Recovering Consequential Damages Under General Liability Policies

Charles P. Edwards and Alexandra Robinson French | Barnes & Thornburg | January 14, 2019

An often-overlooked feature of commercial general liability (CGL) policies is that they provide coverage for damages the insured is legally obligated to pay “because of” bodily injury or property damage. Most courts interpret “because of” broadly to include consequential damages and other damages that, while not themselves property damage, are traceable to covered property damage. While consequential damages are less likely to result from bodily injury, the scope of coverage is the same.

The rule that the standard CGL language providing coverage for damages “because of” property damage includes consequential damages having a causal connection to covered property damage is followed by the majority of courts that have considered the question. As one commentator has noted, “‘Because of’ can, and should, be read to mean: as a consequence of, on account of, or arising from. Certainly, this is the ordinary and usual meaning of ‘because of.’” Scott C. Turner, Insurance Coverage of Construction Disputes § 6:22 (2d ed.).

In Am. Home Assur. Co. v. Libbey-Owens-Ford Co., 786 F.2d 22 (1st Cir. 1986), for example, the court addressed the scope of coverage for damages arising from defective windows installed in the John Hancock office building in Boston. The need to replace the windows resulted in various increased construction and operating costs and delayed the occupancy date from April 1, 1973, to June 1, 1975. Hancock sued the window manufacturer, Libbey-Owens-Ford Company (LOF), and others to recover these damages, which included approximately $11 million for the costs of removing and replacing the windows and an additional approximately $88 million of consequential damages.

The First Circuit held that one reasonable interpretation of the “because of” language is that it “provides coverage not only for property damage, but also for consequential damages resulting from property damage.” Id. at 26. The court further noted that, although the policy would expressly exclude coverage for the $11 million in costs associated with the repair and replacement of LOF’s own product, the policy did not exclude Hancock’s consequential losses resulting from the breakage of LOF’s windows. Id. at 27. Accordingly, the court held, “[g]iven that American Home’s current policy is at best ambiguous, and at worst clearly applicable to cover LOF’s damages, we hold that the policy covers consequential losses stemming from physical injury to LOF’s products.” Id. at 28.

The First Circuit also cautioned the insurance industry that “an insurance company wishing to exclude consequential damages should use specific language to that effect.” Id. at 26. This caution was issued more than 30 years ago, and the “because of” language continues to appear on CGL policies without any specific exclusion for consequential damages.

While the “because of” language is form language found in the vast majority of CGL policies, some states have interpreted the language more broadly than others. In some states, the case law is not necessarily uniform. In California, for example, insurance companies often cite cases narrowly construing the language. But in AIU Ins. Co. v. Superior Court, 51 Cal.3d 807, 814 (1990), the California Supreme Court held that CGL policies cover the costs of reimbursing government agencies and complying with injunctions ordering cleanup under CERCLA, the Superfund statute, and similar statutes. In rejecting the argument that these economic costs were not “because of…property damage,” the court held that, “the event precipitating their legal action is contamination of property. The costs that result from such action are therefore incurred ‘because of’ property damage.” Id. at 842. A California Court of Appeals recently followed AIU in holding that certain delay damages were covered, holding that the “delay constitutes a consequential loss (a loss occasioned by the water intrusion) and as such, is part of the damages NAC must pay ‘because of’ property damage.” Global Modular, Inc. v. Kadena Pac., Inc., 15 Cal. App. 5th 127, 145, review den. (Dec. 13, 2017).

Most of the California confusion stems from reliance on pre-1973 cases. In 1973, the definition of “property damage” in standard CGL language issued by the Insurance Services Office (ISO) was revised to specifically include “loss of use of tangible property which has not been physically injured.” The prior language had defined property damage as “physical injury to or destruction of tangible property, including loss of its use.” See Gunderson v. Fire Ins. Exch., 37 Cal. App. 4th 1106, 1115 (1995). Several courts had held that under this earlier language, the loss of use referred only to property that was physically injured or destroyed. Id. The 1973 revision makes it clear that the loss of use of property which has not been physically injured also qualifies as property damage.

