Risk-Shifting

Construction is financially risky due to several factors:

1. Payment Chain: The construction payment chain involves multiple parties, such as owners, lenders, contractors, subcontractors, suppliers, and laborers. Trust is essential for the smooth flow of funds, but it can be challenging to ensure that everyone receives payment as intended. Delays or non-payment at any level can disrupt the entire chain and cause financial risks.
2. Upfront Costs: Construction projects often require substantial upfront costs before receiving payment. Contractors and suppliers may have to finance these costs themselves, relying on credit or borrowing money. This puts a financial burden on lower-tier subcontractors and suppliers who may be ill-equipped to handle such risks.
3. Complex Collaboration: Construction projects involve numerous contractors, subcontractors, suppliers, vendors, laborers, and equipment lessors. The complexity and interdependence of these parties increase the potential for errors, delays, disputes, and liability issues. Collaboration is necessary for project completion, but when it comes to payment, parties may prioritize self-interest, leading to a protectionist mindset.

Contractual language terms can further shift the financial risk in construction contracts:

1. No Lien Clauses: Some contracts include "no-lien clauses" that waive the ability to file mechanics liens, which provide security for payment. While some states prohibit or regulate such clauses, others may allow them, potentially depriving contractors and suppliers of their lien rights.
2. Subordination of Mechanics Lien Rights: Lien subordination clauses can affect the priority of mechanics liens in case of foreclosure. Contractors' lien rights may be undermined if other security interests or claims take precedence, reducing their chances of getting paid.
3. Pay-if/when-paid Clauses: Contingent payment clauses, such as pay-when-paid and pay-if-paid clauses, determine when contractors, subcontractors, and suppliers receive payment. Pay-if-paid clauses can be particularly risky because payment to lower tiers depends on the contractor receiving payment from higher tiers. The enforceability of these clauses varies by state.
4. Indemnity Clauses: Indemnification clauses transfer certain risks and liabilities to another party. These clauses can hold contractors responsible for claims, damages, or expenses arising from their performance, including personal injury or property damage issues.
5. No Damages for Delay: No damages for delay clauses limit compensation for delays caused by another party's actions. Contractors may only receive time extensions without monetary compensation, while subcontractors bear the financial losses resulting from the delay.
6. Mutual Waiver of Consequential Damages: Consequential damages are indirect damages resulting from a contract breach. A mutual waiver of consequential damages clause can limit the contractor's liability for such damages, shifting the financial risk to the owner.
7. Caps on Liquidated Damages: Liquidated damages clauses establish predetermined amounts of damages for specific breaches or consequential damages. If the cap is too low, contractors may have limited recourse if the damages exceed the predetermined amount.
8. Short Claim Notice Deadlines: Some contracts impose short deadlines for submitting claim notices, making it difficult for contractors to comply. Failure to meet these notice requirements can result in the loss of the claim, even if it is valid.

These provisions aim to protect the employer's interests and impose obligations on the contractor. why contractors may agree to these clauses despite their potential disadvantages?

1. Competition and market pressure:

Contractors may feel compelled to accept onerous contract terms due to intense competition in the construction industry. If they refuse to sign such agreements, they risk losing out on lucrative projects to competitors who are willing to accept the terms. The desire to secure work and maintain a steady flow of projects can outweigh the concerns associated with the contract clauses.

2. Prestige and reputation:

Contractors may be motivated to accept unfavorable contract terms for prestigious projects that offer significant visibility and enhance their reputation. In some cases, being associated with high-profile projects can lead to future opportunities and increased credibility in the industry.

3. Limited negotiation power:

Depending on market conditions, contractors may have limited bargaining power when negotiating contract terms. Employers, particularly those with substantial resources or well-established reputations, may be less willing to entertain amendments or modifications to the contract. Contractors may feel compelled to accept the terms as presented rather than risk losing the opportunity altogether.

4. Cost considerations:

Contractors may factor in the potential costs associated with legal disputes or arbitration proceedings. Challenging unfavorable contract clauses can be time-consuming, expensive, and uncertain in terms of the outcome. Contractors may calculate that accepting the clauses, despite their disadvantages, is a more cost-effective approach in the long run.

5. Lack of alternatives:

In some cases, contractors may perceive limited alternatives to accepting the terms. They may believe that similar clauses are prevalent across the industry, making it difficult to find projects with more favorable terms. Contractors may choose to work within the existing framework rather than face prolonged periods of reduced work or financial strain.

