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CONSTRUCTION CONTRACTS FREQUENTLY CONTAIN A WAIVER OF CONSEQUENTIAL DAMAGES, BUT IS THE WAIVER ENFORCEABLE?

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The AIA prepares standard form agreements that are frequently used by those in the construction industry.  These agreements typically contain a consequential damages waiver.  The most common forms of consequential damages are lost profits and loss of use.  The recovery of these damages are important to those that own and operate apartments, commercial property, and other forms of income generating real estate.  If a construction mistake forces the owner to sustain vacancies or loss of use, he or she is losing money.    

An owner of income property should exercise caution in agreeing to the consequential damages waiver.  The mere fact that the consequential damages waiver is included within the AIA agreement or any other agreement, does not mean that the property owner must agree to it.  All construction contract terms are negotiable, including the AIA contract terms. 

If you are unfamiliar with the consequential damages waiver within the AIA agreement, it is located at Section 15.1.6 of the agreement.  It states:

“The contractor and owner waive claims against each other for consequential damages arising out of or relating to the contract.  This mutual waiver includes (1) damages incurred by the owner for rental expenses, for loss of use, income, profit, financing, business and reputation, and for loss of management or employee productivity or the services of such persons, and (2) damages incurred by the contractor for principal office expenses including the compensation of personnel stationed there, for loss of financing, business and reputation, and for loss of profit except anticipated profit arising directly from the work.  This mutual waiver is applicable, without limitation, to all consequential damages due to either party’s termination in accordance with Article XIV.  Nothing conveyed in this section 15.1.6 shall be deemed to preclude an award of liquidated damages when applicable, in accordance with the requirements of a contract document.”

If your client has already agreed to be bound by the consequential damages waiver, he or she still may be able to recover lost profits or loss of use damages in the event he or she has sustained a loss due to a contractor’s mistake.

Clarity of the Consequential Damages Waiver

A consequential damages waiver must be clear and unambiguous.  In Civic Center Drive Apartments Limited Partnership vs. Southwestern Bell Video Services295 F.Supp.2d 1091 (Northern District CA 2003), the Court held that a waiver of damages in a construction agreement is enforceable so long as the parties had an opportunity to bargain for the wavier and the waiver was clear

If your client utilized the AIA agreement referenced above, the consequential damages waiver therein states that it applies when either party has terminated the agreement in accordance with Article XIV.  Thus, is there a waiver of consequential damages when the contract was performed to completion but, there was a breach or a mistake made during the performance thereof (such as a subsequently discovered construction defect)?  This is not very clear, and may be a basis for recovering lost profits or loss of use damages, even with a signed AIA agreement.        

Furthermore, Section 14.4.3 of the AIA contract states that the Contractor can recover “reasonable overhead and profit on the Work not executed.”  It stands to reason that “profit on work not executed” is a consequential damage because it is a form of lost profit.  Section 14.4.3 of the AIA agreement seems to conflict with the consequential damages waiver at Section 15.1.6., and adds to the uncertainty concerning the scope and application of the consequential damages waiver therein, and whether the parties intended for the waiver to apply to any and all circumstances of breach or for any claims arising out of the contract.  Remember, uncertainty or lack of clarity is a basis for avoiding the limitations imposed by the consequential damages waiver.      

Fraud

The Civic Center casereferenced above states, “a [consequential damages waiver] is unenforceable if it is unconscionable or otherwise contrary to public policy…[and that] contracts which “have for their object … to exempt any one from responsibility for his own fraud … are against the policy of the law.”  Thus, if the contractor committed fraud (intentionally overcharged, intentionally concealed defective conditions, intentionally misrepresented the quality of its work), the consequential damages waiver should not apply.

Conclusion

 If your client has signed a construction agreement that contains a consequential damages waiver and subsequently sustained a loss of profit or loss of use as a result of the contractor’s breach or mistake, you should advise your client to consider whether the consequential damages waiver is enforceable.  This may result in a significant increase in your client’s recovery when a claim is made.  An unclear consequential waiver or a consequential damages waiver that is being utilized by a contractor that committed fraud against your client may be unenforceable.  Please do not hesitate to contact The Law Office of Michael A. Hearn in the event your client requires a review of its construction agreement in contemplation of asserting a claim for loss of use, loss of profits, or other construction related damages.