What’s in Your Waiver (of Consequential Damages)?

In a series of recent television ads, Samuel L. Jackson asks the question, “What’s in your wallet?” For contractors, a more pertinent question is, “What’s in your waiver of consequential damages?” It is increasingly common for project owners to propose significant exceptions to the waiver of consequential damages included in the parties’ contract. When a contractor agrees to include those exceptions, it may find that the waiver actually offers very little in the way of protection from consequential damages claims.

Mutual Waiver of Consequential Damages Becomes Industry Standard

Most discussions about waivers of consequential damages in construction contracts start with the New Jersey Supreme Court’s decision in Perini Corp. v. Greate Bay Hotel & Casino, 610 A.2d 364 N.J. 479 (N.J. 1992). In that case, the owner of a casino was awarded over $14.5M in lost profits against the general contractor hired to manage its casino renovation project. The general contractor’s fee for the project, by comparison, was $600,000.

In response to the Perini Corp. case, it became standard in the construction industry for the parties to include a mutual waiver of consequential damages in their contracts. For example, the American Institute of Architects (“AIA”) added a mutual waiver of consequential damages to its standard A201 General Conditions in 1997. Today, the three organizations that publish the most widely used form construction agreements in the U.S. – the AIA, ConsensusDocs and the Engineers Joint Contract Documents Committee (EJCDC) – include a waiver of consequential damages in their standard agreements.

Why Contractors Need Consequential Damages Waivers

There are numerous reasons why contractors need consequential damages waivers. First, the owner is the party that has the ability to understand what consequential damages it might incur and to take steps to avoid or mitigate those damages (for example, through its leases with tenants, its purchase agreements with buyers and its contractual commitments to third-parties.) Contractors are typically not in a position to fully understand what an owner’s consequential damages might be; nor do contractors have any ability to avoid or mitigate those damages.”

Second, disputes over alleged consequential damages can often be the most contentious part of a dispute and the largest in terms of the amount of money at stake. Eliminating consequential damages reduces the likelihood of a dispute or, at the very least, makes it so that any dispute is more manageable.

Third, and perhaps most importantly, consequential damages risk is simply too difficult to quantify and potentially too large for contractors to justify taking that risk. The amount of consequential damages could, in theory, be many multiples of the fee that a contractor expects to make on the project, as demonstrated by the Perini Corp. lawsuit.

Types of Exceptions Requested by Owners

While most sophisticated owners understand that they need to include a waiver of consequential damages to attract competent general contractors, many of those owners also attempt to modify the waiver of consequential damages by adding exceptions that increase the risk to the contractor. These modifications include the following:

1. Exceptions for Gross Negligence, Willful Misconduct or Fraud

Many owners seek to exclude claims arising from “gross negligence, willful misconduct or fraud.” While there may be some appeal to the idea that a contractor should not be shielded from damages that arise from conduct that is more egregious than ordinary negligence or breach of contract, the reality is that – when a project goes poorly enough to result in a lawsuit – an aggressive owner’s attorney is likely going to allege some combination of gross negligence, willful misconduct or fraud in an attempt to get around the waiver of consequential damages. A contractor defending against those claims may ultimately prevail, but not before it is forced to go through a lengthy discovery process or potentially even a trial to obtain a decision that its conduct did not rise to the level alleged. If one of the purposes of including a waiver of consequential damages is to avoid a dispute in the first place, or at least make any dispute more manageable, exceptions for gross negligence, willful misconduct or fraud undercut that purpose.

The exception for gross negligence is particularly troubling because there is not always a bright line between ordinary negligence and gross negligence. Consider the following excerpt from a 1946 decision of the Minnesota Supreme Court where the Court defined gross negligence in comparison to ordinary negligence:

Gross negligence is substantially and appreciably higher in magnitude than ordinary negligence. It is materially more want of care than constitutes simple inadvertence. It is an act or omission respecting legal duty of an aggravated character as distinguished from a mere failure to exercise ordinary care. It is very great negligence, or the absence of slight diligence, or the want of even scant care.
“substantially and appreciably higher in magnitude than ordinary negligence.”

State v. Bolsinger, 21 N.W.2d 480, 485 (Minn. 1946). Given indeterminate definitions of gross negligence such as this one, it is certainly possible, if not likely, that any lawsuit involving a construction contract that has a gross negligence exception to the waiver of consequential damages will include an allegation of gross negligence.

2. Exception for Claims Covered By Insurance

Another exception often requested by project owners is an exception for claims covered by insurance. Owners seeking to include this exception argue that the contractor is not harmed by it because any consequential damages claim covered by insurance will not be paid by the contractor itself. Owners also argue that, because contractors charge for their insurance on a project, the owners should be able to access that insurance for any covered losses, including consequential damages.

But there are a number of problems that could result from agreeing to this exception. For contractors with large self-insured retentions or large deductibles, the contractor could very well end up liable for consequential damages within their retention or deductible amount. Further, a contractor that exposes its insurance to claims for consequential damages is likely to see an increase in its insurance premiums, which can then impact the contractor’s ability to be competitive with its pricing on future jobs.

3. Exceptions for Indemnity Claims

Often, owners seek to add an exception for claims covered by the contract’s indemnity clause. This exception might be appropriate if the indemnity clause is properly limited to third-party claims for bodily injury and property damage. If, however, the indemnity clause is drafted in such a way that an owner can assert a claim for indemnity against the contractor for its own first-party damages, the indemnity exception could obliterate any protection that the waiver of consequential damages was intended to provide in the first place. (This is sometimes referred to as a “back door” for consequential damages claims.) For this reason, a contractor needs to carefully review and understand its indemnity obligations before agreeing to an indemnity exception to the waiver of consequential damages.

Takeaways for Contractors

As contractors review and negotiate contracts proposed to them by owners, it is not enough to confirm that a waiver of consequential damages has been included. Contractors must understand the nature and extent of any exceptions that are included with the proposed waiver. Otherwise, a contractor may find itself in the same position as Perini Corp. did in the early 1990s – exposed to a claim for millions of dollars of consequential damages on a project that dwarfs any profit it could have ever hoped to make.

Announcements

Fabyanske, Westra, Hart & Thomson, P.A. is pleased to announce that Dean Thomson and Julia Douglass will be speaking on Mediation Strategies on October 17th to the Florida Bar Association Section on Construction Law. For more information click here.

Mark Becker, Kyle Hart, and Dean Thomson are recognized by Minnesota Lawyer as a Power 30 attorney in the field of Real Estate and Construction Law. Congratulations to the three attorneys at Fabyanske, Westra, Hart and Thomson for this recognition.

Hugh Brownwill be presenting a live Webinar on Construction Law Hot Topics for the National Business Institute on July 27th, from 1:00 to 2:30 Central Time. For more information, including registration and how to view the program, click here.