ACREL SPRING MEETINGMARCH 17-19, 2005

LOEWS VENTANA CANYONTUCSON, ARIZONA

THERE MUST BE SOME WAY OUT OF HERE:THE TEN TOP ISSUES IN NEGOTIATING

AIA FORM CONTRACTS

A201 GENERAL CONDITIONS OF THECONTRACT FOR CONSTRUCTION

Lynn R. Axelroth, EsquireBallard Spahr Andrews & Ingersoll, LLP1735 Market Street, 51st FloorPhiladelphia, Pennsylvania 19103-7599Phone (215) 864-8707Direct Facsimile (215) 864-9890Email: axelroth@ballardspahr.comWeb: www.ballardspahr.com©L. Axelroth 2005

Table of Contents

Page

A. WHAT’S AN OWNER OR LENDER TO DO WHEN CONFRONTED WITH AIA DOCUMENTS.................................................................................................11. Introduction..................................................................................................12. The A201, General Conditions of the Contractor for Construction.............2

B. THE TOP TEN........................................................................................................21. Identify the contract documents and limit owner-provided information.....22. Include a requirement to provide and maintain key personnel....................43. Make clear who is designing all portions of the project and address the

issues that flow from contractor designs......................................................44. Expand the indemnification provision to include protection against liens,

governmental fines and/or other losses, including those arising out of the contractor’s breach of the contract...............................................................5

5. Remove the architect as the arbiter of the contract and delete the artificial statute of limitations.....................................................................................5

6. Delete the so-called “mutual” waiver of consequential damages by the owner............................................................................................................6

7. Clarify your payment terms, including change orders and periodic payments......................................................................................................7

8. Review and revise the provisions regarding insurance and bonding...........89. Termination for convenience should be just that and not a windfall for the

contractor.....................................................................................................810. Recognize the lender and provide for its needs...........................................8

C. WRAP UP................................................................................................................9

APPENDIX

A In-depth Look at the A201 “Mutual” Waiver of Consequential Damages A-2

B Lender’s Checklist B -1

i

TOP TEN ISSUES IN THE AIA FORM A201: GENERAL CONDITIONS OF THE CONTRACT FOR CONSTRUCTION

A. WHAT’S AN OWNER OR LENDER TO DO WHEN CONFRONTED WITH AIA DOCUMENTS

1. Introduction

. The AIA forms are among the most widely used in United States construction projects. Because of the familiarity of construction professionals with these forms, it is often argued (and sometimes accurately) that their use will expedite the contract negotiation process. Unfortunately, because the AIA, which publishes these forms, essentially is a trade association for architects and other design professionals, the documents generally afford protections to architects but not to owners and their lenders. Contractors, and sometimes subcontractors, have an impact on these forms because the AIA has sought the endorsement of their respective trade associations on the AIA documents. This endorsement, akin to the “Good Housekeeping Seal of Approval” is an important marketing tool for the AIA. As numerous trade associations and other organizations, such as the Associated General Contractors (the “AGC”), one of the contractor’s trade associations, or the Design Build Institute of America, as another example, develop their own forms, their interest in endorsing the AIA forms, and therefore, their impact on the content of the AIA forms, may become more limited. Whatever the case, despite the AIA’s protestations to the contrary, substantial revisions are necessary in order to protect the interests of owners and lenders. The necessity of doing so is all the more critical because of all the participants in the construction process, the owners and lenders often are the least knowledgeable.

This article identifies some of the issues facing owners and lenders. In many cases, the issues confronting owners and lenders are virtually identical. This is because a lender must always view the construction process as if the lender will be standing in the owner’s shoes, completing an unfinished, failing project. In other cases, their interests may diverge as the lender’s primary focus is its security, but the disparities generally are not too significant.

What follows are a compilation of the top ten issues facing owners and lenders when using the AIA document A201, General Conditions of the Contract for Construction. Included in the sources polled for this article are those issues identified by the Owner’s and Lender’s Division (12) of the ABA Forum on the Construction Industry.1

2. The A201, General Conditions of the Contractor for Construction

1 I had the privilege of chairing Division 12 from 1998, when it was first founded, through 2001. At that time, and in the years following, Division 12 has actively sought to participate in the task forces of the AIA involved in drafting some of the most significant documents. While I cannot say that the Division has had the impact we would have liked, a number of critical issues have been raised, and to some limited extent addressed, in subsequent revisions of some of the documents. We know first hand that while the AIA has from time to time permitted a few owner’s groups to have a seat at the table, owners rarely have had an impact on the menu. You can review Division 12’s list, which is somewhat different from the list in this article, at: http://www.abanet.org/forums/construction/division_12/aiadocs-update.pdf. It also includes comments on the AIA B141, Standard Form of Agreement Between Owner and Architect.

. 2 The A201 supplies the bulk of the non-project specific terms of the agreement between the owner and the contractor. Project-specific terms, such as the time for performance of the contract, the contract sum and the particular scope of work, are set forth in a separate agreement between the owner and the contractor, which accompanies the A201. The A201 can be used with projects where the contract sum is cost plus, cost plus with a guaranteed maximum price or stipulated (or lump) sum, but requires significant tailoring depending upon the type of payment that is being used. Given its flexibility, however, the A201 is one of the most widely used of all of the AIA documents.

An owner generally wants to achieve three things in its construction project, although the relative importance to the owner of each goal may vary from project to project. First, an owner has a specific scope of work in mind, sometimes known as the “program.” Second, the owner needs the work to be completed within a particular timeframe, usually described in a project schedule. Third, and perhaps most importantly, the project (scope and time) must be completed within the owner’s budget. Of course, none of these goals is independent from the other, and as with all aspects of a construction project, the success or lack of success of achieving any one, affects the ability to achieve the balance of the goals.

These three goals were kept in mind when identifying the top ten issues. We recognize that it is an impossible task to select only ten and to make sure that these items are the top ten. Talented individuals will disagree with some of those chosen, no doubt, and they may be correct. I also freely admit to taking an author’s license to include more than ten concepts in the list of top ten, and dare you to try to do otherwise. In any event, the following are those selected. They are listed, more or less, in order of their appearance in the A201, and not in order of importance.

B. THE TOP TEN.

3. Identify the contract documents and limit owner-provided information.

(a) Identify the “contract documents” and their priority . It is important to know just which documents and materials are expected to describe the project and bind the contractor. While this is a blindingly simple premise, the term “contract documents” means something very different in the construction industry from its meaning in other areas of contract law. The term “Contract Documents”1 is defined in subparagraph 1.1.1 of the A201, and includes at least six different categories of items or documents, some of which the contractor is party to, and some of which are provided by others, such as the drawings and specifications prepared by the architect, engineer or other design professional. On the other hand, the list does not include designs prepared by or on behalf of the contractor, such as shop drawings, which are

2 As of the writing of these materials, we are seeking permission from the AIA to publish full text versions of the A201 and the B141. In the past, the AIA foolishly had been reluctant to give permission, but we hope this trend has not continued. If you do not see the documents with the published materials, you will know that we were unsuccessful. We will continue to try to provide them in time to distribute them at the spring program.

1 Capitalized terms not defined in the text have the meanings given to them in the A201.

2

instrumental to defining the final product and may be critical to the success or failure of the project. This is probably a good choice, as the owner does not want to be bound by items it does not control.2

The careful owner will make sure that the A201 sets forth all of the documents and materials that should be included as part of the term “contract documents” whether existing now or to be created later. Moreover, there invariably will be inconsistencies among the documents and an order of precedence, or a mechanism or procedure for determining precedence and resolving inconsistencies, must be included.

(b) Identify the information that the contractor may demand of the owner, and limit the consequences if the information is not provided or is incomplete or incorrect. This can be thought of as part of the exercise of defining the contract documents. Subparagraph 2.2.3 entitles the contractor to rely on the accuracy of information furnished by the owner, except with respect to safety precautions, which remain the contractor’s responsibility. There is no obligation on the part of the contractor, however, to exercise diligence in reviewing the owner’s information, nor is the contractor contractually obligated to inform the owner if it determines that the information is flawed, even if the contractor has actual knowledge that the information is incorrect. The provisions of the A201 make clear that the contractor’s review of the contract documents is for the purpose of facilitating construction only, and not to place any duty on the contractor. Moreover, by including a provision that explicitly states that the review is “made in the Contractor’s capacity as a Contractor and not as a licensed design professional,” the form further attempts to abrogate any design responsibility on the part of the contractor (subparagraphs 3.2.2 and 3.2.3). The subject of design responsibility will be addressed further under the heading numbered “3” below.

Subparagraph 2.2.1 requires the owner to provide certain other information that while not part of the definition of “contract documents,” may have a significant impact on the owner. The owner must provide to the contractor before the contractor starts work, financial information setting forth the owner’s ability to finance the project. Moreover, the owner must also provide such information from time to time “thereafter” upon the contractor’s request. If the owner fails to furnish evidence that financial arrangements are in place sufficient for the owner to “fulfill its obligations under the contract,” the contractor is authorized to stop work. The owner may not “materially vary” the financial arrangements previously disclosed without prior notice to the contractor. There is no reciprocal provision from the contractor, of course. This kind of invasion into the finances of the owner should not be tolerated and would never be acceptable to an owner’s lender, where the consequences could be exponentially more devastating. It does not bear modifying. It should be deleted.3

2 This rationale also supports the proposition that the contractor’s response to a bid or request for proposal should never be included wholesale into the definitions of “contract documents”. Otherwise, there is a risk that the contractor’s qualifications, assumptions or even inaccuracies can be imported unwittingly into the project. The owner may want to include the contractor’s statements about quality and other marketing comments (“puffing”), however.

