Practice Management: Direct vs. Consequential Damages

  • 20 March, 2020

Per AIA contracts , there is a lot of verbiage regarding damages. Often, all parties agree to the waiver of claims due to damages in the AIA contract A201, the general conditions of the contract for construction.

The waiver of claims means that all parties bound together by this contract agree to hold the other parties harmless should damages be claimed. This is done for many reasons, but let's first look at the matter of definition.

First, what is a claim and what makes it direct or consequential? A claim is a formal request to a surety (an insurance company) to be compensated for damages. A direct damage is one that can be directly connected to damage. A common example is that of a roof that has caved in. This would assume that the roof was newly constructed and has failed due to the incompetence of the design. A claim for direct damages would request that the roof be rebuilt if it is found that there was negligence in the design of the roof. Consequential damage is damage that is a theoretical or disconnected effect due to the failure of the roof. An example of consequential damage would be the loss of rent due to the roof failure and the loss of rent to come due to its repair. The cost of rent is not directly connected to the roof damage and is, therefore, consequential-a result of the consequence. It should be noted that contract breaches could be considered consequential damages but, in court, the definition is wide and varied, and often consequential damages are limited to those defined as a result of a loss or consequence.

As noted, in the AIA's A201 contract, these are waived among parties. One reason could be that, with consequential damages, especially, they could be ill defined and could lead to contentious relationships within the contract. However, the contract should anticipate the worst and set up for the best-the best way to deal with unknowns and with contingencies to cover costs should something happen that leads to delays and added costs, etc. Building projects carry risks, and those risks should be managed by all parties. A contract based on rosy situations that does not anticipate issues can be problematic.

However, a main reason for waiving claims for damages is due to business. A construction company or an architecture firm often does not have the assets of wealthy clients or development companies. Bringing claims such as these could bankrupt construction companies and architecture firms. At the very least, the damages could far exceed the profit for the particular project. It is for this reason that many companies will not work with an owner who suggests striking that waiver from the contract.

Practice Management: Direct vs. Consequential Damages

How to deal with these situations? Coming up with alternative methodologies for covering such issues, other than a striking of the waiver, is what is best in these situations. However, this is often covered by professional liability insurance. No matter what, changes to the contract need to be reviewed by lawyers experienced in the construction process so that everyone is mutually covered in these agreements.

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