When a party breaches a contract and the contract does not contain a valid liquidated damages clause, the non-breaching party may be entitled to compensatory damages. The appropriate measure of damages arising from a breach of an enforceable contract is usually “the difference between the value expected from the contract and the value actually received by the non-breaching party.” Tenn. Gas Pipeline Co. v. Technip USA Corp., 2008 WL 3876141, at *5 (Tex. Ct. App. 2008). Actual damages flowing from the breach of contract are either “direct” or “consequential.” Direct damages are those that flow naturally and necessarily from the breach and compensate for loss that is presumed to have been foreseen or contemplated by the parties because of the breach. Id. Examples of direct damages include unpaid contract amounts, cost to repair defective work, and reduced project value due to nonconforming work. Consequential damages are damages that “do not necessarily, but do directly, naturally, and proximately result from” the injury for which compensation is sought. Dorestin v. Hollywood Imports, Inc., 45 So. 3d 819 (Fla. 4th DCA 2010). In other words, they are the result of special circumstances not usually predictable. Not only must the damages be directly traceable to the breach of contract and result from it, but the damages must also be “foreseeable.” Whether a given damage is direct or consequential turns on pertinent contract language, but may also be influenced by such factors as the parties’ business sophistication. Metric Constructors, Inc. v. Hawker Siddeley Power Engineering, Inc., 468 S.E.2d 435 (N.C. Ct. App. 1996). A common example of consequential damages is lost profit on collateral business arrangements. When it comes to construction contracts, contractors, owners, and even designers should be apprehensive about the prospect of consequential damages, because those damages can include lost bonding capacity, financing costs, and possibly extended overhead costs.

The degree of proof as to the amount of consequential damages is higher than for direct damages. Consequential damages must also be pled with greater specificity. The plaintiff has the burden of proving that the damages are not only the proximate consequence of the breach, but that they were also “reasonably foreseeable” or within the “contemplation of the parties” at the time the parties entered into the contract.” Spang Indus., Inc. Ft. Pitt Bridge Div. v. Aetna Cas. & Sur. Co., 512 F. 2d 365, 368 (2d Cir. 1975). The rationale for proving foreseeability is that a party who can reasonably foresee the consequences of a breach of contract can adjust the contract price accordingly to compensate for the risk that is being assumed. While some courts tend to apply an objective test in determining foreseeability, other courts require a subjective showing that the particular damages were actually within the contemplation of the parties. Porous Media Corp. v. Midland Brake, 220 F.3d 954,961-62 (8th Cir. 2000). Further, in order to recover damages caused by a breach, the non-breaching party must act reasonably and timely to mitigate its damages. See Fair v. Red Lion Inn, 943 P.2d 431, 437 (Colo. 1997). However, courts have held that a plaintiff’s failure to mitigate its damages is excused if mitigation would require unreasonable measures. Id.

Once the non-breaching party establishes that the consequential damages it seeks should have been in the contemplation of the breaching party at the time the contract was formed, it must then prove the amount in damages actually caused by the breach of contract, sometimes with “reasonable certainty.” Compania Embotelladora Del Pacifico, S.A. v. Pepsi Cola Co., 650 F. Supp. 2d 314, 322 (S.D.N.Y. 2009). Since consequential damages are considered “special” damages, Federal Rule of Civil Procedure 9(g), as well as several state courts, requires parties to “specifically plead” consequential damages. Therefore, when attempting to prove consequential damages, if a party does not specifically plead those damages, then the evidence of those damages would be inadmissible. Some courts have specifically held that many damages categories typically deemed “consequential” are subject to specific pleading requirements, including diminished bonding capacity, lost opportunity, and lost profits. See, e.g., Safeco Title Ins. Co. v. Reynolds, 452 So. 2d 48 (Fla. 2d DCA 1984) (plaintiffs were not entitled to an award of lost profits because they failed to plead special damages). The present economic climate may have consequences for both pleading and proof of consequential damages. In light of extensive losses throughout the construction industry resulting from plunging property values and a lack of new projects, a plaintiff may be required to specifically plead and prove facts causally connecting its losses to the defendant’s particular actions, as opposed to the economic downturn. See Finkel v. Stratton Corp., 754 F. Supp. 318, 330 (S.D.N.Y. 1990) (recognizing that loss causation of pleadings in real estate securities litigation is not sufficient in light of other plausible explanations for an investors’ ultimate disappointment, like a downturn in the real estate market.)