3 The AGC also publishes a form of contract between an owner and contractor, which integrates an agreement and general conditions into one contract form. The AGC markets its form (e.g., AGC No. 200 - lump sum projects; AGC 230 – cost of the work with an option for preconstruction services) as a more “owner-friendly document. While in many instances that is correct (all things being relative), it also

3

4. Include a requirement to provide and maintain key personnel

. The A201 does not include any requirement that specific individuals or entities be used and available throughout the project (or at such times as they are needed). Of course, one cannot contractually obligate an employee to stay alive during a project (at least one cannot enforce such a provision), nor (at least since the 14th Amendment to the Constitution) is one permitted a contract for involuntary servitude. However, it is permissible and prudent, and fortunately, enforceable if properly drafted, to identify those persons and entities important to the project and to require that they be available and assigned to the project for such time as they are needed. Key personnel provisions could be added to paragraphs 3.3 and 3.9, addressing supervision and construction procedures and superintendence, respectively, and 5.1 and 5.2, defining subcontractors and providing for the award of subcontracts and other contracts for portions of the project work. The absence of provisions addressing this concern is particularly without justification because the drafters of the document demonstrated elsewhere in the A201 that they were aware that the identity of particular individuals and entities can be significant. In subparagraph 4.1.3, for example, the AIA provided an analogous benefit to the contractor by requiring the owner to obtain the contractor’s consent to any architect replacing the one originally identified in the contract.

5. Make clear who is designing all portions of the project and address the issues that flow from contractor designs

. In modern construction practice, it has become customary for certain portions of a project to be designed by specialty contractors or subcontractors. For example, in high-rise office buildings architects often specify general appearance and performance criteria for the curtain wall (outer skin) of buildings. The actual design of the curtain wall, however, usually is undertaken by engineers employed or engaged by the curtain wall subcontractor. The same is true with respect to the design of today’s HVAC systems. More and more design documents and specifications coming from architects are simply performance standards or mandates, such as “the ambient room temperature shall be between 68˚F and 72˚F at all times”. Therefore, a number of different contractors and subcontractors may design portions of the project, in addition to the project architect or engineer. Make sure that they are licensed to do so, are insured and are responsible for their actions.

Subparagraph 3.12.10 of the A201 is an attempt to deal with this issue. It states that the contractor need not provide design services unless the services are specifically required by the Contract Documents (note again the importance of what is included in the definitions of this term) or unless the contractor “needs to provide such services in order to carry out its responsibilities with respect to construction means, methods, techniques, sequences and procedures” (whatever that cumbersome phrase may be determined to mean). The contractor is not required to provide design services in violation of applicable law. However, the A201 does not reconcile what happens if design services are required under one provision, but that it would violate the law to provide them.

contains a virtually identical provision requiring the owner to open its financial information to the contractor. (Paragraph 4.2).

4

If design services are provided by the contractor, it must cause the services to be provided by a licensed design professional. However, there is no affirmative representation from the contractor specifically warranting or covenanting as to whom is providing the design services and the extent of their license to do so. Moreover, the contractor is absolved from responsibility for the adequacy of the performance or design criteria required by the contract documents, whether it is or should be aware of any of their flaws. It is unclear whether the contractor remains liable for the design or engineering services created or provided by its subcontractors, so this language needs to be clarified. Subparagraph 3.12.10 does not deal with the issue of whether the contractor (or any subcontractors providing design services) should be required to carry errors and omissions insurance, which ordinarily is required of design professionals, especially since the design services will not be covered by the contractor’s normal insurance.

6. Expand the indemnification provision to include protection against liens, governmental fines and/or other losses, including those arising out of the contractor ’ s breach of the contract

. The primary indemnity, which is set forth in subparagraph 3.18.1, does not include protection against mechanics’ liens nor for fines that may be asserted by governmental or quasi-governmental authorities or agencies. Moreover, there is no express indemnity for damages arising from a contract breach nor for any losses other than those attributable to personal injury or damage to tangible property (excluding the project property). It excludes consequential, indirect and economic losses (see item #6 below), and losses covered by the insurance policy that the contractor is required to purchase. There is likely to be confusion as to what is or is not covered by insurance and further what happens if certain insurance is not procured, is different from that required, or is procured by someone other than that named in the contract. The prudent owner also will want to modify the provisions of subparagraph 10.3.3, which is a broad indemnification by the owner of the contractor and others with respect to environmental hazards. The environmental indemnification is not limited to the negligent acts or omissions of the owner, and substantially relieves the contractor for its acts and omissions and the acts and omissions of its subcontractors of any tier.4 Also, do not forget to check local laws (common law and otherwise) that affect the enforceability of indemnification clauses. Often they are rendered ineffective because the proper terminology or emphasis was not included as required to comply with law.

7. Remove the architect as the arbiter of the contract and delete the artificial statute of limitations.

(a) An architect is not a judge . In a unique provision, not found outside of the forms published by (or based on) the AIA, the architect is given the role of judge, jury and executioner with respect to project disputes, even if the subject of the dispute is the architect’s own performance. Subparagraph 4.4.1 provides that “[c]laims, including those alleging an error or omission by the Architect. . . shall be referred initially to the Architect for decision” (emphasis added). In matters of “aesthetic effect,” the architect is not simply the initial arbiter. Its decisions are “final.” See subparagraph 4.2.13. The architect also is given judicial immunity,

4 Paragraphs 10.3 through 10.5 bear careful review and editing. They expand the scope of the owner’s liability for environmental problems in significant ways. This did not make the negotiating list of ten, but arguably should have.

5

by relieving itself of liability for the results of its interpretations or decisions so long as they are rendered in “good faith” (subparagraph 4.2.12). Rather than reforming them, these provisions are better excised.

Following the architect’s decision (if not a controversy relating to aesthetics that goes no further), the parties must mediate and then arbitrate (paragraphs 4.5 and 4.6, respectively) before having a right to litigate. Among the most critical problems with the dispute resolution provisions in the A201 is subparagraph 4.6.4, which prohibits the consolidation and joinder in any other proceeding of the architect and any of the architect’s employees or consultants. This wrecks havoc on the principles of judicial economy and fairness. It is almost unheard of that a construction dispute could arise solely because of the acts or omissions of the owner and contractor, excluding the architect, any more than from those of the owner and architect, excluding the contractor. A member of an AIA documents committee once admitted that the reason this provision is included, and that the AIA fights hard to retain it, is that it increases the odds of a favorable decision for the architect.

(b) The AIA should not make law by creating an artificial statute of limitations. Not content as judge, jury and executioner, the AIA, in subparagraph 13.7.1 defines the start of the limitations period for actions between the owner and contractor. It provides different time periods for acts or omissions occurring or deemed to have occurred (i) before the date of “Substantial Completion” of the project, (ii) subsequent to Substantial Completion but before the issuance of the “final Certificate for Payment” and (iii) after the date that the final Certificate for Payment is issued. Events occurring directly on the date of Substantial Completion or on the day that the final Certificate for Payment is issued seem to be unaccounted for. However, even if this problem were corrected, this provision should be stricken. There already is much law in each jurisdiction relating to statutes of limitations, and the contract should allow local law to apply. There is no good reason for the AIA to insert itself into a purely legal matter such as this. It adds to the confusion of already complex construction projects and provides additional opportunities for litigation.

8. Delete the so-called “mutual” waiver of consequential damages by the owner

. In 1997, the AIA inserted one of the more controversial of its provisions into the A201. It is subparagraph 4.3.10, which provides that the contractor and the owner waive all claims against each other for consequential damages arising out of or relating to the contract. While the drafters of this provision claim that it is even handed, it is arguably more beneficial to the contractor for a number of reasons:

(i) Because of difficulties in proof, contractors often were precluded (or at least limited) from obtaining relief for economic losses that may be considered consequential, such as home office overhead, so the impact of saying that these types of damages are now waived is not very great as to the contractor.

(ii) Under other provisions of the A201, the contractor is able to recover certain elements of its lost profits and other consequential damages, while the owner (or the lender standing in the shoes of the owner) is precluded not only from

6

recovering consequential damages, but also from recovering losses that generally are not thought of as consequential ones. For example, the provision expressly forbids the owner from recovering for increased interest payments if it has to extend construction financing. This kind of increased cost generally is not treated as a “consequential damage” under the law, but as a direct, recoverable type of damage.

The provision contains a confusing reference limiting recovery of liquidated damages in the event of delay, and calling into question whether parties can contractually agree as to the amount of delay damages that should be paid. This is an attempt to eliminate liquidated damages clauses, thereby leaving the owner (or lender) with no relief other than perhaps expensive insurance protection for the extensive losses that can result from a project with a contractor-caused delayed opening. Imagine the losses arising from a lost lease, or sale, late or reduced rental stream or missed or lost tax advantage. Now imagine that there is no recovery or recompense, even if the contractor unquestionably causes foreseeable losses and the contractor is the only party that could have controlled the risk.5

9. Clarify your payment terms, including change orders and periodic payments

. There are too many issues relating to payment terms to address them in this summary format. However, an owner must be alert, among other things, to the following:

(a) Whether the definition of “Contract Sum” (subparagraph 9.1.1) dovetails with the provisions set forth in the Agreement, particularly when dealing with “cost plus” or “cost plus a guaranteed maximum price” contracts. The Agreement may permit, or be silent with respect to whether there is payment for defective work, payment for the costs to the contractor of its disputes with its subcontractors, reimbursements to the contractor for bonuses to employees and for the performance of warranty work, and other questionable costs.