It's important to note that the decision to accept or reject these clauses ultimately depends on the specific circumstances, including the contractor's financial position, market dynamics, competition, and strategic considerations. Contractors may weigh the potential risks and rewards before deciding to sign such contracts.

1. Enforceability: The enforceability of a damages cap provision may vary depending on jurisdiction and the specific circumstances of the case. Courts may scrutinize such provisions and consider factors such as unconscionability, public policy, and reasonableness. It's advisable to consult with legal counsel to ensure the provision is valid and enforceable in the relevant jurisdiction.
2. Adequacy of the cap: The cap amount should be carefully considered and determined to be reasonable in relation to the potential damages that may arise from a breach. If the cap is set too low, it may not adequately address the potential losses suffered by the owner. Conversely, if the cap is set too high, it may not effectively limit the contractor's liability.
3. Unforeseen damages: A damages cap provision typically aims to limit liability for specified types of damages, such as consequential or liquidated damages. However, it may not cover all possible forms of damages that may arise from a breach, particularly those that are unforeseeable at the time of contract formation. Parties should be aware that certain types of damages, such as punitive damages, are often not subject to limitation.
4. Insurance coverage: A damages cap provision should be assessed in conjunction with the contractor's insurance policies. If the potential damages exceed the cap, it is crucial for the contractor to evaluate whether their insurance coverage is sufficient to address any additional liability beyond the cap.
5. Impact on bargaining power: The inclusion of a damages cap provision may affect the balance of bargaining power between the parties. Owners may be hesitant to agree to a damages cap if they believe it limits their ability to recover adequate compensation for potential losses. As a result, negotiations on the cap amount and other related provisions may be challenging.

Consequential damages

Consequential damages are indirect damages that are not naturally linked to a breach of contract but are foreseeable at the time of contracting. They go beyond the direct or actual damages resulting from the breach and can include various types of losses such as loss of use, lost rent, lost profits, loss of income, loss of reputation, loss of business, and increased financing costs.

One important aspect of consequential damages is their expansive and unpredictable nature. In some cases, consequential damages can far exceed the direct damages suffered by the injured party or even the value of the contract itself. This means that they can have a significant financial impact on the breaching party.

The case of Perini Corp. v. Greate Bay Hotel & Casino, Inc. is often cited as a seminal case involving consequential damages. In that case, an arbitration panel awarded the casino owner $14.5 million for lost profits due to the contractor's delay in constructing the casino. Although the original contract was worth only $600,000, the absence of a waiver of consequential damages provision or a liquidated damages provision allowed the award to be granted. The Supreme Court of New Jersey later upheld the award, stating that the damages (lost profits) were reasonably foreseeable based on the evidence presented.

Creating a Mutual Waiver of Consequential Damages

Including a mutual waiver of claims for consequential damages and defining consequential damages in the contract can help protect contractors and owners from potential liability for indirect or secondary damages that may arise from a breach of contract.

Article 15 of the AIA A201-2017 General Conditions of the Contract for Construction is a good illustration of a mutual waiver of consequential damages. It specifies the types of damages that are considered consequential and therefore waived by both the contractor and the owner.

A risk should be allocated to a party if the following conditions are met:

1. The risk is within the party's control.
2. The party can transfer the risk through insurance, and it is economically beneficial to do so.
3. The party in question has the preponderant economic benefit of controlling the risk.
4. Placing the risk on the party is in the interests of efficiency, including planning, incentive, and innovation.
5. If the risk occurs, the loss initially falls on that party, and it is not practical or reasonable to transfer the loss to another party.

While control of a risk is an important factor in risk allocation, it is not the only consideration. Other principles should be utilized to adequately address risk allocation in construction contracts. For example, events of "force majeure" are beyond the control of either party, but their consequences must still be assessed and allocated.

Four principles for allocating risks in construction contracts:

1. Which party can best control the risk and its consequences?
2. Which party can best foresee the risk?
3. Which party can best bear the risk?
4. Which party ultimately benefits or suffers the most when the risk occurs?

By considering these principles and factors, parties can work towards achieving a fair and equitable allocation of risks in construction contracts, promoting efficiency, collaboration, and successful project outcomes.

It is crucial for contractors, subcontractors, and suppliers to carefully review and understand the contractual terms and potential risks before entering into a construction contract.