Strategic Use of Limitation of Liability Provisions in Construction Contracts
May 28, 2015

By James E. Braza

One of the most important strategic approaches in modern day construction contract negotiation is leveraging the extent to which the parties will agree to limitations upon certain liabilities. While such limitations fall into a number of different categories, one of the most common is the mutual waiver of consequential damages. Though agreeing to limit the other party’s liability surely comes at some risk, there are benefits that should be carefully weighed before making a go/no-go decision on such a waiver. In particular, the benefit of limiting the total potential of your project cost.

On its face, a mutual waiver of consequential damages can have several advantages for both parties. The most obvious advantage is that it limits one’s liability exposure to a more definable range, allowing for more accurate budgeting and financial management. The second advantage is that a waiver can serve as a significant deterrent to litigation, thereby limiting the claims that either party deems advisable to make and that the other is required to defend. Third, at least from the owner’s perspective, such a limitation saves the dollars that would otherwise be included in a contractor’s bid to “compensate” for the added risk of taking on the otherwise-unlimited liability. Recognizing these advantages, parties to construction contracts now more often than not agree to such a waiver. In fact, one of the most commonly used contract documents – the American Institute of Architects’ A201 General Conditions Document – now includes a waiver of consequential damages provision in its standard form language.

Yet, whether (and to what extent) the parties will agree to any limits of liability is often one of the most difficult issues in construction contract negotiation. Owners typically want to have some party accountable for damages (like lost rent caused by unexcused delay) which, if not recovered, could fatally alter the financial model for the project. Both parties often feel more comfortable if the other has enough “skin in the game,” brought about by its own potential liability, to best incentivize quality performance. Contractors are typically adverse to taking on the risk of a much greater loss than the fee they will earn if the project proceeds smoothly. And owners know that the acceptance of that risk by the contractor often comes at a significant price increase to the owner.

Successful navigation of these waters often compels compromise. When negotiating such a provision, consider the following options to bridge the gap between the parties’ respective sensitivities:

  1. Agree that consequential damages are recoverable, but are limited to the amount of the contractor’s fee (or a multiple thereof).
  2. Agree that consequential damages are recoverable, but are limited to a fixed dollar amount (say, $1 million).
  3. Agree that consequential damages are recoverable, but only to the extent that they are covered losses under the applicable insurance policies.

There are advantages, disadvantages and potential pitfalls to any of these approaches, but all serve the fundamental purpose of reducing the cost of the project by limiting the risk either party is being asked to “buy.”

Whether these benefits are ultimately achieved will turn to a great degree on the specific language chosen. Among other things to consider, here are two important sets of issues. The first is definitional. While the notion of consequential damages is as old as the law of contracts, what constitutes “consequential damages” is often the subject of great debate. All too often, significant litigation ensues over the issue of whether the damages sought to be recovered constitute consequential damages (subject to the waiver) or another type of damages (which are not subject to any limitation). Surely, the benefits of the certainty introduced by a waiver or limit of such damages are quickly defeated if the parties spend several years litigating whether any particular item of damages is properly deemed “consequential.” This risk can be minimized by adding a specific definition of what consequential damages include for a particular project, or by tying the definition to a specific statement of the law (i.e., the Uniform Commercial Code or the Restatement of Contracts).

The second issue relates to insurance. It has become relatively common for parties to agree to limit their exposure for consequential damages to that which is recovered under an insurance policy. Here, the critical challenge is to ensure that the limitation on a contracting party’s liability does not operate to defeat that party’s coverage under the entirely separate insurance contract. This requires careful coordination of contract language with the language of the applicable policies. On bigger projects, involvement of the risk managers and insurance brokers is critical to evaluate this issue.

While not always appropriate, if the right language is drafted, the parties can enjoy significant benefits from a full or limited waiver of consequential damages. And in the end, these provisions often serve the additional benefit of creating a more positive work atmosphere because parties are not constantly documenting potential claims for consequential damages.

If you have any questions regarding the applicability of these concepts within your construction contracts, please contact your Davis & Kuelthau, s.c. attorney or the author, James E. Braza, at 414.225.1421 / jbraza@dkattorneys.com.

 

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