(b) Many jurisdictions now have prompt pay or other acts that overrule contract terms or supply them in areas where none are provided. While clause .1 of subparagraph 9.5.1 permits an owner to withhold payment for “defective work not remedied” that characterization may not be sufficient for state law purposes. Clause .7 permits withholding for “persistent failure to carry out the Work in accordance with the Contract Documents.” Can an owner or lender seriously wait until the contractor’s failures can be characterized as “persistent” before withholding payments to protect itself and the project?

(c) The architect limits the scope of its review of payment applications and the project (see subparagraphs 9.4.2, 4.2.2 and 4.2.3). The owner, or the lender, may require a more in-depth analysis or evaluation. While the architect limits its liability, it gives itself the right to approve and disapprove the elements of the project. The owner must decide whether it truly wants (or is permitted by its lender) to cede “approval” rights to the architect under all circumstances. The architect’s review should be a recommendation only. While it may be a condition precedent for payment to the contractor that the architect approve the application, it should not bind an owner to pay a contractor if the owner is not satisfied (even if the architect is).

5 An article more fully dealing with this provision, which was previously submitted to ACREL as part of the Spring 2000 meeting, is attached as Appendix A.

7

Conversely, an owner may want to approve something that an architect may want to reject. An analogous situation appears in the context of change orders. Subparagraph 7.3.8 provides that to the extent the owner has unilaterally ordered a change in the contractor’s work, the architect is authorized to make an interim determination with respect to any amounts due the contractor. The parties may appeal the interim decision in an arbitration proceeding; however, they must comply with it before the appeal, including payment of the amounts the architect deems not to be in dispute. This may not be what the owner, or the owner’s lender, had in mind.

(d) Payment terms and release of retainage, are tied to achieving “Substantial Completion” and final completion. Therefore, the definitions of these terms are critical. Subparagraph 9.8.1 should be expanded, with all of the essential elements of completion noted, along with necessary use and occupancy and other governmental and regulatory approvals and permits that are needed by the owner.

10. Review and revise the provisions regarding insurance and bonding

. Article 11 provides many opportunities for concern and negotiation. Arthur Pape is addressing these more fully in his materials. For purposes of this summary, we will leave a warning: “Beware!” The provisions are technical in part and impose substantial requirements on the owner to carry specific types of property insurance, with unexpected elements such as requiring the owner to cover work stored off-site as well as losses not covered by the contractor’s deductibles. (See subparagraphs 11.4.1.4 and 11.4.1.3.)

11. Termination for convenience should be just that and not a windfall for the contractor

. Subparagraph 14.4.3 assures that a contractor’s children will always be well fed, well dressed and well educated. Many projects, especially public ones or ones where the public has an interest, require that the public owner must be able to cancel it, without cause. This type of provision also is useful – some say essential – in all agreements. Consider what happens when a contractor may be performing less than adequately, but not so egregiously that a termination for default would be easily established. If a termination is contested, the costs of litigation may be prohibitive even if the suit ultimately is won. In those cases, if an owner can terminate the contract without cause (for convenience) it is fair for the contractor to receive payment for all work properly performed and costs properly incurred, along with demobilization (or stand down) costs, and perhaps a small incentive payment for the contractor’s trouble. The A201, however, gives the contractor all of that as well as “reasonable overhead and profit on work not executed.” If the contractor receives its overhead and profit on work it has not performed, the owner essentially is paying for the balance of the project, without getting any of the benefit. The contractor’s allocated rent and home office employees and equipment are all covered, despite the fact that they can be allocated to other projects. The contractor gets all of the benefit, but none of the risks of the project – risks that often translate into losses as part of a normal construction project.

12. Recognize the lender and provide for its needs

8

. It is a rare project that does not require financial assistance from an outside institution, government, investor, bond issue or other third party. That third party has interests that need to be acknowledged and protected, but which are not recognized in the A201. The only provision purporting to benefit a lender is subparagraph 13.2.2. That provision allows assignment of the construction contract to “an institutional lender providing construction financing for the Project” (emphasis added). The two elements required, that it be construction (and not permanent, equity or other) financing and be by an institution (and not governmental, bond investor or other lender) cover only a fraction of the many types of financing utilized in modern construction projects. Moreover, when and how the assignment is effected is unclear. Unfortunately, what may be most clear is that the lender is obligated to assume all of the owner’s obligations under all of the contract documents, a status that likely conflicts with the requirements of the lender’s loan agreements with the owner.

The lender may be most concerned with the payment provisions, and these appear in many parts of the contract. A lender must make sure that: it does not pay for work already paid for by the owner; that it has sufficient evidence that the work is properly completed; that it does not have to pay for work off-site or where liens have or may attach; and that a party not bound to the lender is not making financial decisions binding the lender. Unfortunately, all of the foregoing concerns exist with the A201. For example, subparagraph 7.3.8 provides that where the parties have not reached agreement on a change order, the architect will make an interim determination. The parties can appeal that determination, but the disagreement must first be taken to the architect! Lender’s counsel will need to read the entire document, but certainly will pay closest attention to Articles 2 (containing the owner’s obligations, which it may have to assume), 7 (relating to changes in the work), 8 (governing time), 9 (governing payments and completion), 11 (covering insurance and bonds), and 14 (governing termination and contract suspension).

It is not only modifications to existing provisions that are needed. Provisions need to be added, such as requiring dual obligee riders to insurance bonds, broad indemnification of the lender, and lien waivers and releases in its favor. Attached as Appendix B is a checklist that will assist a lender (or a lender’s lawyer) in the evaluation of a construction contract. While not containing every issue, it addresses some of the most common concerns.6

B. WRAP UP.

There are many tens of top ten items to negotiate when using the A201 and the other AIA family of documents. There also is no way to know which items will be the most important without knowing the details of the project and the particular interests of the client. Each owner’s

6 Another source for these and other issues facing both the owner and the lender is Fundamentals of Construction Law, edited by Carina Enhada O’Hara, Cheri Gatlin and Fred Wilshusen, and published by the ABA Forum on the Construction Industry in 2001. The first chapter is entitled “The Owner’s Perspective” and could have been called “The Owner’s and Lender’s Perspective.” (It has been given some authority by its recent citation by the Colorado Supreme Court in BRW, Inc. v. Dufficy & Sons, Inc. No. 03SC104, Advance Sheet, October 4, 2004). There also are chapters on other aspects of the construction process, including the rights and responsibilities of design professionals, prime contractors and subcontractors, damages, dispute resolution, and scheduling, among other things. There also is a list of useful websites, a glossary of terms and a summary of significant cases.

9

appetite for risk and ability to control and allocate the risks will be different. The one consistent element, however, is that the form must be modified, and modified substantially.

10

APPENDIX A

IN-DEPTH LOOK AT THE A201 “MUTUAL”WAIVER OF CONSEQUENTIAL DAMAGES

DEVELOPING THE PROJECT –

WHAT’S NEW IN THE YEAR 2000

AIA CONTRACT DOCUMENTS:OF ANTELOPES AND ALLIGATORS –

THE AIA A201 WAIVER OF CONSEQUENTIAL DAMAGESFROM THE OWNER’S PERSPECTIVE

AND OTHER TROUBLING TALES

REPRINT FROMACREL SPRING 2000 MEETING

MARCH 30 - APRIL 2, 2000PALM DESERT, CA

©2000

Presented byLynn R. Axelroth, EsquireBallard Spahr Andrews & Ingersoll, LLP1735 Market Street, 51st FloorPhiladelphia, PennsylvaniaPhone: (215) 864-8707Fax: (215) 864-9890Email: axelroth@ballardspahr.com

Appendix APage 1

Table of Contents

Page

I. INTRODUCTION.........................................................................................................1

II. THE PROBLEMS WITH THE WAIVER....................................................................2A. What Are Consequential Damages?..................................................................2

1. According to the A201 (1997)...............................................................22. The Definition According to Case Law.................................................3

B. Further Ambiguity...........................................................................................101. Are the Contract Documents Complementary?...................................102. Liquidated Damages............................................................................153. How “Similar” is “Similar”?................................................................184. How “Mutual is “Mutual”?..................................................................18

C. The Biggest Antelope of All -- Recharacterization of Costs...........................181. The Impetus for Recharacterization of Costs.......................................182. Examples of Recharacterization..........................................................19

III. POLICY ISSUES.........................................................................................................20A. Mitigation of Damages....................................................................................20B. Allocation of Risk............................................................................................20C. Punishment of the Breaching Party..................................................................21

IV. CONCLUSION: INCREASED WORK FOR LAWYERS........................................22

Appendix APage 2

AIA CONTRACT DOCUMENTS:OF ANTELOPES AND ALLIGATORS –

THE AIA A201 WAIVER OF CONSEQUENTIAL DAMAGESFROM THE OWNER’S PERSPECTIVE

AND OTHER TROUBLING TALES

I. INTRODUCTION

There is no reason that you should know this, but in my family we use the word “antelope” to describe unexpected and unplanned-for events. For example, it is an “antelope” event if you’re delayed while driving to the airport because a truck overturns on the highway, releasing its load of chickens, and the road is closed while the police, the Department of Agriculture and volunteers from the SPCA try to herd the panicking poultry in. This is more than normal rush hour traffic or even a fender-bender delay. This is a serious “oops”.

