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Understanding Consequential Damages

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To fully understand how contracts for DG projects should address consequential damages, it is important to understand what they are and how they differ from direct damages.

Direct vs. Consequential Damages

Direct damages are losses that one would reasonably expect to be incurred by a non-breaching party to a construction contract when the other party breaches the contract. Examples of direct damages include unpaid contract amounts and costs to repair defective work.

Consequential damages, on the other hand, result from special circumstances that are not usually foreseeable by the contracting parties at the outset of a project. These damages flow indirectly from a breach of contract or performance of services on a construction project. Lost business revenue by an Owner is a good example of a consequential damage.

It is entirely reasonable for DG to contractually assume responsibility for losses that arise directly from our negligence, and we are appropriately insured to do so. However, because of their unpredictable nature and potentially exorbitant cost, we should avoid signing up for consequential damages. The following hypothetical illustrates why:

A Hypothetical Scenario:

Say DG is working on a large greenfield project. We are on budget and on target to complete the project before the end date memorialized in the contract. Equipment is getting delivered and installed. The PM is making vacation plans. Suddenly, a critical piece of product equipment starts malfunctioning. All attempts to fix it fail and the project is veering off schedule.

The Owner sends written notice to the project team informing them that they have been relying on the completion date to go into production and fill an order for their largest customer. The Owner informs the project team that they will hold DG responsible for any and all consequential damages as a result of project delays. The PM checks DG’s contract. It does not contain a waiver of consequential damages.

The Owner’s damages in this case are consequential in that they do not directly relate to the missed project completion date. Instead, the Owner’s damages relate to loss of production. We can generally quantify what an Owner’s direct damages might be if our services are negligently performed and need to be re-performed, or the work of our subcontractors is defective and needs to be repaired. However, the losses that the Owner would suffer if they could not make product are a huge unknown and it would be extremely difficult to anticipate DG’s potential exposure and insure against such risk. For this reason, we should seek waivers of consequential damages in our contracts.

Contract Tips on Consequential Damages

1. It is critical to have a carefully drafted waiver of consequential damages clause that we can rely on if something goes wrong on a project. The following is an example of a reasonable waiver of consequential damages clause:

Contractor and Owner waive all claims against each other for consequential damages arising out of or relating to this Contract. This mutual waiver includes (1) damages incurred by Owner for losses of use, income, profit, financing, business and reputation, and (2) damages incurred by Contractor for losses of financing, business and reputation, and for loss of profit except anticipated profit arising directly from the Work.

2. It is important to understand precisely what damages are and are not waived in a consequential damages clause. It is becoming more common to see exclusions in waivers of consequential damages that effectively render a waiver useless. Watch out for such illusory waivers of consequential damages.

3. Don’t forget your subcontracts! DG’s standard subcontract forms include a mutual waiver of consequential damages. This is beneficial for both DG and our subcontractors. However, it is important that we align any waiver of consequential damages (or lack thereof) in our agreement with the Owner with our subcontracts.

If we have no waiver of consequential damages in our contract with the Owner, we should not include a waiver of consequential damages in our subcontracts. Why? If a client alleges DG is responsible for consequential damages that arise out of the performance of our subcontractors, DG is responsible for covering the Owner’s losses and cannot recoup them from our subcontractors.

If a waiver of consequential damages in our agreement with an Owner is effectively no waiver at all as discussed above, we should flow down the same language to our subcontracts so that there is no gap in what we owe to the Owner and what we can recover from our subcontractors.

How to Review a Non-Disclosure or Confidentiality Agreement

From time to time, Dennis Group (DG) is asked to sign Non-Disclosure Agreements or Confidentiality Agreements (“NDA”). Typically, we'll receive NDAs while pursuing a project or at the beginning of a project. It's important to know what DG’s obligations are under an NDA and to conduct yourself accordingly because to the extent you are working on projects subject to NDAs, these agreements apply to you.

The following guide will help you review and understand the language of an NDA.

