AIA A201’s “Mutual” Waiver of Consequential Damages

October 18, 2016 Firm News

A Laurie & Brennan article featured in the Construction Law Corner Fall 2015 eNewsletter.

by Ty D. Laurie and Jessica Manning1

The so-called “mutual” waiver of consequential damages clause first appeared in the 1997 A201 General Conditions of the Contract for Construction (“A201”).   Despite commentaries objecting to it over the years,2 it remained in the 2007 edition with one minor and insignificant change.   Although this waiver has been promoted as being both fair and beneficial to the whole construction industry,3it is neither.   The language of the waiver leaves parties with unintended adverse consequences to address.   The mutual waiver of consequential damages was one of the most significant changes in the evolution of the A201 and remains one of the most important provisions to focus upon in negotiations.

I. THE CLAUSE

The A201 mutual waiver clause has aggravated a perplexing problem — how to define “consequential damages,” the subject of the waiver.   In an attempt to clarify, subparagraph 15.1.6 of the 2007 A201 (formerly 4.3.10 of the 1997 A201) provides:

15.1.6   Claims for Consequential Damages.   The Contractor and Owner waive all claims against each other for all consequential damages arising out of or relating to this Contract.   This mutual waiver includes:.1                 damages incurred by the Owner for rental expenses, for losses of use, income, profit, financing, business and reputation, and for loss of management or employee productivity or of the services of such persons; and

.2                 damages incurred by the Contractor for principal office expenses including the compensation of personnel stationed there, for losses of financing, business and reputation, and for loss of profit other than anticipated profits arising directly from the Work.

The “mutual waiver is applicable, without limitation, to all consequential damages due to either party’s termination in accordance with Article 14,” and it is not intended to “preclude an award of liquidated damages,” should the parties include such in the Contract.

Section 15.1.6 lists examples of the “consequential damages” that the Owner and the Contractor waive.   Other than the examples listed, there is no other definition, reference or explanation provided in the document of what the boundaries are of the damages being waived.   And unfortunately, other provisions in the A201 fail to provide further clarity.   For instance, subparagraph 1.2.3 of the A201, vaguely provides “well-known technical or construction industry meanings” are to be used in interpreting the Contract Documents.4

II. WHY IT CAME INTO BEING?

One of the most significant examples of consequential damages is lost profits.   Many believe that the award of $14.5 million in lost profits in Perini Corp. v. Greate Bay Hotel & Casino, Inc.,5 provided the impetus for the inclusion of the limitation on consequential damages in the AIA A201 as general contractors were appalled by the Perini decision.

The Perini award contained two parts: (1) lost profits arising after the intended completion date but before substantial performance, and (2) lost profits arising after substantial performance.   At the time, the major complaint concerning the award was the fact that the Owner was able to recover lost profits after the project was substantially completed, not that lost profits under all circumstances were undeserved.   The court upheld the arbitrators’ award of lost profits after the point of substantial completion because a rather extensive ornamental facade that was intended to alert and attract patrons to the casino had not been completed.   As a result, patrons had difficulty finding and accessing the casino.   The court agreed that the failure to construct the façade could adversely affect the number of patrons attracted to the project, not only in the busier summer season, which would have followed the completion date had it been met, but also through the winter months when prospective patrons were even less likely to enter a destination not easy to find.6    These damages would likely not have been available to the Owner, if the parties were using the 1997 or 2007 A201.   At least that is one way to interpret the result.

One might ask why the AIA would agree to the inclusion of such a clause that would bar the owner from recovering for lost profits against the contractor for significant unexcused delays. The answer is quite simple.   Not coincidentally, prior to 1997 another seminal case, Duncan v. Missouri Board for Architects,7 established design professional liability for a tragic collapse of a pedestrian bridge at a popular hotel in Kansas City.   There, the court reasoned that because the engineer had to review the shop drawing that was found to be in error and caused the collapse, the engineer was liable.8    This case caused havoc in the design professional community resulting in substantial changes to the 1997 A201.   Essentially, in exchange for agreeing to the design delegation language the AIA desired in order to protect design professionals from another Kansas City Hyatt result, the general contractor organization –Association of General Contractors (“AGC”) — was able to persuade the AIA to include numerous provisions in A201 that would protect contractors for years to come.   The headline provision, of course, was the waiver of consequential damages.   While it is labelled and is indeed “mutual” to some degree, the types of damages waived by the owner are broader than what the general contractor waives against the owner.