Alligators, by contrast, act predictably. We know that they are likely to take a big bite out of whatever is nearby. If an alligator is hungry, and there is prey within its sights, the alligator quickly snaps it up and swallows it down.

Well, it is of antelopes and alligators that I think when I review the latest edition of the AIA A201 General Conditions of the Contract for Construction,1 and, in particular the “mutual” waiver of consequential damages clause. Although this waiver has been promoted as being both fair and of benefit to the whole construction industry,2 I think it fails of its purpose, leaving the parties with antelopes and alligators to address and avoid.

This paper will review the problems with the new waiver of consequential damages, beginning with the difficulty in defining the terms in the waiver and the resultant ambiguity. It will also explore other ambiguities in the contract language, with particular emphasis on the impact on liquidated damages clauses. It will also note the potential for contractors to recharacterize costs to avoid the results of the waiver. Finally, the paper will briefly outline some of the policy reasons for eliminating the mutual waiver.

The mutual waiver of consequential damages is one of the most significant changes in the A201 (1997), but it is by no means the only area of concern in the AIA family of documents. Attached to this article, as Appendix I, is an outline of some of the major issues facing owners and lenders when using the AIA’s most common construction contract delivery forms.

1 The latest edition of the AIA A201 General Conditions of the Contract for Construction will be referred to in this paper as “A201 (1997)”.

2 See Howard Goldberg, Memorandum to Documents Committee April 18-20, 1996, p.1: “By their subjective nature, these claims [for consequential damages] typically are the largest, most costly and the most likely to lead to a windfall to one party and economic disaster to the other. The possibility of a windfall recovery is one of the most substantial impediments to settlement in disputes over delays or change orders. Eliminating these exposures should substantially reduce the overhead cost of contractors for the benefit of the whole construction industry.”

Appendix APage 3

II. THE PROBLEMS WITH THE WAIVER

A. What Are Consequential Damages?

1. According to the A201 (1997).

New subparagraph 4.3.10 of the A201 (1997) reads as follows:

4.3.10 Claims for Consequential Damages. The Contractor and Owner waive all claims against each other for all consequential damages arising out of or relating to this Contract. This mutual waiver includes:

.1 damages incurred by the Owner for rental expenses, for losses of use, income, profit, financing, business and reputation, and for loss of management or employee productivity or of the services of such persons; and

.2 damages incurred by the Contractor for principal office expenses including the compensation of personnel stationed there, for losses of financing, business and reputation, and for loss of profit other than anticipated profits arising directly from the Work.

This mutual waiver is applicable, without limitation, to all consequential damages due to either party’s termination in accordance with Article 14. Nothing contained in this subparagraph 4.3.10 shall be deemed to preclude an award of liquidated direct damages, when applicable, in accordance with the requirements of the Contract Documents.

New subparagraph 4.3.10 lists examples of the “consequential damages” that the owner and the contractor are expected to waive. Other than the listed examples (such as, with respect to the owner, “rental expenses and loss of use, income, profit, financing, business ... reputation, and ... productivity ....” and with respect to the contractor, “principal office expenses ... loss of financing, business ... reputation, and profits ... other than [with respect to] ... the Work”), there is no other definition, reference or explanation provided in the document of what is intended by the mutual waiver of damages. Perhaps the intent of this provision is found by referring to other provisions of the General Conditions. For example, subparagraph 1.2.5 of A201 (1997) provides that “well-known construction industry meanings” are to be used in interpreting the contract documents. Unfortunately, there are no recognized meanings to the words “consequential damages.”3

3 Subparagraph 1.2.5 of the A201 (1997) provides as follows: “Unless otherwise stated in the Contract Documents, words which have well-known technical or construction industry meanings are used in the Contract Documents in accordance with such recognized meanings.”

Appendix APage 4

2. The Definition According to Case Law.

Although damages are a fundamental issue in breach of contract cases, no two courts or treatises define consequential damages in the same way.4 Further complicating the issue, the definitions used by the courts often appear to be at odds with the resulting categorization found by those same courts.

The ancient case of Hadley v. Baxendale5 still features prominently in present day discussions of consequential damages.6 Notwithstanding these ancient roots, a working definition of consequential damages in the context of construction contracts is difficult to come by. One court recently admitted that it had been unable to find any California case defining consequential damages.7

Although this paper will not attempt a definitive discussion of the definition of consequential damages, it will point out the contradictions in the area and, thus, the opportunity for confusion and controversy.

Consequential damages have been defined as:

(1) damages that may not naturally flow from the breach but arise from special circumstances;8

(2) damages “which arise from the intervention of ‘special circumstances’ not ordinarily predictable ... [and which] are compensable only if it is determined that the special circumstances were within the ‘contemplation’ of both contracting parties,” and where “‘contemplation’ includes what was actually foreseen and what was reasonably foreseeable”;9

4 For general rules governing awards for breach of a construction contract, see Crankshaw v. Stanley Homes, Inc., 131 Ga. App. 840, 207 S.E. 2d 241 (1974); J. Calamari & J. Perillo, Contracts, §§ 14-17, 22 (1970); J. Corbin, 5 Contracts, §§ 1089, 1094 (1951).

5 9 Ex. 341, 156 Eng. Rep. 145 (1854).

6 See, e.g., Spang Industries v. Aetna, 512 F.2d 365, 368 (2d Cir. 1975) (“Hadley v. Baxendale limits the recovery to those injuries which the parties could reasonably have anticipated at the time the contract was entered into.” The court went on to say that, “[t]here can be no question but that Hadley v. Baxendale represents the law in New York and in the United States generally.”) Id. Accord Ebasco Services, Inc. v. Pennsylvania Power & Light, 460 F. Supp. 163, 213 n. 62 (E.D. Pa. 1978) (discussing Pennsylvania law) (“The most famous case contrasting general and special (or consequential) damages is Hadley v. Baxendale . . .”). Accord Mendoyoma, Inc. v. County of Mendocino, 8 Cal. App. 3d Supp. 873, 879-80; 87 Cal. Rptr. 740 (1970) (the doctrine announced in Hadley v. Baxendale, limiting damages to those reasonably foreseen by the parties, is followed in the Restatement of Contracts and in California).

7 DP Service, Inc. v. AM International, 508 F. Supp. 162, 167 (N.D. Ill. 1981).

8 Robert K. Cox, John J. Tieder & Michael J. Denton, Owners’ Damages, Basic Principles and Guidelines, Construction Briefings, March 1983, at 3. See also 25 C.J.S., Damages § 2 at 617.

9 Roanoke Hospital Association v. Doyle & Russell, Inc., 215 Va. 796, 801 (1975) (hospital brought suit for damages due to contractor’s failure to complete on time).

Appendix APage 5

(3) “damages that were caused by the breach, which were within the contemplation of the parties at the time of the contracting, and were reasonably foreseeable at the time of the contracting, and which are reasonably certain at the time of the contracting”;10

(4) damages that the parties reasonably should have contemplated;11

(5) damages that typically result from late completion of the project but also that are peculiar to the injured party and “not expected to occur regularly to others in similar circumstances”;12 and

(6) “ripple effects on the promisee’s business from the breach”.13

Consequential damages are intended to be distinguished from damages that are otherwise called direct or general. These types of damages, however, are often defined in a similar manner. For example, direct damages in construction actions have been described as:

(1) damages “which, in the ordinary course of human experience, can be expected to result from a breach”;14

(2) damages that are generally foreseeable as the result of a breach;15

(3) damages incurred as a result of a contractor’s failure to exactly perform (although substantial performance has been rendered) unless otherwise waived;16

(4) damages that arise “outside considerations affecting the land itself”;17 and

10 Steven G. M. Stein, ed., Remedies and Damages, § 11.02 [1], Construction Law (1990).

11 Imdieke v. Blenda-Life, Inc., 363 N.W. 2d 121, 125 (Minn. Ct. App. 1985) (emphasis added); see also Spang Industries v. Aetna, 512 F.2d 365 (2d Cir. 1975).

12 Robert K. Cox, supra n. 8 at 3.

13 Richard A. Posner, Economic Analysis of Law, § 4.8 (3d ed. 1986).

14 Roanoke Hospital, supra, at 801.

15 Robert K. Cox, supra at 3.

16 Woodruff v. Hough, 91 U.S. 596 (1876).

17 11 A.L.R. 4th 891 (1982).

Appendix APage 6

(5) “all unavoidable harm that the builder had reason to foresee when the contract was made”.18

When comparing these lists, it is hard to distinguish between the definitions of direct damages and the definitions of consequential damages. Both speak of reasonable foreseeability and import other traditional notions of contract damages. At best, cases have suggested that general damages are those “ordinary damages that flow directly from the breach,” with consequential or special damages as those “collateral losses, such as expenses incurred or gains prevented” resulting from the breach.19 But these descriptions, when applied in practice, seem to add little certainty to the discussion.20 The antelopes are everywhere. Nor does an analysis of specific examples of owner’s or contractor’s damages add any clarity to the discussion.

a. Owner’s Compensatory and Consequential Damages.

One of the most significant examples of consequential damages may be lost profits. Indeed, the award of $14.5 million in lost profits in Perini Corp. v. Greate Bay Hotel & Casino, Inc.,21 is reported to be the impetus for the inclusion of the limitation on consequential damages in the A201 (1997).

