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Construction Contractors Beware the Consequences of Consequential Damages

April 7, 2022 Construction Industry Legal Blog

Reading Time: 5 minutes


Consequential damages for breach of a construction contract are a significant risk that contractors need to understand and be aware of in connection with construction projects.  This blog explains the difference between consequential damages and direct damages for breach of contract, and provides recommended ways for construction contractors to mitigate their exposure to liability for consequential damages as part of contract negotiations.

Consequential Damages

What are Consequential Damages and How are They Different than Direct Damages? 

When a construction contractor breaches a construction contract, there are two major categories of potential damages the contractor might be liable to pay, direct damages and consequential damages.  Direct damages, also known as general damages, are those that can be said to necessarily and naturally flow or result from the specific contract breach and compensate for the value of the promised performance. [1]  For example, if the contractor fails to properly complete a portion of the project, the contractor would be responsible for the costs to correct the work so that the owner receives the benefit of the contractually bargained for work.  Direct damages, while they can be costly, are generally a known and quantifiable risk that the construction contractor knowingly undertakes when entering into a construction contract.

Consequential damages, on the other hand, can be much more of an unknown risk and can lead to disastrous liability in certain circumstances.  Consequential damages are losses or injuries that are not the type that would almost always flow directly and immediately from the breach, but that result as a consequence of the breach in a particular case, and may be recoverable if they can be said to have been within the contemplation of the parties at the time they made the contract. [2]  Typical examples of consequential damages include lost profits, lost rents, loss of use, damage to reputation, and interest and finance charges.  While consequential damages are generally more difficult to prove and recover in court, because the amounts can be so unpredictable and can oftentimes be very large, they can present a significant risk for contractors that is difficult to quantify.

For example, suppose a contractor is required to complete the construction of a 250-unit apartment complex within 9 months.  The contractor completes the work timely, but during the inspection process it is determined that the fire-safety system is not working, and it takes 30 days and costs $25,000 to repair the issue.  However, the repairs also delay issuance of the certificate of occupancy for 60 days, and the apartment owner claims it lost $1000 a month in profit on each unit for the two months the opening of the complex was delayed.  The contractor could potentially be liable not just for the $25,000 in direct damages, but also for the $500,000 in consequential damages for the owner’s lost profits caused by the breach.  Similarly, the fire-safety subcontractor might also be liable to the contractor for those same damages for breach of the subcontract.

Ways to Lower the Risk of Consequential Damages

Because of this type of unpredictability and potential for significant downside risk, it is important that contractors be aware of the potential for consequential damages and do what they can try to mitigate that risk in the construction contract negotiations.  Most states will enforce a properly worded consequential damages waiver, including Florida, [3] and such waivers are becoming more common in construction contracts.  For example, the 2017 AIA A-201 General Conditions contain a mutual waiver of consequential damages by the contractor and the owner in Article 15.1.6.  While a mutual waiver would mean that the contractor would also be waiving the right to recover for its consequential damages should the owner breach the contract, generally the potential consequential damages the contractor might suffer, such as additional financing charges, lost profit on other projects, home office overhead, etc., will be less than the typical consequential damages an owner is likely to suffer.  Therefore, on balance, the mutual consequential damages waiver is beneficial to the contractor.

Oftentimes, project owners may insist on having a liquidated damages provision in the contract to try to agree to an amount, or liquidate, in advance certain consequential damages for delay in exchange for a waiver of consequential damages in general.  While liquidated damages can also be problematic, this is generally a good tradeoff for the contractor because the liquidated damages are a known daily rate and can be quantified and planned for, as opposed to the unknown and potentially unlimited liability that exposure to consequential damages may present in certain circumstances.  Thus, in many cases, a contractor will be better served to accept a reasonable liquidated damages provision in exchange for obtaining a waiver of consequential damages.

If an owner is unwilling to waive consequential damages, the contractor should at least try to negotiate some type of cap or limit on the amount of consequential damages either party may recover in case of a breach.  For example, the consequential damages might be capped at a percentage of the contract price, or in a cost-plus contract, capped at some percentage of the contractor’s fee.  At least in that case, the contractor can limit its risk of consequential damages to a known and quantifiable amount to allow it to at least know the amount of risk it is accepting in entering into the contract, rather than expose itself to an unknown and potentially very large consequential damages.

Conclusion

Consequential damages for breach of a construction contract can have enormous potential consequences for the unwary contractor.  Contractors therefore must be aware of potential consequential damages in connection with their work.  They should also attempt to minimize that risk where they can in their contracts,  and should consider consulting an experienced construction law attorney to assist in negotiating an enforceable contractual waiver or limitation on consequential damages.

[1] Keystone Airpark Auth. v. Pipeline Contractors, Inc., 266 So. 3d 1219 (Fla. 1st DCA 2019).

[2] Id.

[3] Id. at 1224 (upholding consequential damages waiver in engineering professional services contract).

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