By Wolf Saar, FAIA
Imagine that you’re an architect who designed a building for a manufacturer of a new virtual reality technology. During construction, a heavy snowfall results in significant ice buildup, and part of the roof collapses onto the manufacturing floor, delaying project completion. While the contractor installed the roof according to plan, your firm is likely responsible for several design defects that prevented proper drainage and caused the ice buildup.
Your client makes a claim for the cost of rebuilding the damaged structure. Due to the time lost to redesign and rebuild the facility, your client could not fulfill customers’ manufacturing orders and missed out on income and profits. During the redesign and rebuild period, a competitor served the market. Your client makes a claim for lost profits which, by their calculations, far exceeds the cost to rebuild.
The cost to rebuild the facility itself is a “direct damage,” as it directly relates to the alleged contract breach: failure to design a roof to withstand a heavy snowfall and promote drainage. The lost profits that your client claims as a result of the delay in completing the facility is a “consequential damage.” Consequential damages are “indirect expenses” or “expectation damages” connected to the alleged breach and can be significantly disproportionate to your fee or many times the cost of repairing the actual damage. Consequential damages can generally be awarded if they were reasonably foreseeable when the parties entered into the contract. That will be a question for the judge or jury to determine.
A recent case that addressed consequential damages is Perini Corporation v. Greate Bay Hotel and Casino. Originally built in 1980 as the Brighton, the hotel and casino was the first ground-up casino in Atlantic City, but was about half the size of its competitors. It attempted to appeal to “high rollers,” but without boardwalk access or a visible entrance from the boardwalk, the hotel realized no profits in its first years of operation. It suffered severe cash flow problems and low monthly revenue; thereafter, the owners of the Sands in Las Vegas purchased the property.
In 1983, the Sands decided to renovate the property, including the creation of a new entrance and “new glitzy glass façade” to lure customers from the boardwalk. The budget was originally $16.8 million and was subsequently increased to $24 million. In July 1983, the Sands owners hired Perini as construction manager for $600,000.
The Sands informed Perini that it was critical to complete the project by summer to capitalize upon the high season. Perini assured the Sands’ owners they could achieve the summer 1984 target, and the parties agreed to a May 31, 1984 substantial completion date.
Although portions of the project were finished before substantial completion, the entrance and façade were not complete until late August, four months late and at the end of the lucrative summer season. The Sands filed for arbitration of their claim for lost profits. Perini argued that, if either party had contemplated lost profits, the contract would have addressed them. The Sands argued that Perini knew how important the date of substantial completion was, that lost profit damages were foreseeable, and Perini—as the breaching party—should make the owners whole. The panel awarded the Sands $14.5 million in damages for lost profits.
Perini challenged the award in New Jersey state court, where the lower courts affirmed the arbiters’ award. The New Jersey Supreme Court ruled that the Sands’ lost profits were recoverable consequential damages because they were “reasonably foreseeable” and cited four reasons for its decision:
1. Perini was aware of the purpose of the project, i.e. attract new customers.
2. Perini understood the Sands’ desire and need to finish the project before the summer season.
3. Perini knew the Sands owners would delay the project until the following year if Perini couldn’t agree to complete the work on time.
4. Perini was “well aware of the high stakes involved in the Atlantic City casino-construction industry.”
The ruling sent shockwaves through the construction industry. AIA responded in its A201-1997 General Conditions of the Contract for Construction by introducing a clause to address the risks associated with consequential damages. The “waiver of claims for consequential damages” clause waives claims between the owner and contractor for consequential damages arising out of or relating to the contract. On the owner’s side, the mutual waiver includes damages incurred for rental expenses, losses of use, income, profit, financing, business, and reputation, and for loss of management or employee productivity, or the services of such persons. On the contractor’s side, the mutual waiver includes damages incurred for principal office expenses (including compensating personnel stationed there), for losses of financing, business, and reputation, and lost profit. The mutual waiver applies to all consequential damages, but does not preclude assessment of liquidated damages. The waiver continues to be a part of the 2017 release of A201.
Architects should also consider potential damages—and how to limit them—in their contracts. As described in the hypothetical at the beginning of this article, an architect could find itself in the same situation as Perini. Like A201, AIA proactively added a similar waiver to owner-architect agreements. The clause states that an architect and owner waive consequential damages for claims, disputes, or other matters in question arising out of or relating to the agreement. The mutual waiver applies to all consequential damages due to either party’s termination of the agreement. Incidentally, liquidated damages are rare in professional services contracts and not part of the AIA owner-architect documents.
Although the mutual nature of the waiver makes it more likely that an owner will agree to it, it is often a subject of contract discussions. At the very least, including the waiver in A201 and in the owner-architect agreements raises the issue of consequential damages and provides an opportunity to negotiate.
So, what happened to the Sands? The building was imploded at 9:37pm ET on October 18, 2007, the first-ever casino-hotel implosion on the East Coast. It was accompanied by a fireworks show and numerous parties along the boardwalk.
Wolf Saar, FAIA is the current Vice Chair of the AIA Contract Documents Committee and Managing Director of VIA Architecture’s Seattle office, an influential west coast regional practice in architecture and urban planning noted for its leadership in transit, infrastructure and housing design in Canada and the US. Wolf has been a frequent presenter at AIA National Conferences and AIA-sponsored webinars regarding Contract Documents.