procured specically for the project. e dierences in approach between project-specic con- tracts and standard specications for construction may result from negotiation. Project-specic contracts are negotiated by the parties and are typically for larger, more complex undertak- ings with signicant amounts of risk and cost involved. ese projects attract larger market participants, in some cases even joint ventures, who may be in a stronger position than a smaller contracting entity to absorb the risk of such a waiver. ese larg- er projects typically have a more signicant risk prole, and the potential for larger consequential damages claims that comes with such, necessitating the need to eliminate claims for con- 91 Amended and Restated Concession Agreement for US36 and the I-25 Managed Lanes, Colorado High Performance Transportation Enterprise and Plenary Roads Denver LLC., 131 (Feb. 25, 2014), https://www.codot.gov/programs/ctio/projects/us-36/us-36-phase-ii/p-3/ us-36-public-private-partnership-executed-concession-agreement/ amended-and-restated-concession-agreement.pdf. 92 Pharm. Prod. Dev., Inc. v. TVM Life Sci. Ventures VI, Ltd. P’ship., 2011 Del. Ch. LEXIS 33, at *26 (Del. Ch. Feb. 16, 2011). varies. State DOTs most oen use three kinds of consequential damages provisions: (i) mutual waiver; (ii) limitation of liability for payment of consequential damages, which may be dened or le undened, as well as separately limiting liability for payment of prot, anticipated prot, and/or indirect costs of any nature; or (iii) excluding anticipated prots from any contract adjust- ment and/or damages claim. is study has analyzed a broad range of the “standard specications” of each state DOT. ese standard specications are contract provisions that are a suggested starting point for construction projects. Each project will typically present these documents to the market at bid stage, with some modications as necessary to reect the risks and opportunities of each unique project, as applicable. During the bid phase, these documents are negotiated to arrive at the nal contract. Appendix A provides a summary of the consequential dam- ages provisions contained in a range of contract documents, across a broad range of transportation entities. Appendix A breaks down the consequential damages clauses into the follow- ing categories: • Contract Type: is category identies whether the docu- ment is a standard specication document, unspecic to any project, or a contract negotiated for a specic project. • Mutual Waiver: is category identies whether the docu- ment contains a mutual waiver of consequential damages. • Limitation of Liability: is category identies certain losses that the DOT has disclaimed and will not be liable for. • Scope of Consequential Damages: is category identies contracts where the DOT has dened consequential dam- ages to include certain kinds of losses. • Consequential Damages Carve Outs: is category identi- es contracts where the DOT has dened consequential damages to exclude certain kinds of losses. Appendix B identies the terms of those provisions in greater detail. B. Trends in Consequential Damages Clauses Based on the analysis described in the previous section, this report identies a number of important trends in various state DOTs’ approaches to consequential damages provisions. An ex- ample of each kind of provision, and a discussion about trends related to that provision, follows. 1. Mutual Waivers Provisions a. Example A typical form of waiver is included in the concession agree- ment between the Colorado High Performance Transportation Enterprise, a division of the Colorado DOT, and the private

NCHRP LRD 88 15 sequential damages at the outset. Smaller, less complex projects may not present the potential for signicant consequential dam- ages, negating the need to waive them completely. 2. Limitation of Liability for Consequential Damages and Scope of Consequential Damages Provisions ese two provisions are closely related. Limitation of liability provisions identify certain losses that are not deemed consequen- tial, and scope of damages provisions further denes what losses can be counted as consequential. Some specications packages limit consequential damages without then dening them. a. Example e Arkansas State Highway and Transportation Depart- ment’s Standard Specications for Highway Construction in- cludes an emblematic example of a provision limiting liability for consequential damages. Specically, it removes liability for anticipated prots, providing that “claims shall be in sucient detail to enable the Engineer to determine the basis for entitle- ment and the costs incurred, excluding loss of anticipated prots, organization or overhead expenses not related directly to the project, or interest.”93 b. Trends Of the 51 DOTs, 33 limit DOT liability for consequential damages in their standard specications, while 14 do not. Of the 14 states that do not limit liability for consequential damages, 12 do limit liability for anticipated prot. Of the 33 re- maining states and the District of Columbia that