III. WHAT IS A CONSEQUENTIAL DAMAGE?

There are no universally recognized meanings to the words “consequential damages”.9    Nor do any of the provisions of the A201 relating to claims for damages shed light on the meaning.   In fact, other provisions only add to the confusion by describing damages that may be paid under certain circumstances that appear to be the same types of damages that have been waived pursuant to 15.1.6.10    Moreover, in the vast majority of places in which damages are awarded or discussed, there is no reference to Section 15.1.6 or the waiver.11

Damages are a fundamental issue in breach of contract cases, yet no two courts or treatises define consequential damages in the same way.12    Further complicating the issue, the definitions used by the courts often appear to be at odds with the resulting categorization found by those same courts.

The ancient case of Hadley v. Baxendale13 still features prominently in present day discussions of consequential damages.14    Notwithstanding these ancient roots, a working definition of consequential damages in the context of construction contracts is difficult to come by.   In fact, one court reluctantly admitted that it was unable to find any California case defining consequential damages.15

To date, consequential damages have been defined as followed:

  1. damages that may not naturally flow from the breach but arise from special circumstances;16
  2. damages “which arise from the intervention of ‘special circumstances’ not ordinarily predictable … [and which] are compensable only if it is determined that the special circumstances were within the ‘contemplation’ of both contracting parties,” and where “‘contemplation’ includes what was actually foreseen and what was reasonably foreseeable”;17
  3. “damages that were caused by the breach, which were within the contemplation of the parties at the time of the contracting, and were reasonably foreseeable at the time of the contracting, and which are reasonably certain at the time of the contracting”;18
  4. damages that the parties reasonably should have contemplated;19
  5. damages that typically result from late completion of the project but also that are peculiar to the injured party and “not expected to occur regularly to others in similar circumstances”;20 and
  6. “ripple effects on the promisee’s business from the breach”.21

Consequential damages are intended to be distinguished from damages that are otherwise called direct or general.   However, these types of damages are often defined in a similar manner.   For example, direct damages in construction actions have been described as:

  1. damages “which, in the ordinary course of human experience, can be expected to result from a breach”;22
  2. damages that are generally foreseeable as the result of a breach;23
  3. damages incurred as a result of a Contractor’s failure to exactly perform (although substantial performance has been rendered) unless otherwise waived;24
  4. damages that arise “outside considerations affecting the land itself”;25 and
  5. “all unavoidable harm that the builder had reason to foresee when the contract was made”.26

When comparing these lists, it is difficult to distinguish between the definitions of direct damages and the definitions of consequential damages.   Both speak of reasonable foreseeability and import other traditional notions of contract damages.   At best, cases have suggested that general damages are those “ordinary damages that flow directly from the breach,” with consequential or special damages as those “collateral losses, such as expenses incurred or gains prevented” resulting from the breach.27    But these descriptions, when applied in practice, seem to add little certainty to the discussion.28    Nor does an analysis of specific examples of Owner’s or Contractor’s damages add any clarity to the discussion.

When it came to owner’s lost profits, the contracting community took no chance on interpretation.   The A201 clearly lists lost profits as a consequential damage that the owner waives against the general contractor despite some jurisdictions labeling an owner’s lost profits as direct as opposed to consequential damages.   For instance, the lower court in Oliver B. Cannon & Son, Inc. v. Dorr‑Oliver, Inc.,29 treated lost profits, including depreciation, as a direct loss, although the higher court reversed and remanded the judgment on the grounds that the method used to calculate lost profits was speculative.   The fact that lost profits were appropriate damages was not questioned by the court.   Similarly, in Northern Petrochemical Co. v. Thorsen & Thorshov, Inc.,30 the court upheld a jury award of $267,000 for profits lost to the owners of a plastic extrusion factory due to delayed occupancy of the building.   Although the courts did not clearly classify loss of profits and loss of use as either direct or consequential damages, it characterized such as the “proper subject of damages where … the loss is a direct and proximate result of the injury complained of and the damages are within the contemplation of the parties at the time of making the contract,” terminology often used to describe direct damages.31    The court went on to state that loss of profits is an appropriate measure of damages resulting from the loss of use “when the anticipated profits can be proved to a reasonable, although not necessarily absolute, certainty.” 32