The Perini award contained two parts, those lost profits arising after the intended completion date but before substantial performance, and those lost profits arising after substantial performance. The court allowed lost profits after the point of substantial completion, because even at this point, the ornamental facade intended to attract customers had not been completed. The court determined that the failure to construct the facade could reasonably be expected to affect the attraction of patrons, not only in the summer season immediately following the contracted-for completion date, but also carrying through the winter months.22 These damages, if they had arisen under the A201

18 Young v. Johnston, 475 So. 2d 1309, 1314 (Fla. Dist. Ct. App. 1985) (quoting Restatement (First) Contracts, § 346(1)(a)).

19 Fort Washington Resources, Inc. v. Tannen, 901 F. Supp. 932, 943 (E.D. Pa. 1995).

20 Reference to Federal Acquisition Regulations, Part 31 Contract Cost Principles and Procedures, CCH Government Contracts Reports (1997),also provides little or no assistance. FAR 31.202 defines “direct costs” as any cost that can be identified specifically with a final cost objective. FAR 31.203 defines “indirect costs” as any cost not directly identified with a single, final cost objective but identified with two or more cost objectives, or pooled costs allowed by contract terms. In a fine example of circular reasoning, “final cost objective” is defined as a cost objective that has allocated to it both direct and indirect costs.

21 129 N.J. 479 (1992) (arbitrators awarded over $14,500,000 in lost profit damages arising out of delayed opening to casino owner against general contractor employed to manage the casino renovation project).

22 Id. at 507.

Appendix APage 7

(1997), likely would not be available to an owner. At least that is one intended result.

However, some jurisdictions have labeled the owner’s lost profits as actual damages. For example, the court in Oliver B. Cannon & Son, Inc. v. Dorr-Oliver, Inc.,23 treated lost profits, including depreciation, as a direct loss, although the court reversed and remanded the judgment because it determined the method used to calculate lost profits was speculative.

In Cannon & Son, a painting subcontractor was held liable to a factory owner for over half a million dollars in lost profits, over one-fifth of which constituted depreciation of buildings and equipment during a shutdown caused by the subcontractor. Similarly, in Northern Petrochemical Co. v. Thorsen & Thorshov, Inc.,24 the court upheld a jury award of $267,000 for profits lost to the owners of a plastic extrusion factory due to delayed occupancy of the building. Although the courts did not clearly classify loss of profits and loss of use as either direct or consequential damages, it characterized such as the “proper subject of damages where ... the loss is a direct and proximate result of the injury complained of and the damages are within the contemplation of the parties at the time of making the contract,” terminology often used to describe direct damages.25 The court went on to state that loss of profits is an appropriate measure of damages resulting from the loss of use “when the anticipated profits can be proved to a reasonable, although not necessarily absolute, certainty.”26

Other types of damage actions have spawned equally confusing results. Interest payments on debt to finance a project may be either compensatory or consequential damages. In Roanoke Hosp. Ass’n v. Doyle & Russell, Inc.27 they were both. In Roanoke, a hospital brought suit for damages due to the contractor’s failure to complete on time. The court concluded that “added interest costs (including expenditures on borrowed funds and interest revenue lost on invested funds) during the construction period arising from the longer term of borrowing necessitated by the contractor’s unexcused delays” are direct damages because it is well known that “construction contracts ... require third-party financing.”

23 394 A.2d 1160, 1163 (Del. 1978).

24 297 Minn. 118, 123-124, 211 N.W. 2d 159 (1973).

25 Id. at 125.

26 Id.

27 215 Va. 796, 802-3, 214 S.E. 2d, 155 (1975). See also Chestnut Hill Development Corp. v. Otis Elevator Co., 739 F. Supp. 692, 702 (Mass. App. Ct. 1990) (interest costs incurred and interest revenue lost are predictable results of the delay and are compensable, direct damages).

Appendix APage 8

These costs were distinguished from increased costs due to higher interest rates during the extended term, because the court deemed these to be “unpredictable” or arising from special circumstances.28 It is difficult to understand how this relates to subparagraph 4.2.10, which seems to provide that all “financing” costs are waived.

In Hemenway Co. v. Bartex, Inc. of Texas29 the court permitted recovery for both extended rental payments and interest on interim financing. These were viewed as appropriate elements of delay damages.30 However, in Brewhouse, Limited v. New Orleans Public Service Inc.,31 the court did not allow recovery for additional interest during the delay, but only for lost rents because no take-out financing was in place or delayed.

In J.W. Plaisance v. Malcom Duton,32 the court awarded the owner additional living expenses when the contractor failed to provide an accessible all-weather road and driveway for the owner’s mobile home by the contracted-for date, as these expenses “were reasonably within the contemplation of the parties at the time of making the contract.” The court determined that the contractor laid a defective road, rendered useless by heavy rains, causing the owner to delay delivery of the mobile home and to store his furniture elsewhere. The court makes no distinction between consequential and direct damages, but simply characterizes all of the costs as within “the contemplation of the parties at the time of the contract.”33

The cost of storing furniture or equipment to be delivered to the site in anticipation of the contracted-for completion date would not be recoverable under A201 (1997), although such losses clearly were found foreseeable and contemplated by the parties.34 Even the owner in Cooperstein v. Patrician Estates35 would presumably be denied the benefit of his bargain and anything in the way of damages from the contractor who took nine months to complete one month’s work.

28 Id.

29 373 So. 2d 1356 (La. Ct. App. 1979).

30 Id. at 359.

31 614 So. 2d 118 (La. Ct. App. 1993).

32 336 So. 2d 1034, 1036 (La. Ct. App. 1976).

33 Id. at 1036.

34 Id. See also Fairfax County Redev. v. Hurst & Assoc., 231 Va. 164, 343 S.E. 2d 294 (1986).

35 117 A.D.2d 774 (N.Y. App. Div. 1986).

Appendix APage 9

b. Contractor’s Compensatory and Consequential Damages.

As with the description of owner’s damages, courts and commentators often fail to characterize damages as compensatory or consequential. Rather, damages generally are grouped only as recoverable or not.36

For example, in Moore Constr. Co., Inc. v. Clarksville Dep’t. of Elec.,37 Clarksville hired Moore to do certain site preparation and exterior work and engaged Kennon Construction Company to erect the office building and warehouse.38 The project required the work to be performed in sequence, with first Moore then Kennon, and then Moore again.39 Kennon experienced problems during its work, leading Moore to incur a variety of damages, including an increase in the cost of materials, overhead, insurance, bonding, supervisory and central office labor costs, loss of use of equipment, loss of interest on retainage, and loss of interest on anticipated income.40 The court found “that it is reasonably foreseeable that a contractor, whose ability to complete its work is impaired by the owner and whose performance is thereby substantially delayed, will suffer direct damages and that the extent of these damages will depend on the unique facts of each case.”41

The court did not make a distinction between the definitions of compensatory and consequential damages, but simply determined which costs were the foreseeable, direct results of the delay. There is no indication that the use of the word “direct” was intended to convey any meaning as to the nature of the damages other than that they were foreseeable.

The court did not permit recovery for Moore’s loss of use of the interest accruing on its retainage or its loss of use of the interest it might have been able to earn on the contract funds that remained unpaid while the delayed work was completed.42 Denial of recovery was not based on the characterization of the type of damages but on the speculative nature of the evidence presented.

36 See e.g. Steven G.M. Stein, supra n. 10, § 11.02[2].

37 707 S.W.2d 1 (Tenn. Ct. App. 1985).

38 Id. at 3-5.

39 Id.

40 Id. at 6.

41 This seems to combine the definitions of compensatory and consequential damages.

42 Id. at 14.

Appendix APage 10

In Indiana & Michigan Elec. Co. v. Terre Haute Indus. Inc.,43 the court upheld an award of damages arising from delays caused by inclement weather, improper performance by other contractors and I&M’s interference. In contrast to clause 2 of subparagraph 4.3.10, the court labeled as compensatory damages, among other things, expenses incurred for delays, including overhead and supervision.44

B. Further Ambiguity.

1. Are the Contract Documents Complementary?

As discussed at length above, there is no clear definition in the case law or in subparagraph 4.3.10 of what constitutes consequential damages and, therefore, what damages are waived. There also is little rationale presented as to why one category of foreseeable damages should be included and another excluded.45

The provision purporting to waive all consequential damages does not contain a definition, but it provides that certain identified items are not recoverable costs. Subparagraph 4.3.10 uses the word “includes”, not the words “includes, without limitation”. Is the list intended as illustrative only, with all other provable damages acceptable? Or, is the list intended as examples only, providing a general idea of the specific damages that are waived?

This issue is further complicated because the first sentence in subparagraph 4.3.10 following the list uses the phrase “without limitation” to describe the applicability of the waiver for the termination provisions of the A201 (1997). Clearly then, the drafters are aware that this type of modifier can be used.

Subparagraph 1.2.1 of A201 (1997) provides that the various agreements between the owner and contractor and other documents that constitute the contract are “complementary”. Generally, that means the documents should be read together, with the provisions of one filling out or completing the provisions of the others. How then, does subparagraph 2.2.1 relate to the waiver of recovery of financing costs required by subparagraph 4.3.10?

Subparagraph 2.2.1 of A201 (1997) requires the owner to provide the contractor with evidence of the owner’s financing of the project. This requirement is a condition precedent to the contractor beginning or continuing work. Indeed, the owner is not permitted to vary its financial arrangements materially without notice to the contractor. If the contractor knows that the owner must obtain financing, and the owner is obligated to open its financial

43 507 N.E.2d 588, 591-592 (Ind. Ct. App. 1987).

