Direct vs. Consequential: Why precise contract language matters

When entering into a construction contract, it is important to understand and account for the differences between direct damages and consequential damages, as these differences can determine what damages may be recoverable.

Direct damages, sometimes referred to as general or proximate damages, follow from the type of breach alleged or the damages that directly, immediately, and naturally result from the act complained of. Direct damages compensate for the value of the promised performance and are typically limited to expectation damages, which measure what it would take to put a party in the same position that it would be in had the breaching party performed as promised under the contract. For example, many states permit the recovery of the cost incurred to retain another contractor to complete or correct defective construction work as expectation damages.

Consequential damages include damages that do not directly flow from the breach of contract. Consequential damages are derivative or collateral losses beyond the immediate scope of the contract, and include costs that a party might not have incurred if the breaching party had not breached the contract, but they are not part of what such party was originally supposed to get from the breaching party. Some common examples of consequential damages include lost profits, loss of use, lost rental income, additional payments to contractors due to delays, additional administrative costs, diminution in value, financing costs, rental expenses, and reputational damage.

The distinction between direct and consequential damages can be critical because many contracts, including widely used forms such as the AIA, contain clauses that waive the right to recover consequential damages for claims or disputes arising on a project. In the event of a breach, such a waiver clause would leave direct damages as a party’s only avenue for recovery. Unfortunately, many contracts do not define or list specific examples of consequential damages in conjunction with such waiver clauses, which creates uncertainty for parties by leaving the task of categorizing the different types of damages claimed to the courts.

The importance of the distinction between direct and consequential damages, and the impact of such a waiver clause, were illustrated in a recent decision in Florida. In Orlando Health, Inc. v. HKS Architects, Inc., the owner sought to recover over $5.5 million in repair costs from an architect that the owner incurred due to the defective plans, including costs for repairing a slab, adequately supporting an overhang, evening out a floor, reinforcing beams, and demolishing and reinstalling previously completed work, and costs for peer review services, site visits, and extended project management costs. The parties’ contract contained a non-specific waiver of consequential damages, and the Court found that the owner’s costs of remediation and repair were not consequential damages because the need for extensive repairs arose within the scope of the immediate transaction between the owner and the architect and the costs to repair and remediate were direct, natural, logical, and necessary consequences of the architect’s deficient plans.

The Orlando Health case illustrates the importance of understanding the differences between direct and consequential damages during contract negotiations. From an owner’s perspective, this case illustrates the possibility of recovering repair costs incurred to fix problems caused by design defects, even in cases involving a contractual waiver of consequential damages. For design professionals and contractors, this case illustrates the risk that could potentially be avoided with a robust and explicit waiver of consequential damages.

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