As with the description of damages as direct versus consequential, courts and commentators consistently fail to characterize damages as compensatory or consequential.   Rather, damages generally are grouped only as recoverable or not.33    For instance, in Moore Constr. Co., Inc. v. Clarksville Dep’t. of Elec.,34 Clarksville hired Moore and Kennon for two separate projects.35    Kennon faced problems during its work, leading Moore to incur a variety of damages.36    The court found “it is reasonably foreseeable that a Contractor, whose ability to complete its work is impaired by the Owner and whose performance is thereby substantially delayed, will suffer direct damages and that the extent of these damages will depend on the unique facts of each case.” 37   The court did not make a distinction between the definitions of compensatory and consequential damages, but simply determined which costs were foreseeable, direct results of the delay.38

IV. WHY THE WAIVER IS NOT FAIR

As discussed above, there is no clear definition in the case law or in subparagraph 15.1.6 of what constitutes consequential damages and, therefore, what damages are waived.   There is also little rationale presented as to why one category of foreseeable damages should be included and another excluded.39

The provision purporting to waive all consequential damages does not contain a definition, but it provides that certain identified categories of damages are not recoverable.   Subparagraph 15.1.6 uses the word “includes”, not the words “includes, without limitation”.   It is unclear whether the list is intended as illustration, with all other provable damages acceptable or whether it is intended as an example only, providing a general idea of other direct damages that are waived.   This issue is further complicated because the first sentence in subparagraph 15.1.6 following the list uses the phrase “without limitation” to describe the applicability of the waiver for the termination provisions of the A201.   Clearly, the drafters are aware that this type of modifier can be used, but fail to leave users with an understanding of what it means when it is used in one circumstance and not another within the very same provision.

There is also no exclusion for insurance recovery.   As a result, this clause has perhaps the unintended consequence of barring recovery for lost profits and other damages that the owner may have required the general contractor to insure as part of its insurance program.   Contract drafters should exercise caution so that the contractor’s insurance program procured for a particular project is not eroded or limited by liability limitation clauses such as a waiver of consequential damages.

The general principle of limited recovery of consequential damages should be that if a risk of loss is known to only one party to the contract, the other party is not liable for the loss if it occurs.   This principle induces the party with knowledge of the risk either to take appropriate precautions himself or herself or, if he or she believes that the other party might be the more efficient preventer or spreader (insurer) of the loss, to reveal the risk to that party and pay the other party to assume it.   Incentives are thus created to allocate the risk in the most efficient manner.40    A clause limiting liability represents the agreement of the parties “on the allocation of the risk of economic loss in the event that the contemplated transaction is not fully executed, which the courts should honor.” 41

Perhaps most importantly, even if a court would interpret the specific list of waived “consequential damages” in the A201 as exhaustive, this list clearly favors the general contractor.   Whereas the owner waives almost any damage resulting from a delayed project, including lost profits, lost financing opportunities and the like, the general contractor merely gives up –for the most part–the ability to seek lost home office overhead and lost opportunity costs for other unrelated jobs.   In general, such claimed damages often make up a small, and most attenuated, portion of a general contractor’s delay claim. The general contractor retains its ability to claim the vast majority of the delay damages it would normally claim should compensable delays occur, whereas the owner is unable to seek any actual damage should unexcused delays occur, except of course if liquidated damages are included elsewhere in the contract.

This discussion is not intended to be unfettered criticism of the A201.   Under the best of circumstances it is an impossible task to produce form documents that are acceptable to all parties for all purposes.   In fact, that is one of the objections to using form documents of any kind.   However, the focus should be to reach the most equitable and efficient results possible.   Given the great uncertainty in the interpretation of the A201’s waiver of consequential damages, the only assurance is that litigators will have much to do.

 


1   This article takes liberally from a prior article written by Alec Mosely, Lynn Axelroth and Ty Laurie and presented at the 2011 ABA Forum on the Construction Industry Annual Meeting.   We thank Alec and Lynn for their hard work, excellent thoughts and significant contributions to the original article and state that the opinions in this paper, as modified, are our own and may not reflect Alec’s and Lynn’s opinions.

2   See, e.g., Goodrich, “Selected Owners’ Issues with Respect to the AIA A201-1997,” 2 Construction Bulletin 2-3, Saul Ewing (2006) (mutual waiver penalizes Owners far more than Contractors); Community Development Law Center, “Construction Contract Checklist” 5 (Rev. ed. 2002); ABA Forum on the Construction Industry (FCI) Division 12 List (promulgated by Division 12 and not brought before or sanctioned by the Forum), “Update of “Hot Button” Issues with AIA Documents,” (1999) (delete waiver of consequential damages).