44 Id. at 599 (emphasis added).

45 Commentators may argue that a party should not assume a risk not commensurate with any possible reward. Isn’t the question, rather, whether an aggrieved party should be denied the benefit of its bargain by the party causing, and in a position to control, the breach?

Appendix APage 11

arrangements to inspection by the contractor, why is not interest a foreseeable, direct form of damages?

There are other examples where the forms may not be internally consistent. Assume, for the moment, that the A201 (1997) is accompanied by another AIA document, the A111 (1997).46 Article 7 of the A111 (1997) identifies the costs of the work for which the contractor may be paid.

Subparagraph 7.2.2 provides an opportunity to reimburse wages or salaries of personnel stationed at the contractor’s principal or other non-site offices if the parties agree. If the parties agree, are these same types of costs waived under subparagraph 4.3.10 if an owner default causes delays? Surely the contractor would expect to recover as a element of damages, at least those items it is permitted as a cost of the work. That result, however, might not be the case and another antelope may be the result instead.

It is difficult to understand how subparagraph 1.2.1 of the A201 (1997) (that all documents are complementary) can be given effect when subparagraph 7.2.2 of the A111 (1997) (permitting recovery for home office personnel) and subparagraph 4.3.10 of the A201 (prohibiting recovery for home office personnel) are mutually exclusive. The language of subparagraph 4.3.10 is not permissive. It states absolutely that: included within damages waived are “[d]amages incurred by the Contractor for principal office expenses including the compensation of personnel stationed there .... ”

Similarly, how will the contractor recover “[d]ata processing costs related to the Work”? These are permitted costs of the work under subparagraph 7.6.6 of A111 (1997). However, might these costs also be characterized as home office overhead costs, arguably not permitted by subparagraph 4.3.10.2 of A201 (1997)?

This article is written from the owner’s perspective, so you might wonder why it points out items of the contractor’s recovery. The answer is simple. If the contract is not clear, it will spawn controversy and litigation. Disputes benefit no one.

What about other provisions of the A201 (1997)? They are equally unhelpful and confusing.

Paragraph 2.4 permits an aggrieved owner to perform the contract work if the contractor, after notice, fails to do so. The owner may thereafter deduct from payments due to the contractor “the reasonable47 cost of correcting such deficiencies, including owner’s expenses and compensation for the architect’s

46 Standard Form of Agreement Between Owner and Contractor, where the basis of payment is the Cost of the Work Plus a Fee with Guaranteed Maximum Price.

47 Although not within the scope of this paper, one wonders why the owner should be limited to an objective standard of reasonableness rather than the actual cost resulting directly from the contractor’s default, neglect or failure. This standard is a new addition to the A201 (1997).

Appendix APage 12

additional services made necessary by ... [the contractor’s] default, neglect or failure.”48

Will the owner, pursuant to this provision, be able to collect for the loss of management or employee productivity arising out of the contractor’s default because, for example, such individuals must undertake the contractor’s work or correct the contractor’s errors. Under subparagraph 2.4.1, I would say “yes”. Under subparagraph 4.3.10.1, maybe not.49

Subparagraph 3.2.3 creates a similar dilemma. It states that if the contractor does not review the Contract Documents for errors, omissions and inconsistencies or fails to report those errors, omissions or inconsistencies it discovers, the contractor “shall pay such costs and damages to the Owner as would have been avoided if the Contractor had performed such obligations.”

Suppose the contractor has been engaged to build the first branch offices of a bank newly arrived to the state. Suppose further that the contractor recognizes that the load-bearing capacity of the branch will not support the safe deposit boxes and other necessary equipment, but that the contractor fails to mention that fact to the architect or owner. For what should the contractor be liable?

Under subparagraph 4.3.10, the contractor would argue that the owner should be entitled to, at most, the work related to the added structural support. All of the costs and expenses relating to the fact the grand opening was delayed, furnishings and equipment had to be stored off site and other foreseeable damages such as loss of business reputation occurred, will be borne by the innocent party least able to identify or control the risk, that is, the owner. So much for fair and equitable risk allocations.

In contrast to subparagraph 3.2.3, subparagraph 3.7.4 is more clear in its description of the damages available to the owner in the event of certain contractor defaults. There, if the contractor performs work “knowing it to be contrary to laws, statutes, ordinances, building codes, and rules and regulations with ... notice to the Architect and Owner, the Contractor shall ... bear the costs attributable to correction.” So, when the contractor knows its work violates the law, it bears the cost of correction.50 When the contractor knows its work is in error, it pays the costs and damages that could have been avoided.51

48 A201 (1997) subparagraph 2.4.1.

49 The AIA made sure, at least, that the architect’s compensation would not be at risk. Subparagraph 2.4.1 maintains the prior provision allowing compensation for the architect’s additional services.

50 A201 (1997), subparagraph 3.7.4.

51 A201 (1997), subparagraph 3.2.3.

Appendix APage 13

Are these intended to be two different measures of damages? If so, perhaps our bank owner is not out of luck after all, although it is hard to understand why knowingly failing to report a design flaw is worse than knowingly performing work that is contrary to law. If the measure of damages is meant to be the same, why isn’t the language identical?

What about the contractor who simply completes the work defectively? Direct damages likely would be the cost of repairing or replacing the defective construction.52 Where the repair or replacement would involve unreasonable economic waste, however, the owner’s recovery of damages may be based on the difference in value of the completed work as compared to the value it should have had if the contractor had performed.53

To what would an owner be entitled then, under the A201 (1997) and how would value be calculated? Without considering loss of income, profit or use, can a fair measure of damages be determined? Perhaps the result is not too harsh if the defective work is the failure of the diving board at a homeowner’s pool, as in Ideal Pool Corp. v. Hupp.54 However, the result clearly would be unjust where the defective construction of a water system for a new hotel renders the hotel unsuitable for guests.55

Subparagraph 5.4.2 seems to be wholly outside the strictures of the waiver of consequential damages. It provides that if a subcontract is assigned to the owner, and work has been suspended in excess of 30 days, “the Subcontractor’s compensation shall be equitably adjusted for increases in cost resulting from the suspension.” Arguably, although such a result is not logical, the subcontractor is entitled to compensation for lost business opportunities and increased costs in home office overhead, since the waiver of such claims applies only to the contractor and owner. Perhaps the owner will argue that the subcontractor has waived such claims because of the flow-down provisions of subparagraph 5.3.1.56

52 Bethesda Lutheran Church v. Twin City Constr. Co., 356 N.W.2d 344 (Minn. 1984); Williams-Bowman Rubber Co. v. Industrial Maintenance, Welding & Machinery Co., 677 F. Supp. 539 (N.D. Ill. 1987).

53 An example of economic waste is if the correction would require destroying a substantial amount of properly completed work. Ferrari v. Barleo Homes, Inc., 490 N.Y.S.2d 827 (N.Y. App. Div. 1985).

54 370 S.E.2d 32 (Ga. Ct. App. 1988).

55 See Wharfside Two, Ltd. v. W. W. Gay Mechanical Contractor, Inc., 553 So.2d 193 (Fla. 1st Dist. Ct. App. 1988), affirmed 545 So.2nd 1348 ( Fla. 1989).

56 Subparagraph 5.3.1 of A201 (1997) provides as follows:

“5.3.1 By appropriate agreement, written where legally required for validity, the contractor shall require each subcontractor, to the extent of the Work to be performed by the subcontractor, to be bound to the contractor by terms of the Contract Documents, and to assume toward the contractor all the obligations and responsibilities, including the responsibility for safety of the subcontractor’s Work, which the contractor, by these documents, assumes toward the owner and architect. Each subcontract agreement shall preserve and protect the rights of the owner and architect under the Contract Documents with respect to the Work to

Appendix APage 14

However, waivers of rights are strictly construed,57 and it would be imprudent to rely on such where substantial sums may be at risk.

The contractor is required to purchase certain insurance coverages, including protection against “claims for damages ... because of injury to or destruction of tangible property, including loss of use resulting therefrom.”58 What does this mean? Elsewhere in A201 (1997) the phrase “loss of use” has been deleted, most notably in the contractor’s indemnification of the owner in Paragraph 3.18. Is the requirement in subparagraph 11.1.1.5 vestigial or intentional?

There is similar confusion in the owner’s insurance requirements. For example, subparagraph 11.3.1.1 requires the owner to carry property insurance including “compensation for Architect’s and Contractor’s services and expenses required as a result of such insured loss.” (emphasis supplied). Just what do these expenses entail?

There is no confusion, however, under the paragraph headed “Business Income Insurance”.59 Here, in case the waiver set forth in subparagraph 4.3.10 was not sufficient, the owner again “waives all rights of action against the Contractor for loss of use of the Owner’s property, including consequential losses

be performed by the subcontractor so that subcontracting thereof will not prejudice such rights, and shall allow to the subcontractor, unless specifically provided otherwise in the subcontract agreement, the benefit of all rights, remedies and redress against the contractor that the contractor, by the Contract Documents, has against the owner. Where appropriate, the contractor shall require each subcontractor to enter into similar agreements with sub-subcontractors. The contractor shall make available to each proposed subcontractor, prior to the execution of the subcontract agreement, copies of the Contract Documents to which the subcontractor will be bound, and, upon written request of the subcontractor, identify to the subcontractor terms and conditions of the proposed subcontract agreement which may be at variance with the Contract Documents. subcontractors will similar make copies of applicable portions of such documents available to their respective proposed sub-subcontractors.”