do limit liability for consequential damages, two-thirds dene consequential damages in the same way, as including, but not limited to: (i) loss of bonding capacity; (ii) loss of bidding opportunity; and (iii) insolvency. Only ve of the 51 DOTs do not limit liability for prot and/ or anticipated prot. is limitation is separate from the limita- tion on consequential damages. is approach would appear to provide some certainty to the parties in respect to a signicant liability that may or may not be limited by waiver of, or limita- tion on, consequential damages.94 On their own, these limitations do not dene consequen- tial damages specically enough to necessarily avoid litigation. However, these three categories of consequential damages are arguably the broad categories of losses that would have the most signicant costs associated with them, along with lost prot, which is discussed below. 93 Ark. State Highway and Transp. Dep’t., Standard Specifi- cations for Highway Construction, 62 (2014). 94 See the contrasting approaches in Tenn. Gas Pipeline v. Technip United States Corp., 2008 Tex. App. LEXIS 6419 (Tex. App. Aug. 21, 2008) and Cherokee Cty. Cogeneration Partners, L.P. v. Dynegy Mktg. & Trade, 305 S.W.3d. 309 (Tex. App. 2009) (where the distinction appears to be whether or not anticipated profit drawn from sale of energy produced by a successfully delivered project was contemplated by the contract between the parties, or whether it was incidental to it). 3. Consequential Damages Carve Out Provisions a. Example e concession agreement between the Texas DOT and the private developer for the construction of the SH288 toll lanes includes more detail than a generic mutual waiver by excluding certain losses as consequential damages: Notwithstanding any other provision of the CDA Documents and except as set forth in this Section 29.4.13, to the extent permitted by applicable Law, Developer shall not be liable for punitive damages or special, indirect, incidental or consequential damages, whether arising out of breach of this Agreement or the Lease, tort (includ- ing negligence) or any other theory of liability, and TxDOT releases Developer from any such liability. e foregoing limitation on Developer’s liability for consequential damages shall not apply to or limit any right of recovery TxDOT may have respecting the following: (a) Losses (including defense costs) to the extent (i) covered by the proceeds of insurance required to be carried pursuant to Section 26.1, (ii) covered by the proceeds of insurance actually carried by or insuring Developer under policies solely with respect to the Project and the Work, regardless of whether required to be carried pursuant to Section 26.1, or (iii) Developer is deemed to have self-insured the Loss pursuant to Section 26.1.4(c); (b) Losses arising out of fraud, criminal conduct, intentional mis- conduct (which does not include any intentional Developer Default), recklessness, bad faith or gross negligence on the part of any Develop- er-Related Entity; (c) Developer’s indemnities set forth in Article 12 and Section 26.5 or elsewhere in the CDA Documents; (d) Developer’s obligation to pay liquidated damages in accordance with Section 29.5 or any other provision of the CDA Documents; (e) Losses arising out of Developer Releases of Hazardous Materials; (f) Developer’s obligation to pay compensation to TxDOT as provided in Article 4 (but exclud- ing any payment on account of future Revenue Payment Amounts); (g) amounts Developer may owe or be obligated to reimburse to TxDOT under the express provisions of the CDA Documents, includ- ing TxDOT’s Recoverable Costs; (h) interest, late charges, fees, trans- action fees and charges, penalties and similar charges that the CDA Documents expressly state are due from Developer to TxDOT; and (i) any credits, deductions or osets that the CDA Documents expressly provide to TxDOT against amounts owing Developer.95 It should be noted that the above carve outs are not mutual— they are for the state DOT’s benet only. In the above example, the carve outs from the damages waiver can be categorized into losses covered by insurance (items (a) and, to some extent (c) and (e) above), bad faith dealings by the counterparty (item (b) above), and losses that are dened and quantied under the agreement (items (d), (f), (g), (h), and (i) above). However, the costs associated with each carved-out category are likely reason- ably foreseeable at the time of contracting, as the likelihood of incurring such costs and the amounts of such costs are know- able or easy to predict. In this respect, even with the additional carve outs in the latter example, the mutual waiver clause still acts as a mechanism for both parties to avoid taking on the risk of potential exposure to an unknown amount of damages. 95 Comprehensive Development Agreement State Highway 288 Toll Lanes in Harris County, Texas Department of Transportation and Blueridge Transportation Group, LLC., 136 (March 4, 2016), https://ftp.dot.state.tx.us/pub/txdot-info/hou/sh288_toll_lanes/ executed/da.pdf.