3 See Howard Goldberg, Memorandum to Documents Committee April 18-20, 1996, p.1:   “By their subjective nature, these claims [for consequential damages] typically are the largest, most costly and the most likely to lead to a windfall to one party and economic disaster to the other.   The possibility of a windfall recovery is one of the most substantial impediments to settlement in disputes over delays or change orders.   Eliminating these exposures should substantially reduce the overhead cost of contractors for the benefit of the whole construction industry.”   Ernstrom and Dehmler, Mutual Waiver of Consequential Damages: The Contractor’s Perspective, 1811 The Constr. Law. (January 1998).

4   Subparagraph 1.2.3 of the A201 (1.2.5 in the 1997 edition), provides as follows:   “Unless otherwise stated in the Contract Documents, words that have well-known technical or construction industry meanings are used in the Contract Documents in accordance with such recognized meanings.”   But without recognized meanings, this provision is of no help at all in unraveling the definition of “consequential damages.”

5   129 N.J. 479, 610 A.2d 364 (N.J. 1992).   In a 2-1 decision, arbitrators awarded over $14,500,000 in lost profit damages arising out of the delayed opening of a casino to the owner against the general contractor employed to manage the casino renovation project, which was upheld by this court and overruled on other grounds by Tretina Printing, Inc. v. Fitzpatrick & Assoc., Inc., 640 A.2d 788, 793 (N.J. 1994) (adopting a different standard of review for arbitration awards).   Interestingly, although the aggressive stance of the lawyers was among the reasons pointed to by those considering Perini an outrageous result, it was the architect and contractor on the arbitration panel who rendered the award with the lawyer on the panel opposing the ruling.

6   Perini Corp. v. Greate Bay Hotel & Casino, Inc. at 507.

7   Duncan v. Missouri Board for Architects, 744 S.W.2d 524, 541 (Mo. App. 1988).

8   Id.

9   See Ernstrom and Dehmler, supra n. 3, at 6.

10 The A201’s index identifies the following provisions as relating to claims for damages: 3.2.4, 3.18, 6.1.1, 8.3.3, 9.5.1, 9.6.7, 10.3.3, 11.1.1, 11.3.5, 11.3.7, 14.1.3, 14.2.4 and 15.6.1, the last of which is the section waiving consequential damages.   Sections 3.2.4 and 6.1.1 refer to Article 15, but only with respect to the procedures stated in that Article concerning how to make a claim.   The references to the amount or types of damages eligible to be received are not qualified in any of the other provisions, except 14.2.4, which precludes the Owner from recovering damages expressly waived if the Contractor is terminated and the unpaid balance of the Contract Sum exceeds the cost of finishing the work and the Owner’s other damages.   No similar limitation is placed on the Contractor in connection with damages or sums it may owe to the Owner, nor on the damages the Owner may owe to it.   For example, if the Contractor is permitted to terminate the contract,  § 14.1.3 provides that the Contractor may recover from the Owner “payment for Work executed, including reasonable overhead and profit, costs incurred by reason of such termination and damages.”   The parties are left to wonder if the Contractor’s reasonable overhead includes the cost of home office personnel working on the project, as might be expected, or if recovery is precluded by (1) clause .2 of  § 15.1.6 waiving “damages incurred for principal office personnel” and (2) the statement that the waiver is applicable “to all consequential damages due to either party’s termination in accordance with Article 14.”   Further confusing the issue is Section 8.3.3, which states that with respect to claims relating to time, Section 8.3 “does not preclude recovery of damages for delay by either party under other provisions of the Contract Documents.”   Perhaps Section 8.3.3 is intended to apply if the contract has a liquidated damages provision covering delays, but the contract is silent as to whether that (or something else) is the reasoning behind this statement.

11 Id.

12 For general rules governing awards for breach of a construction contract, see Crankshaw v. Stanley Homes, Inc., 131 Ga. App. 840, 207 S.E. 2d 241 (1974); J. Calamari & J. Perillo, Contracts,  § §  14-17, 22 (1970); J. Corbin, 5 Contracts,  § §  1089, 1094 (1951).

13 9 Ex. 341, 156 Eng. Rep. 145 (1854).