57 See Psaty & Fuhrman, Inc. v. Housing Authority of City of Providence, 68 A.2d 32, 35 (R.I. 1949) (a contract clause prohibiting payment of damages for delay or hindrance calls for strict application); S.L. Rowland Constr. Co. v. Beall Piper and Tank Corp., 540 P.2d 912, 918 (Wash. Ct. App. 1975) (construction contract provision waiving the right to damages for delay will be strictly construed); Owen Constr. Co. v. Iowa State Department of Transportation, 274 N.W.2d 304, 306 (Iowa 1979) (the general rule is that a “no damage” clause in a contract is valid, but due to the harsh results induced thereby, will be strictly construed).

58 Clause 11.1.1.5, A201 (1997).

59 Subparagraph 11.3.3, A201 (1997).

Appendix APage 15

due to fire or other hazards however caused.”60 The owner, who has no seat at the table when the AIA forms are drafted, once again goes hungry.

1. Liquidated Damages.

Subparagraph 4.3.10 expressly provides that nothing contained in it is intended to “preclude an award of liquidated direct damages” (emphasis added). There is no definition of what constitutes direct liquidated damages. Subparagraph 4.3.10 by its terms concerns “consequential” damages and does not use the term “direct” anywhere else in this provision. It is unclear, then, for what the owner may bargain.

The term “liquidated damages” refers to the specific sum of money that has been expressly agreed to by the contracting parties as the amount of damages recovered by either party for a specified breach by the other.61 The damages set forth in the agreement must be the result of the parties’ good faith efforts to estimate the actual damage that likely will ensue from the contract’s breach.62 Because the amount agreed to is an estimate, the exact amount of the damages is uncertain and not readily capable of ascertainment.63 Indeed, liquidated damage clauses generally will be upheld only if, at the time the contract was made, it appeared that the harm flowing from the breach would be difficult to estimate.64 This type of agreed damage clause is extremely helpful where damages from breach may involve intangible, remote, or hard to prove elements, but where such damages are nevertheless real.65

In sum, liquidated damages clauses by nature are uncertain and, in practice, may give the non-breaching party more or less than their actual losses. In exchange for saving time that would be spent calculating exact damages, the parties accept the fact that the agreed on amount may over or under compensate the injured party.

60 Id. In a recent case, a federal court, interpreting Mississippi law, narrowly construed the provision in AIA A107, Abbreviated Form of Agreement Between Owner and Contractor, mutually waiving rights for “damages caused by fire or other perils to the extent covered by property insurance...or any other property insurance applicable to the work.” The court held that the waiver did not bar an insurer’s claim for damages to nonwork property. In explaining its reasoning, the court states that if the parties had intended that the contract should waive all claims against each other, they would have so provided. Fidelity and Guaranty Ins. Co. v. Craig-Wilkenson, Inc., 948 F. Supp. 608 (S.D. Miss. 1996) affirmed without opinion 101 F.3d 699 (5th Cir. 1996). If the new A201 (1997) were part of the parties’ agreement, the court presumably may have arrived at a contrary result.

61 Stein v. Bruce, 366 S.W.2d 732, 735 (Mo. Ct. App. 1963).

62 In re Plywood Co. of Pa., 425 F.2d 151, 154 (3d Cir. 1970).

63 13 Am. Jur. 2d Building and Construction Contracts, § 84 (1964).

64 Dan B. Dobbs, Remedies, § 12.5 (1973).

65 Id.

Appendix APage 16

In contrast, direct damages are those that flow naturally or ordinarily from a contract breach.66 Direct damages are compensable because they are the expected result from the breach. Unlike “consequential” damages, direct damages generally are predicable and “undeniably” within the contemplation of the parties at the time the contract was drafted.67

Direct damages by nature may be more easily identified and quantified. In contrast, courts generally uphold liquidated damages clauses only if the harm flowing from the breach is difficult to estimate accurately and the non-breaching party would be unable to prove his or her damages exactly.68 The term “liquidated direct damages”, therefore, attempts to merge two concepts that may be mutually exclusive, or that at least contain contradictory elements.

As previously noted, courts uphold and enforce liquidated damages as they pertain to uncertain and intangible damages.69 If the agreed-to amount is reasonable, courts will routinely enforce the liquidated damages clauses. Indeed, courts view liquidated damages as a good thing. Such clauses minimize trial time, make for greater certainty, serve to limit the exposure of the parties and thus encourage enterprise. For this reason, courts may resist any restrictions or qualifications added to liquidated damages clauses.70

Courts may be especially resistant if the qualification to a liquidated damages clause only adds confusion. When the word “direct” is added to the liquidated damages clause, the intent and interpretation becomes unclear. As far as I have been able to determine, no court or commentator has defined these three words when used together. The addition of the word “direct” into an established contractual concept may dismantle a helpful tool. The result certainly will be an increase in litigation.

The merging of “direct” and “liquidated damages” may cause contracting between contractors and owners to become more difficult, cumbersome and less productive. The marriage of “liquidated” damages to “direct” damages could cause courts to interpret the term to mean that liquidated damages only cover injuries flowing directly from a contract’s breach. To the extent that the flexibility of a liquidated damages clause facilitated, expedited or enabled an agreement to be reached, contractor and owners could suffer as a result of its demise.

66 Long v. Abbruzzetti, 254 Va. 122, 487 S.E.2d 217 (1997).

67 R.K. Chevrolet, Inc. v. Hayden, 480 S.E.2d 477 (Va. 1997).

68 Dan B. Dobbs, Remedies, § 12.5 (1973).

69 Id.

70 Id.

Appendix APage 17

It has been suggested that the term “direct” was added to the description of liquidated damages to prevent the contracting parties from doing indirectly what they waived the right to do in subparagraph 4.3.10. The theory is that if the contracting parties waive claims to consequential damages, they should not be able to recover for such damages through a liquidated damages clause. With the confusion as to what constitutes consequential and direct damages, however, the additional language is unlikely to provide any clarity.71

Whether damages from breach of contract are direct or consequential is a question of law,72 and often a question of jurisdiction. For example, attorney’s fees are generally not recoverable unless a breach of contract has forced a plaintiff to maintain or defend a suit against a third person. In that circumstance, however, the fees may constitute a direct damage.73 Furthermore, although lost profits may be seen as consequential damages in many circumstances, unpaid fees accruing under a service contract, including elements of profit, may constitute direct damages.74

In summary, the phrase “liquidated direct damages” attempts to unify two very different concepts of damages. The definition of direct damages (as opposed to consequential damages) is by no means clear. As a result, the addition of the term “liquidated direct damages” is likely to cause increased uncertainty and litigation.

2. How “Similar” is “Similar”?

The waiver of consequential damages is applicable to claims by the contractor against the architect if the owner procures a “similar” mutual waiver of claims from the architect against the contractor. How similar is similar? If there are carve-outs for the architect for some items that arguably are consequential damages, is this still similar? Who decides, and when is that decision made? And who is most likely to suffer consequential damages and at what cost?

3. How “Mutual is “Mutual”?

The list of consequential losses that are waived by the owner is not identical to the list of losses waived by the contractor. Some may be explained

71 See, e.g., nn. 5-45 supra. See also Otis Elevator Co. v. Standard Constr. Co., 92 F. Supp. 603, 607 (D.C. Minn. 1950), quoting Liljengren Furniture & Lumber Co. v. Mead, 42 Minn. 420, 44 N.W. 306 (1890) (“where the contractor or builder engages to construct and complete a building by a certain time, having the entire control and responsibility of its construction ... the loss of the use of a building may be said to be the direct and inevitable result of a failure to complete it within the time specified”).

72 Id at 481.

73 Long v. Abbruzzetti, 254 Va. 122, 487 S.E.2d 217 (1997).

74 See, e.g., Combustion Systems Services, Inc. v. Schuylkill Energy Resources, Inc., 1993 WL 496946 (E.D. Pa. 1993) (holding that if a breach occurs because a party does not pay fees it was contractually obligated to pay, the fees can be recovered by the injured party as direct damages).

Appendix APage 18

because the item may belong peculiarly to one entity or another, such as loss of use being an item of owner’s damage and not of contractor’s damage. Other items are not as clear, such as “rental expenses”. There, the owner is precluded from recovery but the contractor is not. Also, the owner is prohibited from the recovery of its lost profit and income, but the contractor is specifically allowed profit arising directly from its work.

B. The Biggest Antelope of All -- Recharacterization of Costs.

1. The Impetus for Recharacterization of Costs.

If a contractor is faced with the loss of substantial categories of damages, it is not unreasonable to expect that it will look for other ways to recover its costs. Simply increasing its bid is an unlikely result, because the contractor will not want to lose its competitive edge. The contractor, then may resort to recharacterizing “indirect costs” as “direct costs”, thus increasing costs to the owner both in situations involving change orders, as well as damages for breach.75

This cannot be an intended result.

2. Examples of Recharacterization.

Under the present system, a contractor may account for craft labor, forepersons and field superintendents as a direct cost of the project. The project manager may or may not be a direct cost. A corporate officer generally will be an indirect cost.

As with personnel costs, materials and equipment may be direct or indirect costs. Materials installed in the work clearly are direct. Construction equipment stationed at the job site, if needed for the work and used exclusively for the work, also will be a direct cost. Items such as fuel and equipment maintenance may fall into either category. Home office supplies generally will be indirect costs, as will other elements of home office overhead such as accounting and payroll services, general insurance, rent, telephone and facsimile and other administrative expenses.

