Construction Risk

Boilerplate Can Burn!

There are no “industry standard” construction form documents.  But the forms issued by the American Institute of Architects (AIA) come close, being widely used.  One key provision to be considered is the issue of consequential damages.

“Consequential damages” are damages, losses or injuries which do not flow directly and immediately from the wrongful act of a party, but rather from some consequence of that act, such as lost profits or damage to reputation.

Some years ago, in the case of Perini Corp. v. Great Bay Hotel, a New Jersey appellate court upheld a fourteen million dollar consequential damages award against a general contractor for the owner’s lost profits resulting from late completion – where the general contractor’s total compensation was only $600,000!

In response to this and similar cases across the country, the AIA, at the urging of contractors, included the mutual waiver of consequential damage in the 1997 forms (see Paragraph 4.3.10) of the General Conditions to the Contract for Construction, AIA Document A201 (1997); there are analogous provisions in the current Owner/Architect agreement forms.).  By eliminating consequential damages, the AIA intended that contractors and architects be protected against damages awards which are grossly disproportionate to the compensation received for their services.

Although the waiver is mutual, owners, contractors and architects need to consider the potential impact of this provision.

For example, consider the development of a luxury condominium project.  The owner/developer probably won’t see a dime of net income until the project is completed and it starts unit closings.  During construction, however, the owner is incurring costs: interest and financing fees; taxes, insurance and other carrying costs; administrative costs, overhead and salary of sales and development personnel.  The owner’s hope of making money is premised, in part, upon construction being completed in time to get units closes and costs paid or eliminated before those costs eat away any chance of profit – or worse.

If the contractor fails to complete by the promised completion date, the owner will pay interest and carrying costs longer than planned.  Equity investors, who have a preferential return on capital, will earn more money, leaving less bottom line for the developer.  Buyers might be able to terminate their contracts because of a missed delivery date.  Contractors can be delayed, too.  Drawings may be incomplete and may need to be revised, resulting in extra delay and expense.

To the extent that these damages are considered “consequential” damages, and a party signed an unmodified AIA contract, that party won’t recover a penny.

An alternative to deleting the waiver is to reconsider liquidated damages.  Liquidated damages are amounts recoverable in a fixed amount upon occurrence of a defined event.  If liquidated damages clauses are drafted properly so as not to be punitive, than after appropriate economic analysis, they are usually enforceable by the courts.

Liquidated damages have been generally anathema to contractors.  Since the adoption by the AIA of the mutual waiver language, however, more contractors are willing to negotiate a serious and meaningful liquidated damage remedy — especially if the alternative is the deletion of the waiver of consequential damages clause, and the possibility of uncapped liability for the contractor.

The moral of the story: If you are presented with an unmodified AIA contract for signature, think twice, because the consequences of signing an unmodified AIA contract could be significant.

ABOUT THE AUTHOR:  Lawrence Moss is an attorney with the law firm of D’Ancona & Pflaum LLC, 111 E. Wacker Drive, Suite 2800 , Chicago , IL 60601 ; Tel: (312) 602-2000.  The firm’s web site is: Report, Vol. 5, No. 4 (May 2003)

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