The complex nature of a construction contract and its execution can result in damages for several different reasons. For example, a contractor that is required to “standby” during a project delay caused by the owner might be unable to take on additional replacement work and therefore absorb vast overhead expenses or even additional insurance costs. See Broward County v. Brooks Builders, Inc., 908 So. 2d 536, 540 (Fla. 4th DCA 2005). That same contractor might also seek damages for lost profits while remaining in that standby period. However, when evaluating recoverability related to lost profits, damages should be distinguished as to whether the damages would be “direct” or “consequential.” Lost profits from the project at issue would be considered “direct damages” and thus not excluded by contractual waivers of consequential damages; however, lost profits from other projects due to a breach of contract for the project at issue could be proven to be consequential. See Tenn. Gas Pipeline Co. v. Technip USA Corp., No. 01-06-00535, 2008 WL 3876141, at *7 (Tex. 1st D.C.A. 2008). Although a plaintiff must prove causation and damages to recover lost profits on the project at issue, it faces an easier burden than when seeking lost profits on other projects. Foreseeability is more easily proven, if not presumed, and the amount of damages need not be established with the same degree of certainty required for recovery of lost profits on other projects.[1] Other claims also require a closer evaluation of whether the claim is foreseeable or reasonably certain, such as in claims for diminished bonding capacity, where many courts have found that lost profits were not “reasonably foreseeable.” See Lewis Jorge Constr. Mgmt., Inc. v. Pomona Unified Sch. Dist., 102 P.3d 257, 266 (Cal. 2004).

Where contractors have been obligated to complete extra work because of the owner’s interference, and sought additional profit as a percentage of the value of the additional work, courts are split. Some courts have rejected this extra profit as a compensable damage, awarding the contractor the amount of profit it originally anticipated earning, but not increasing that amount to cover the extra work the contractor did not anticipate but was required to perform. Lewis Jorge Const. Mgmt., Inc. v. Pomona Unified School Dist., 102 P.3d 257, 264-65 (Cal. 2004). Even less likely is recovery of lost profit in the form of a percentage of “indirect expenses” suffered by the contractor on the project. C.J. Langenfelder & Son, Inc. v. Pa. Dep’t of Transp., 404 A.2d 745, 754 (Pa. 1979).

Where completion of the project is delayed, some contractors seek to recover “lost opportunity damages,” such as those profits they believe they would have made on other projects but for the delay. These damages are much more speculative than lost profits and constitute consequential damages. Although small to midsized contractors with limited manpower, resources, and bonding capacity may have a colorable argument that delayed completion consumed their resources and precluded them from securing or performing contracts on other projects, they will face challenges. To recover lost profits on other projects, a party must prove the damages were within the parties’ contemplation at the time they signed the contract. Schonfeld v. Hilliard, 218 F.3d 164, 172 (2d Cir. 2000). The party must also prove with reasonable certainty the additional net profits it would have earned but for the defendant’s breach. Blue Water Environmental, Inc. v. Inc. Village of Bayville, N.Y., 2006 WL 1642691, at *6 (N.Y. Dist. Ct. 2006). A contractor’s simple showing of a reduced net profit level in the year in which the delayed project was finally finished, as compared with the previous few years, by itself will rarely be sufficient. The contractor will need to prove, through expert testimony, that the reduced profit level for a given period was more likely than not caused by the defendant’s breach. Compania Embotelladora Del Pacifico, S.A. v. Pepsi Cola Co., 650 F. Supp. 2d 314, 322-23 (S.D.N.Y. 2009). If a contractor does not have a record of making a profit, it will face an even greater challenge in meeting its burden of proof. See, e.g., Water Engineering Consultants, Inc. v. Allied Corp., 674 F. Supp. 1221, 1224 (S.D. W. Va. 1987).

Diminished bonding capacity claims should be evaluated to determine whether the foreseeability and reasonable certainty requirements can be satisfied. In determining whether a contractor has proven that its lost profits resulting from lost bonding capacity were foreseeable, a number of courts have found such lost profits “were not actually foreseen nor reasonably foreseeable.” Daniel Int’l Corp. v. Better Const., Inc., 593 So. 2d 524 (Fla. 3d DCA 1991). Even if the contractor proves that its lost bonding capacity was reasonably foreseeable at the time the contract was singed, it must still prove with reasonable certainty the amount of profit it would have earned, but for the lost bonding capacity. This might require the contractor to identify specific jobs it bid on—or would have bid on, but for its inability to obtain a bid bond—and demonstrate the profit it would have earned on each such project using generally accepted accounting principles.

Like other parties to a construction contract, a project owner may also be entitled to consequential damages for “untimely” or “defective” work. Thus, if a contractor furnishes incomplete or nonconforming work, the owner is generally entitled to recover the difference between the original contract price and the actual cost to compete the project in conformance with the parties’ agreement.[2] While a contract may require the owner to absorb certain expenses such as inspection fees and utilities, those expenses would be direct damages. However, fuel expenses and increased labor costs resulting from a defect or delayed installation can show cause for consequential damages. Project financing can also cause consequential damage claims when an owner is forced to pay additional interest on a construction loan when a project is not completed by a specific date. Although, when determining the type of damages appropriate in that circumstance, a court would likely take into consideration the “sophistication” of the parties as well as the language of the contract to see if it alludes to financing provisions. See Chestnut Hill Dev. Corp. v. Otis Elevator Co., 739 F. Supp. 692, 703 (D. Mass. 1990).