What is to prevent a contractor from allocating formerly indirect categories of expenses to direct categories? A portion of the home office could be redesignated as exclusively project related, with its personnel and equipment accounted for as such. Although one might argue that such a change will be cumbersome or difficult, once a revised accounting system is put into place, I believe it could quickly become routine.

In a presentation on July 30, 1997 to the Construction Contracts Committee of the Philadelphia Bar Association, two consultants, Evans M. Barba,

75 Costs for changes will increase because a savvy contractor will be consistent in its application of its accounting procedures in all contexts of the contract. Therefore, even if limited to “direct” costs and a pre-determined percentage for profit and overhead, if direct costs include more items (and profit and overhead needs to account for less), the contractor will recover more, at the owner’s expense.

Appendix APage 19

P.E., CEO of Barba-Arkhon International Inc., and Robert S. Bright, Senior Manager of Price-Waterhouse LLP (now PricewaterhouseCoopers), both argued that it would be relatively easy to make the necessary changes. The main caveat of their thesis was that the contractor would have to apply consistently its new accounting methodologies to all of its projects. That requirement, however, is not new where enforcement of claims is involved.76

What a herd of antelopes trampling the owner if the result of the mutual waiver of consequential damages is more money to the contractor for indirect costs and a bigger profit component, all at the owner’s (and the project’s) expense!

III. POLICY ISSUES.

A. Mitigation of Damages.

In eliminating an award of consequential damages, subparagraph 4.3.10 places the burden of mitigation of damages on the non-breaching party. In instances where direct, out-of-pocket costs are not substantial (although the consequential costs may be), a contractor may choose to breach its contract with the owner to fulfill another contract that it finds more profitable. Alternatively, the contractor may realize that due to unforeseen circumstances, the project may be delayed, leading to substantial consequential damages for the owner. The contractor’s incentive to mitigate the effects of the delay are limited to the damages the contractor may incur.

Knowing that it faces this possibility, a risk-adverse owner may spend much of the executory period of the contract preparing to mitigate potential losses. This preparation, whether in the form of insurance, a built-in time cushion, or a constant readiness to have another party step in, will undoubtedly cost money. For example, in allowing for extra time for completion, the owner may sacrifice the ability to sign leases with tenants who need an early lease commencement date. Thus, the owner pays a premium to prevent consequential losses and good economic business practice is sacrificed.

This result is contrary to established principles of mitigation. A nonbreaching party should not be required to take mitigating action that the breaching party is equally able to take.77

B. Allocation of Risk.

The general principle of limited recovery of consequential damages should be that if a risk of loss is known to only one party to the contract, the other party is not liable for the loss if it occurs. This principle induces the party with

76 Records must be compiled in accordance with “sound and recognized accounting principles”. Southern New England Contracting Co. v. State, 345 A.2d 550 (Conn. 1974).

77 Robert K. Cox, supra, n. 8 at 12, n.193.

Appendix APage 20

knowledge of the risk either to take appropriate precautions himself or herself or, if he or she believes that the other party might be the more efficient preventer or spreader (insurer) of the loss, to reveal the risk to that party and pay the other party to assume it. Incentives are thus created to allocate the risk in the most efficient manner.78 A clause limiting liability represents the agreement of the parties “on the allocation of the risk of economic loss in the event that the contemplated transaction is not fully executed, which the courts should honor.”79

The discussion on mitigation highlights the fact that subparagraph 4.3.10 effectively allocates the risk of the contractor’s breach to and assumption of consequential damages on the owner. However, such assignment violates our notions of efficient distribution of risk since the contractor is in the better position to perceive trouble, avoid risk and minimize its consequences when trouble occurs. This is especially true in cases where, as is common, the owner is unfamiliar with construction practices. Information costs are greater to the owner than to the contractor. Societal resources will be wasted where the owner is forced to spend time preparing for and investigating a breach that the contractor is in a better position to foresee, prevent and correct.

C. Punishment of the Breaching Party.

Fundamental concepts of justice and public policy often point to punishment of wrongdoers. It challenges our concepts of fairness and fair play to let the breaching party off the hook and to cause the innocent party to bear its burdens without recourse.

Although in the context of a tort action, Story Parchment Co. v. Paterson Parchment Paper Co.,80 provides a concise explanation of our need to recover even difficult to measure damages rather than relieving the injuring party from the requirement to compensate the injured victim:

Where the tort itself is of such a nature as to preclude the ascertainment of the amount of damages with certainty, it would be a pervasion of fundamental principles of justice to deny all relief to the injured person, and thereby relieve the wrongdoer from making any amend for his acts. In such case, while the damages may not be determined by mere speculation or guess, it will be enough if the evidence show [sic] the extent of the damages as a matter of just and reasonable inference, although the result be only approximate. The wrongdoer is not entitled to complain that they cannot be measured with the exactness

78 Richard A. Posner, supra, n. 13, § 4.9 (3rd ed 1986).

79 Metropolitan Life Ins. v. Noble Lowndes Int’l, Inc., 84 N.Y.2d 430, 436 (N.Y. Ct. App. 1994).

80 282 U.S. 555 (1931).

Appendix APage 21

and precision that would be possible, if the case, which he alone is responsible for making, were otherwise.81

If the wrongdoer should be liable where damages are imprecise, why not when they are measurable and foreseeable but characterized as consequential?

III. CONCLUSION: INCREASED WORK FOR LAWYERS

This paper is not intended to be unfettered criticism of the A201 (1997). Under the best of circumstances it is an impossible task to produce form documents that are acceptable to all parties for all purposes. In fact, that is one of my objections to using form documents of any kind. However, the hoopla surrounding the addition of subparagraph 4.3.10, and the resultant pressure to use it, is of great concern to me. I believe that the one certainty of the inclusion of subparagraph 4.3.10 in A201 (1997) is that litigators will have much to do.

John W. Hinchey, 1996-97 Chair of the ABA Forum on the Construction Industry, wrote of “Expanded Opportunities for Construction Lawyers” in the July, 1997 edition of The Construction Lawyer.82 He posits that construction lawyers are “renaissance people” who can expand their practices by virtue of their many skills.83 I agree.

We need not increase the uncertainty and costs of construction projects to ensure employment. It serves no one to let the alligators gouge the owner while the antelopes stampede, all masquerading as risk allocation.

81 Id. at 563.

82 Vol. 17 No. 3, p.21, July, 1997.

83 Id.

Appendix APage 22

APPENDIX B

LENDER’S CHECKLIST

1. Are the contractor and architect (and other consultants) acceptable to the lender?

2. Are the plans and specifications that are referenced in the construction contract the same plans and specifications that the lender has reviewed and approved?

3. Is there a guaranteed maximum price (GMP) or stipulated sum? Has the lender signed off on the amount? Are there too many allowances or exclusions to the GMP or stipulated sum? Are the unit prices, if any, acceptable?

4. Are the payments to the contractor coordinated with the payments to the owner made under the loan agreement? Is the retainage consistent? Are the requirements of the loan agreement for submissions consistent with those of the construction contract? For example, if the loan agreement requires that a certain form be submitted by the contractor with each draw request, does the construction contract require the contractor to submit such document? How will change orders be funded? What are the conditions to final payment?

5. Are there procedures for obtaining lien releases (or waivers) from the contractors, subcontractors and architect, as permitted by state law? Before release of final payment, must the contractor evidence that it has paid all subcontractors? Is the contractor obligated to pay all lien claimants? May the owner withhold payments to the extent there is a filed or threatened lien?

6. Are any special payment provisions mandated by law being following?

7. Is the time for performance of the work consistent with the time required under the loan agreement? Are there provisions for liquidated damages? If so, are they sufficient and enforceable?

8. Must the contractor make claims for delay within a specific period of time? Must the architect approve them? What are the dispute resolution procedures?

9. Should the rights of the contractor and architect to assign their contracts be limited?

10. Is the insurance required of the contractor and architect adequate and for the lender’s benefit?

11. Is the contractor required to obtain all the permits? If hearings are required, are the contractor and architect obligated to participate in all necessary proceedings?

12. Is payment provided for on-site or off-site stored materials? If so, are there protections for the lender?

Appendix BPage 1

13. Are there sufficient warranties? Are warranties of subcontractors to be delivered to the owner at the end of the job? Will the warranties also benefit the lender?

14. Are there clear default provisions? Does the lender receive notice and have a right to cure (with longer cure periods)?

15. Is there a contingent assignment of subcontracts and the architect’s agreements with its consultants?

16. Is the lender included in the indemnities?

17. Has the lender and its attorney reviewed Division 01000 of the Specifications?

18. Must the contractor and/or its subcontractors be bonded? Is the lender an obligee under the bonds? Has the lender reviewed the dual obligee rider and the bonds?

19. Have the contractor and architect executed a consent to assignment? Will the contractor and architect perform for the lender? Are there other protections for the lender included?

20. Are the obligations in the architect’s agreement consistent with the requirements of the construction contract?

21. Must the architect provide all services necessary to complete the project for basic compensation?

22. Who is inspecting the contractor’s work and under what standard?

23. Who reviews shop drawings and is responsible for errors or omissions? Is the contractor responsible for any portion of the design? If so, does that responsibility comply with applicable laws, and is the contractor properly insured?

24. Who coordinates the work of subcontractors, multiple prime contractors and other consultants?

Appendix BPage 2