The Ambiguous Nature of Consequential Damages

by | Dec 29, 2021

By Andy Hilger

Consequential damages and contractual waivers of the same are commonplace in the construction industry. However, when the rubber meets the road, parties often disagree about what actually falls into the bucket of consequential damages. In Michigan, consequential damages can generally be defined as such damages which may fairly and reasonably be considered as arising naturally from the breach and may reasonably be supposed to have been within the contemplation of both parties at the time the contract was made.

Lost profits provides the best example of the ambiguous nature of consequential damages because, depending on what is being claimed, they often fit the definition of both direct damages and consequential damages. The best way to illustrate this is by example. In the following scenarios, suppose a contractor is hired to build a new grocery store and both parties agree to a contractual waiver of consequential damages.

First, consider the damages incurred by the contractor if the owner breaches the contract such that the contractor is unable to complete the project. In this example, the contractor is unable to realize all of the profit built into the contract price. Here, the contractor has the better argument that these profits are not consequential in nature but are instead a direct damage resulting from the owner’s breach.

Next, consider the types of damages the store owner would incur if the contractor breached the contract by not completing the store until 3-months after it was supposed to. The owner will most likely have incurred actual losses in the form of lost profits by not being able to operate the store in the planned timeframe. The contractor will argue that these lost profits are not recoverable as they are consequential in nature. Conversely, the owner will argue that these damages are direct damages because it was reasonably foreseeable and within the contemplation of the parties that it would incur losses by not being able to open the store on time. Scenarios like this are usually the most difficult to determine whether the losses are direct or consequential in nature and may depend on other language of the contract or other facts.

Finally, suppose the owner breaches the contract in such a way that causes the contractor to have diminished bonding capacity. Therefore, the contractor is unable to procure work it otherwise would have been able to procure. In this scenario, who bears the responsibility for the lost profits the contractor could have realized on the contracts with those third parties? The contractor will argue that it was foreseeable that the owner’s breach would cause a loss in bonding capacity and that it is also foreseeable that a contractor would be unable to pursue certain work without sufficient bonding. However, the owner will argue that lost profits based on unknown contracts with unknown third parties was not something within the contemplation of the parties at the time the contract was entered. Absent a showing that this was within the contemplation of the parties, these types of profits are more likely to be deemed consequential in nature.

As a practical tip, parties can avoid unnecessary disputes regarding the nature of consequential damages by further defining the parties’ understanding of the same in the language of the contract.

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