Patrick Kelly and Kendall Hudgins | Gray Reed
When project delays occur due to natural disasters, the financial implications can be severe. Construction stakeholders often focus on immediate physical damages while overlooking the potentially devastating impact of liquidated and consequential damages provisions. Understanding these crucial contract elements before disaster strikes can mean the difference between manageable delays and catastrophic financial losses.
Liquidated Damages: The Daily Cost of Delay
Definition and Purpose
Liquidated damages are pre-determined daily charges that come into effect when project delays occur. These charges are specifically designed to provide compensation to owners for losses they anticipate experiencing due to project delays. The liquidated damages provision in the contract essentially attempts to define the owner’s risk in the event of project delays. For these provisions to be enforceable, they must represent a reasonable estimate of the potential damages that could result from such delays, rather than serving as a penalty.
Chain of Responsibility
In typical construction projects, general contractors commonly accept liquidated damages provisions in their contracts with owners. These costs don’t simply stop at the general contractor level; they frequently cascade down through the project hierarchy to affect subcontractors. Given this flow-down effect, it’s crucial for subcontractors to thoroughly review and understand the liquidated damages provisions in the prime contract, as these terms will likely impact their obligations.
Risk Management Strategies
To protect themselves, construction stakeholders should implement several key strategies. First, they should negotiate to limit their exposure to only those damages directly caused by their own fault or negligence. Second, it’s essential to establish reasonable caps on the total amount of liquidated damages that can be assessed. Finally, contracts should explicitly state that force majeure events, such as natural disasters, exclude the application of liquidated damages. In fact, all terms included in liquidated damages provisions should be specific to avoid broad exposure.
Consequential Damages: The Hidden Risks
Definition and Purpose
Consequential damages similarly arise when there are project delays, but these damages are often difficult to define and anticipate when contracting. These damages are designed to compensate parties for any reasonably foreseeable damages at the time the contract was made that may result from project delays. Rather than explicitly defining consequential damages, construction contracts generally include provisions waiving or holding a party liable for consequential damages, which the judge or jury may then retroactively attempt to quantify after the damages occur from project delays.
Types of Consequential Damages
Consequential damages encompass a broad range of potential losses. These include:
- Lost profits that result from project delays
- Business interruption costs that affect ongoing operations
- Damage to professional reputation that may impact future opportunities
- Lost business opportunities that arise from the inability to complete the project on schedule
Protection Strategies
To guard against consequential damages, parties should negotiate comprehensive waivers that limit their exposure. These waivers should specifically include provisions that exclude liability for natural disasters and other force majeure events. Additionally, stakeholders should evaluate their insurance coverage options, particularly regarding business interruption coverage, to ensure adequate protection against these risks.
Best Practices for Damage Provisions
Construction stakeholders must conduct thorough reviews of all damage provisions before executing any contracts. This review should lead to negotiations for clear limitations on liability that protect all parties’ interests. Throughout the project, it’s essential to maintain detailed documentation of any delay causes and their impacts. Additionally, maintaining open and consistent communication with all project parties can help address potential issues before they escalate into significant problems.
Weathering the Storm: Key Takeaways
Liquidated and consequential damages represent significant financial risks in construction contracts, particularly during natural disasters. By understanding these provisions and implementing appropriate risk management strategies, stakeholders can better protect their interests. Remember that the time to negotiate these provisions is before signing the contract—not after a disaster occurs. Work with experienced construction law counsel to ensure your contracts properly address these critical issues.
When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.