What Are Consequential Damages?
To properly weigh the risks and benefits of waiving consequential damages, it is essential to define the term. Unfortunately, there is no universally accepted definition.
Broadly speaking, however, consequential damages are indirect damages. That is, they are not the direct and proximate result of a breach of contract. Classic examples of direct damages in the construction context include the costs to repair faulty work (owner) and general conditions costs associated with project delays (contractor).
Consequential damages, also known as special damages, lack that concrete definition. In addition, “the line between direct and consequential damages often is not a bright one,” and the “distinction is not always so easily applied in practice.” James Const. Grp., LLC v. Westlake Chem. Corp., 650 S.W.3d 392, 417 (Tex. 2022).
A Texas appellate court compiled various sources on consequential damages:
“[despite] the vast number of cases purporting to define consequential damages by repeating the same time-honored but general definitions and distinctions between consequential and direct damages, the meaning remains elusive ... [F]ew transactional lawyers can define consequential damages accurately and many misconstrue the impact a waiver of such damages may have ... [N]o one knows what consequential damages are or may be, at least not with predictability or uniformity.”
DaimlerChrysler Motors Co., LLC v. Manuel, 362 S.W.3d 160, 181 (Tex. App. 2012) (internal citations and quotations omitted).
Clearly, consequential damages are nuanced — but it is fair to say that they cover the broad spectrum of indirect costs arising out of a breach. Some common examples are listed below:
Examples of Consequential Damages
- Owner
- Prime/Subcontractors
- Financing costs
- Lost business opportunities
- Lost revenue, lost rent, etc.
- Reputational harm
AIA Standard Language
As consequential damages remain notoriously difficult to define, reflexively waiving them on a multimillion-dollar project can be particularly problematic. This is especially noteworthy as the American Institute of Architects (AIA) includes such a waiver in its standard contract language — and it has become an industry standard/custom to waive consequential damages.
The AIA waiver appears in section 15.1.7 and is conveniently titled, Waiver of Claims for Consequential Damages. The section specifies that the waiver is mutual, applying to both owners and contractors, and does not include liquidated damages (LDs).
The AIA appears to have been influenced by the case of Perini Corp. v. Greate Bay Hotel & Casino. Perini Corp. v. Greate Bay Hotel & Casino, 129 N.J. 479, 610 A.2d 364 (1992). In the Perini case, an arbitrator awarded the Sands Hotel and Casino more than $14.5 million in damages for lost profits against the general contractor, Perini, whose contract was worth approximately $24 million with a fee of $600,000. The result in the case has drawn considerable attention because a substantial portion of the damages was awarded for the failure to complete an ornamental facade whose only function was to attract customers, based on the hotel’s contention that it intended to "increase its profits by attracting more patrons" from the surrounding area. The delayed completion of this relatively minor, nonfunctional element of the project resulted in millions of dollars in delay damages.
Home Office Overhead — Consequential Damages?
At a minimum, parties sitting down to negotiate construction contracts should consider the types of damages likely to arise during performance and ask themselves whether they are prepared to release the other side from all liability.
Consider delay damages. Depending on the jurisdiction, home office overhead incurred during a period of delay could be considered a consequential damage and would therefore be waived.
In a Virginia case, one party further blurred the line between consequential and direct damages when it identified home office overhead costs (among others) as direct or consequential at different times. Envirotech Corp. v. Halco Eng’g, Inc., 234 Va. 583, 587 (1988). Finally, at oral argument, it “confirmed…that the damages sought…‘may be fairly characterized as consequential.’” The Virginia Supreme Court agreed with that characterization and held that the consequential damages waiver in the underlying contract meant home office overhead costs were waived.
Other jurisdictions take a different approach. In Texas, for example, the law expressly addresses these issues to protect state and local governments in litigation. Tex. Civil Practice and Remedies Code ann. § 114.004 (West 2013). Article 114.004(b)(1) and (3) of the Texas Civil Practice and Remedies Code specifies that a plaintiff cannot recover consequential damages or unabsorbed office overhead in adjudications with a Texas state agency.
At the local level in Texas, home office overhead is similarly unavailable on breach of contract claims for construction projects. Consequential damages are generally also unattainable; however, the “increased cost to perform the work as a direct result of owner-caused delays or acceleration” remains recoverable. Tex. Local Government Code Ann. § 262.007 (West 2003).
These authorities indicate that home office overhead may be claimed as a consequential damage during delay claims, but also may not apply, depending on the jurisdiction and even the parties involved in the dispute. Again, it is critical to know where you are and what potential remedies may be contractually waived.
A Look Through the Lens of Different Perspectives
Before signing a broad waiver of consequential damages, all parties to a construction contract should consider the applicable law (if any) defining what constitutes consequential damages. They should also consider whether there are any damages that might be considered consequential that they are not prepared to waive and carve out exceptions.
Owner Perspective
Lost profits are one of the major consequential damages that an owner could be giving up by agreeing to a waiver. Like the owner in the Perini case that recovered millions of dollars in lost profits, it might not be advisable to waive these particular damages if the harm is not otherwise mitigatable or compensable. However, If an owner feels confident that LDs can make them whole, it may be worth waiving consequential damages to avoid costly, uncertain and drawn-out litigation.
Contractor Perspective
When negotiating around consequential damages, a contractor should ensure that any waiver applies equally among the parties. By demanding mutuality of the waiver, a contractor can protect itself against a one-sided waiver that might leave it on the hook for the owner’s lost profits.
Most analysts of this provision agree that it favors the contractor. In many sectors of the construction industry, most particularly the industrial sector, it is a common practice for contractors to insist that a clause waiving consequential damages be included in the construction contract.
Subcontractor Perspective
Like prime contractors, subcontractors should demand mutuality of the waiver when negotiating their contracts, especially when the prime and owner have mutually waived.
Subcontractors often operate under tight margins and can be significantly affected by delays or disputes beyond their control. Waiving consequential damages protects subcontractors from claims by contractors or owners for losses that are disproportionate to their scope of work, such as:
- Financial penalties incurred upstream by the contractor.
- Delays in project completion caused by factors outside the subcontractor’s control, such as design changes or unforeseen site conditions.
- Extended commitments that result in lost opportunities for other projects.
By waiving consequential damages, subcontractors can better manage their risks and avoid financial exposure to liabilities they cannot control.
Drafting an Effective Waiver Clause
Careful drafting is essential to avoid potential pitfalls. An effective waiver clause should:
- Use Clear and Precise Language: Avoid vague terms and explicitly define what constitute consequential damages.
- Include Mutuality: Ensure the waiver applies equally to all parties — owners, contractors and subcontractors — to promote fairness.
- Address Specific Risks: Tailor the clause to reflect the unique aspects of the project and the parties’ risk tolerance.
- Incorporate Exceptions: Consider carveouts for intentional misconduct, gross negligence or specific types of losses that one party deems critical.
Conclusion
The consequential damages waiver is a valuable tool for managing risk in the dynamic environment of construction projects. By excluding liability for indirect losses, it enables parties to focus on addressing direct issues and completing the project efficiently. However, success hinges on careful drafting, mutual agreement and a clear understanding of the provision’s implications. For subcontractors in particular, these waivers offer critical protection against disproportionate financial risks. As with any contractual term, it is crucial to consult legal and industry experts to ensure the waiver aligns with project goals and legal requirements. Ultimately, a well-crafted waiver of consequential damages promotes collaboration, reduces disputes and supports the successful delivery of construction projects.