Defining "Confidential Information"

The definition of Confidential Information is a key clause in an NDA. Confidential Information typically includes items such as information concerning the subject matter of the NDA (e.g., our client’s or potential client’s project). Confidential Information can also include financial information, trade secrets, intellectual property, proprietary and other sensitive information of the party seeking protection from the NDA. Sometimes NDAs are mutual, meaning that the agreement protects the Confidential Information of both parties.

Watch out for:
Make sure that you understand the scope of what is defined as Confidential Information. It is often useful to require that the party disclosing Confidential Information label it as such so there's no misunderstanding and we can care for and treat the information appropriately. Do not underestimate how broad the scope of Confidential Information can be. Along with everything listed above and more, it can also include DG’s work product.

Exclusions from Confidential Information

NDAs also typically contain language to clarify what should not be considered Confidential Information. Some common examples of exclusions include information that was in the public domain or already in the receiving party’s possession at the time of disclosure and information required to be disclosed pursuant to law.

Term of Agreement

The term of an NDA is the period of time during which our obligation to maintain confidentiality lasts. Typically, this term encompasses a period of years. We usually see 3, 5, or 10-year terms.

Watch out for:
How we must treat Confidential Information pursuant to an NDA can be more stringent than how we are accustomed to treating our own confidential information. No matter what our intended use of Confidential Information may be, whether it be for marketing purposes or otherwise, we should always seek written permission from the disclosing party when in doubt.

Confidentiality Obligations

In addition to understanding the breadth of what does and does not constitute Confidential Information in an NDA, it is important to know what our actual obligations are. NDAs typically state that the Confidential Information must be held by the recipient in strict confidence and that the Confidential Information must not be used for any other purpose. Most NDAs also state that Confidential Information must not be disclosed without the prior written consent of the party disclosing the information.

Watch out for:
In rare instances, we may find that the obligation to maintain confidentiality pursuant to an NDA is perpetual. We should push back on such obligations because they are overly burdensome from an administrative standpoint.

Application to Third Parties

When we enter an NDA, it typically applies to employees, consultants, subcontractors, and agents. Therefore, we should discuss our confidentiality obligations on a project with our project teams and, at a minimum, send them and our subcontractors a copy of the NDA. We should also ask employees and subcontractors to confirm in writing that they have read the NDA and agree to be bound to it to the same extent as DG is bound. Email is fine for this purpose. For a more formal form of NDA acknowledgment, contact General Counsel.

Return or Destruction of Confidential Information

NDAs often contain a provision dealing with the return or destruction of Confidential Information at the time of termination of the agreement. This may include an obligation to certify in writing that we have destroyed all documents containing Confidential Information that we received. This may be difficult to do 5+ years after the fact and we typically want to retain at least one copy of any project documents for archival purposes.

Remedies for Breach

Money damages as a result of a breach of confidentiality are difficult to ascertain. The appropriate remedy for a breach of confidentiality under an NDA is injunctive relief. In this case, the non-breaching party goes to court and seeks an order directing the breaching party to stop disclosing the Confidential Information.

Watch out for:
Sometimes NDAs contain indemnification clauses for breach of confidentiality. For the same reason that injunctive relief is more appropriate than money damages in the event of a breach (i.e., money damages are unforeseeable and immeasurable), we do not want to agree to indemnify the other party for our potential breach of an NDA.

Red Flags (When to Seek Advice)

Exclusivity/Non-Competition

An exclusivity clause is a promise not to work for a competitor of the party with whom we are entering an NDA. Due to the nature of DG’s business, we should never accept such a provision in a contract. Such promises limit DG’s business for other clients and impacts DG’s obligations under existing agreements.

Intellectual Property

Keep an eye out for language in an NDA that suggests that the other party obtains rights in DG’s intellectual property. One example might be DG’s standard details that we intend to use on the project that is the subject of the NDA and on other projects for different clients. If we do not carefully review language in an NDA concerning DG’s intellectual property, we risk inadvertently transferring our rights in such intellectual property to the other party.

Keep in mind that currently only the Senior Partners have authority to sign NDAs on behalf of DG.

In Conclusion...

The next time you receive an NDA on one of your projects, read through it while relying on this guide. NDAs are usually 5 pages or less in length, so it should not take you long. You will be surprised how much better you understand the language and its implications.

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Legal Bites: Consequential Damages