For the Client: Considering Consequential Damages

March 2014

COMMUNITIES: PRIVATE PRACTICE
For the Client: Considering Consequential Damages

BY NAHOM GEBRE, ESQ., P.E.

NAHOM GEBRE, ESQ., P.E.Your client wants your professional services for a project where any problem, including a negligent error or omission on your part, could result in significant damages to the client beyond those that are directly caused by you. You have to manage this potential risk.

While it is common in commercial contracts to limit the amount that may be received on account of consequential damages or other specific types of damages—or to exclude such recovery entirely—many clients see no reason to limit the risk of the engineer to direct losses caused by the engineer’s negligence.

Direct Losses Vs. Consequential Damages
Direct losses can occur in any design contract. They are usually measured by conventional objective formulas. They include the cost to cure a problem caused by the party being held responsible. Direct losses could be the costs of repairing a negligently designed roof, the incremental construction costs of adding an element of a project negligently omitted from the design, or the medical expenses of someone injured because of the engineer’s negligence in design or contract administration.

Sometimes, a claimant asserts that the actions of the engineer caused consequential damages—those that go beyond direct losses. Consequential damages are usually defined by courts, and the definitions often vary, but they tend to be those damages that are more remote and difficult to evaluate. They are tangentially related to particular transactions, and more subjective; they also could be of great significance to the client and catastrophic to the engineer. Lost profits caused by delay in completing the project is one example.

Waiving consequential damages means that both parties to the agreement are acknowledging known, and calculable, risks and recognizing that many unclear, and incalculable, risks exist. A mutual waiver of consequential damages is not a completely exculpatory clause for either party, but one that simply limits the liability of each party to a significant, but not catastrophic, amount.

Contractual Liability Vs. Tort Liability
An engineer is potentially liable in both contract and tort to the client. The negligence of the engineer may entitle the client to sue either under a tort theory for negligence or a contract theory for breach of contract caused by the negligence. When a client proceeds under both tort and contract causes of action, each theory of liability has its own distinct damages and its own distinct statute of limitations.

First, damages recovered under a contract theory are measured differently than damages recovered under a tort theory. In certain jurisdictions, this difference may make the tort remedy more advantageous to the client because contract damages are generally limited to direct damages deemed to flow “naturally” from the breach, such as the directs costs of fixing a problem caused by design error. The recovery for additional damages, often referred to as “special” or “consequential” damages, is limited for an action in contract. Thus, damages such as lost profits resulting from the interruption of use of a facility are only awarded under a contract theory when such damages were in the reasonable contemplation of the parties at the time they made the contract.

By contrast, under an action in tort, the limitation of damages may only be tied to the idea of proximate causation and the general policy that denies recovery to certain types of interests. The ability of a client to recover in an action in tort against the engineer when the damages sought are purely economic in character often depends upon whether the breach of contract is considered a tort; in many cases, a breach of contract is not considered a tort unless a legal duty independent of the contract itself has been violated. The possible award of consequential damages is most closely associated with tort law.

With engineers, conduct constituting a breach of contract also may constitute a tort. An engineer has the legal duty to perform the duties of the contract according to the standards of the profession. In a breach of contract situation, the law does not charge a breaching party with all the losses caused by its breach. Usually, the breaching party is not chargeable with all consequential or less direct damages. Yet the foreseeability requirement—the standard used most frequently in determining whether consequential damages can be recovered—has been applied by modern courts in such a way as to diminish protection. For that reason, the engineer should seek to exclude this liability for consequential damages in the contract. This can be done expressly or by limiting the responsibility of the engineer to correction of the work caused by defective design.

It may be in the interest of the client and the engineer to include a mutual waiver of consequential damages. Both EJCDC document E-500, Standard Form of Agreement Between Owner & Engineer for Professional Services (2008), and AIA document B101–2007, Standard Form of Agreement Between Owner and Architect, have a mutual waiver of consequential damages clause. Clauses limiting consequential damages are strictly construed by the courts and are subject to the same general rules with respect to enforceability as applied to other limitation of liability clauses. As in all situations involving legal interpretations, local legal counsel should be consulted for an explanation of the distinctions between direct and consequential damages.

Nahom A. Gebre, Esq., P.E., is a risk management attorney for Victor O. Schinnerer & Co. Inc.

CNA/Schinnerer’s professional liability insurance program has been commended by NSPE since 1957.