14 See, e.g., Spang Industries v. Aetna, 512 F.2d 365, 368 (2d Cir. 1975) (“Hadley v. Baxendale limits the recovery to those injuries which the parties could reasonably have anticipated at the time the contract was entered into.”).   The court went on to say that, “[t]here can be no question but that Hadley v. Baxendale represents the law in New York and in the United States generally.” Id.   Accord Ebasco Services, Inc. v. Pennsylvania Power & Light, 460 F. Supp. 163, 213 n. 62 (E.D. Pa. 1978) (discussing Pennsylvania law) (“The most famous case contrasting general and special (or consequential) damages is Hadley v. Baxendale . . .”).     Accord Mendoyoma, Inc. v. County of Mendocino, 8 Cal. App. 3d Supp. 873, 879-80; 87 Cal. Rptr. 740 (1970) (the doctrine announced in Hadley v. Baxendale, limiting damages to those reasonably foreseen by the parties, is followed in the Restatement of Contracts and in California).

15 DP Service, Inc. v. AM International, 508 F. Supp. 162, 167 (N.D. Ill. 1981).

16 Robert K. Cox, John J. Tieder & Michael J. Denton, Owners’ Damages, Basic Principles and Guidelines, Construction Briefings, March 1983, at 3.   See also 25 C.J.S., Damages  §  2 at 617.

17 Roanoke Hospital Association v. Doyle & Russell, Inc., 215 Va. 796, 801 (1975) (hospital brought suit for damages due to Contractor’s failure to complete on time).

18 Steven G. M. Stein, ed., Remedies and Damages,  §  11.02 [1], Construction Law (1990).

19 Imdieke v. Blenda-Life, Inc., 363 N.W. 2d 121, 125 (Minn. Ct. App. 1985) (emphasis added); see also Spang Industries v. Aetna, 512 F.2d 365, 367 (2d Cir. 1975).

20 Robert K. Cox, supra n. 16, at 3.

21 Richard A. Posner, Economic Analysis of Law,  §  4.8 (3d ed. 1986).

22 Roanoke Hospital, supra n. 17, at 801.

23 Robert K. Cox, supra at 3.

24 Woodruff v. Hough, 91 U.S. 596 (1876).

25 11 A.L.R. 4th 891 (1982).

26 Young v. Johnston, 475 So. 2d 1309, 1315 (Fla. Dist. Ct. App. 1985) (quoting Restatement (First) Contracts,  §  346(1)(a)).

27 Fort Washington Resources, Inc. v. Tannen, 901 F. Supp. 932, 943 (E.D. Pa. 1995).

28 Reference to Federal Acquisition Regulations, Part 31 Contract Cost Principles and Procedures, CCH Government Contracts Reports (1997), also provides little or no assistance.   FAR 31.202 defines “direct costs” as any cost that can be identified specifically with a final cost objective.   FAR  31.203 defines “indirect costs” as any cost not directly identified with a single, final cost objective but identified with two or more cost objectives, or pooled costs allowed by contract terms.   In a fine example of circular reasoning, “final cost objective” is defined as a cost objective that has allocated to it both direct and indirect costs.

29 394 A.2d 1160, 1163 (Del. 1978) (a painting subcontractor was held liable to a factory owner for over half a million dollars in lost profits, over one-fifth of which constituted depreciation of buildings and equipment, during a shutdown caused by the subcontractor).

30 297 Minn. 118, 123-124, 211 N.W. 2d 159 (1973).

31 Id. at 125.

32 Id.

33 See e.g. Steven G.M. Stein, supra n. 18,  §  11.02[2].

34 707 S.W.2d 1 (Tenn. Ct. App. 1985).

35 Id. at 3-5 (Moore was hired for site preparation and exterior work and engaged Kennon to erect an office building and warehouse.   The project required the work to be performed in sequence, with first Moore then Kennon, and then Moore again).

36 Id. at 6 (damages included an increase in the cost of materials, overhead, insurance, bonding, supervisory and central office labor costs, loss of use of equipment, loss of interest on retainage, and loss of interest on anticipated income).

37 This seems to combine the definitions of compensatory and consequential damages.

38 Id. (The court failed to indicate whether the use of the word “direct” was intended to convey any meaning as to the nature of the damages other than they were foreseeable).

39 Commentators may argue that a party should not assume a risk not commensurate with any possible reward.   Isn’t the question, rather, whether an aggrieved party should be denied the benefit of its bargain by the party causing, and in a position to control, the breach?

40 Posner, supra n. 21,  §  4.9 (3d ed. 1986).

41 Metropolitan Life Ins. v. Noble Lowndes Int’l, Inc., 84 N.Y.2d 430, 436 (N.Y. Ct.
App. 1994).