Similar to contractors, project owners may recover for lost profits, such as loss of income, due to the delay in a construction project by the contractor. Lost profits in that scenario is a result from the owner not being able to use the property while in the delay period, causing possible damages such as loss of reasonable rental payments. However, like most claims for consequential damages, the owner might have to specifically plead facts to show that the construction project was entered into for creating rental income. Another form of lost income is loss of resale profits due to inexcusable delay, measured by the difference in fair market value on the actual date of completion and the date specified in the contract. Cates Constr., Inc. v. Talbot Partners, 980 P. 2d 407, 412 (Cal. 1999). Owners seeking to recover loss of resale profits in the current economy, reasoning that the unit would have been sold prior to the downturn absent the contractor’s delay, will need to show lost profits resulting from its inability to sell were within reasonable contemplation of the parties at the time of contracting. Elar Invest. Inc. v. Southwest Culvert Co, Inc., 676 P.2d 659, 665 (Ariz. Ct. App. 1983).

When negotiating the terms of a construction contract, many times consequential damages are addressed by a liquidated damages provision. In most jurisdictions, a contractual liquidated damages provision will be enforced if: (1) at the time of contracting, the amount fixed was a reasonable forecast of the just compensation for harm caused by the breach and (2) the harm caused by the breach is very difficult to estimate accurately. Brooks v. Bankson, 445 S.E.2d 473 (1994). A liquidated damages provision will not be enforced if, under the circumstances, it is more in the nature of a penalty. City of Rochester v. E&L Piping, Inc., 764 N.Y.S.2d 514 (N.Y. Dist. Ct. 2003). Liquidated damages are a substitute for actual damage; thus, recovery of liquidated damages bars recovery of actual damages. A provision that allows the owner to choose between liquidated damages and actual damages or that permits the owner to pursue them both is void. MCA Television Ltd. v. Pub. Interest Corp., 171 F.3d 1265, 1272 (11th Cir. 1999).

Many contractors and architects attempt to allocate risk and responsibilities for consequential damages with owners using contract waivers. Starting in 1997, major design and construction trade organizations included forms of waivers in their standard design and contractor trade association contracts. Contractors and designers are leveraging this promotion of contract waivers by their trade organizations with the assertions that these waivers are now standard in contracts. Further, owners have increasingly insisted upon these waivers worded to suit their interests. Seeing this increased interest and use of trade association contract forms, it is important for constructions lawyers negotiating these provisions to become acquainted with the complicated issues these waivers address, and the contract interpretation issues within them.

These waivers attempt to identify specific risks considered by the contracting parties to be “consequential damages,” which one party then waives the right to recover from the other, and requiring the contracting parties waive in advance any future claims they might have against the other. These waivers may be unintended and unexpected results; therefore, these waivers should be carefully evaluated and modified to reflect the parties’ expectations regarding which damages are to be waived, and those that are not to be waived.[3]

Owners and contractors take on negotiation of these waivers from decidedly different views. Contractors tend to view such waivers so that the contractor’s potential exposure is proportional to its compensation under the original contract. Owners, on the other hand, generally believe the contractor should be accountable for damages caused by its failure to manage risks within its control, regardless of the extent of the risks. Moreover, owners may view standard waivers as unjustifiably favoring contractors. This conflict can be solved by equal and fair allocation of risks to the contractor that it can successfully and effectively manage, compensation proportionate with those risks, insurance, and offsets to the owner in exchange for an agreement to limit the risks to the contractor under applicable law.

When incorporating these provisions, they should be clearly defined to avoid uncertainty about whether certain elements of damages are within the definition of consequential damages. See Gulf American Industries v. Airco Indus. Gases, 573 So. 2d 481, 489 (La. Ct. App. 5th Circ. 1990). Furthermore, if both a waiver of consequential damages and liquidated damages clause exist within a contract, the contract should clearly state that the liquidated damages clause is a limited exclusion to the waiver of consequential damages. Parties negotiating mutual waivers should consider the following general approaches: (1) attempt to identify each type of risk and expressly allocate prevention or mitigation responsibility between the parties; (2) identify damages that may result from breaches of particular contractual obligations and decide in advance (i) whether such damages will be recoverable, and (ii) the appropriate measure of damages; (3) identify damages the parties agree to waive with the greatest precision possible, and define ambiguous terms; (4) consider other provisions of the draft contract that might later be construed as inconsistent with or excepted from the waiver; and (5) add cross-references, order-of-precedence language, and other terms necessary so the contract as a whole clearly and accurately reflects the parties’ intent.

Many factors can impact the recoverability of consequential damages, such as common law implied warranties, or indemnity provisions. Therefore, when entering into a construction contract, parties should carefully evaluate the proposed contract language to fully comprehend the risks they are about to assume. In order to prevent any extensive consequential damages that might result from a construction project, parties should use whatever power they may have while creating their contract to predestine certain expenses that a party would incur in the event of pervasive defects or significant project delays. Even after the contract is formed and the construction project is ongoing, parties should still regularly refer back to their contract, and make reasonable efforts to execute their obligations, so as to avoid possible disputes. Because the economic climate is constantly changing, anticipating obstacles to a construction project is particularly important when entering into a contract. Ultimately, the difference between substantial and reasonable damages can be decided by taking the time to appreciate contract language and negotiate terms that create an equitable balance of responsibility.