Many people, even while negotiating the terms of a contract “mutual waiver of consequential damages” clause, fail to appreciate the distinction between direct and consequential damages. A federal district court judge in Pennsylvania has penned a thoughtful decision on this issue, worth noting.
The project was construction of a new Motel 6, and the contractor stopped work before it was complete, but already late. Hoping for a fall 2014 opening, the Motel 6 owner finally opened in the spring of 2015, using others to finish. The subsequent dispute has focused on damages, and specifically what damages are allowed as “direct” damages and what damages are barred by a contract clause prohibiting “consequential” damages.
The court first noted that foreseeability is not the standard:
[I]t is true in some sense that predictability is relevant to determining whether damages naturally flow from a breach and are considered direct or indirectly result and are considered consequential. But that definition has never been very instructive for analyzing particular damages, and foreseeability is the limit of all contract damages, not the distinction between direct and consequential damages. [citations omitted]
Quoting from a federal appellate decision, the court noted –
"Rather than turning on foreseeability, the difference between direct and consequential damages depends on whether the damages represent (1) a loss in value of the other party's performance, in which case the damages are direct, or (2) collateral losses following the breach, in which case the damages are consequential." Atl. City Associates, LLC, v. Carter & Burgess Consultants, Inc., 453 F. App'x 174, 179 (3d Cir. 2011). "Direct damages refer to those which the party lost from the contract itself—in other words, the benefit of the bargain—while consequential damages refer to economic harm beyond the immediate scope of the contract." Id. (quoting Penncro Assocs., Inc. v. Sprint Spectrum, L.P., 499 F.3d 1151, 1156 (10th Cir. 2007))
Further, “direct damages are the costs of a plaintiff getting what the defendant was supposed to give — the costs of replacing the defendant's performance. Other costs that the plaintiff may not have incurred if the defendant had not breached, but that are not part of what the plaintiff was supposed to get from the defendant, are consequential.”
Applying those standards to the current dispute, the court held that costs of completion, including a project manager’s fee, would be direct costs. Utility costs were also direct costs, being tied to what the contractor had agreed to cover during construction. On the other hand, lost income, and costs of advertising and insurance (in this instance, insurance for operating the hotel), were not part of what the original contractor was obligated to provide, and so would be considered consequential. Trickier were questions about extended rental of storage units holding furniture, fixtures and equipment which were to be installed in the hotel, and costs of financing. The former were considered consequential, but incremental interest costs incurred monthly during the period of delay were considered as direct damages. (The contract had standard AIA language, which includes the word “financing” among the list of potential costs or damages being waived by the owner. The court concluded that that word in context refers to replacement financing or line of credit financing, and not to already-existing construction loan monthly costs.)
To sum up, the court distinguished between “a loss in value of the other party's performance” and “collateral losses following the breach,” to distinguish between direct and consequential damages. Something to keep in mind during the next contract negotiation. The case is Jala v. DDG Constr., 2016 U.S. Dist. LEXIS 150969 (E.D. Pa., Nov. 1, 2016) (LEXIS subscription required).