The California Court of Appeals recently clarified confusion in Thee Sombrero, Inc. v. Scottsdale Ins. Co., 2018 WL 5292072 (Cal. Ct. App. Oct. 25, 2018). The case involved a nightclub called El Sombrero that had its use permit modified after a fatal shooting so that it could be operated only as a banquet hall. The owner sued its security service (CES) alleging that its negligence in allowing the shooting had caused economic damages to the club, including a diminution in the value of the club associated with the modified use permit. After obtaining a default judgment in the amount of the diminished value of the club, the club owner sued CES’s liability insurer (Scottsdale) for indemnity. The trial court granted summary judgment for Scottsdale, holding that the club’s claims were “for an economic loss, rather than for ‘property damage’ as defined in and covered under the policy.” Id., at *2.

The California Court of Appeals reversed, holding that the club’s loss of use as a nightclub constituted property damage and that the resulting diminished value of the club qualified as damages “because of” that property damage. The court went so far as to hold that it “defies common sense to argue otherwise.” Id., at *8. The court specifically distinguished the earlier California cases interpreting the older definition of property damage. Id., at *15-16.

Courts also have found coverage for economic losses that arise “because of” bodily injury. In Cincinnati Ins. Co. v. H. D. Smith, L.L.C., 829 F.3d 771, 774 (7th Cir. 2016), for example, the court addressed coverage for an underlying claim brought by the state of West Virginia against drug distributors for costs incurred by the state as a result of its citizens’ addiction to drugs supplied by those companies. Id. at 773. The question presented was whether the costs incurred by West Virginia were “because of” bodily injury. Id. at 774-75. The court held they were. Id.

The court based its holding on its recognition that a CGL policy “cover[ing] suits seeking damages ‘because of bodily injury’…provides broader coverage than one that covers only damages ‘for bodily injury.’” Id. at 774 (original emphasis). The court illustrated the breadth of “because of” in the language at issue by giving the following example:

[A]n individual has automobile insurance; the insured individual caused an accident in which another individual became paralyzed; the paralyzed individual sues the insured driver only for the cost of making his house wheelchair accessible, not for his physical injuries. If the insured driver had a policy that only covered damages “for bodily injury” it would be reasonable to conclude that the damages sought in the example do not fall within the insurer’s duty. However, if the insurance contract provides for damages “because of bodily injury” then the insurer would have a duty to defend and indemnify in this situation.

Id. (quoting Medmarc Cas. Ins. Co. v. Avent Am., Inc., 612 F.3d 607, 616 (7th Cir. 2010)).

The types of consequential damages courts have held are covered by the standard “because of” language in CGL policies are various and extensive.

The Turner treatise, for example, lists the following:

Construction delay and loss of use, liquidated damages for delay, construction impact (i.e., loss of worker efficiency in performing construction work), relocation and storage costs; temporary repairs, diminution in the value of property, later resulting physical injury to other tangible property, the cost to remove and reinstall (or replace) good work in order to access the property damage (often called “rip and tear” damage), the additional repair and reconstruction costs required to bring the building into compliance with the current building code, loss or reduction of production, lost rents, lost profits, increased overhead, environmental response costs under CERCLA and similar statutes, costs incurred for mitigation or prevention of further property damage or bodily injuries, investigation and inspection costs, costs for clean-up and debris removal, costs of notifying adversely affected parties, the insured’s indemnity obligations to others (such as to the insured’s surety on a performance bond), loss of good will or damage to reputation, and emotional distress… 

Turner, § 6:22.

The few courts that have upheld denials of coverage for consequential damages have often confused whether the claimed damages constituted property damage, with the operative question of whether the damages were because of property damage. See, e.g., Kvaerner  N. Am. Constr. Inc. v. Certain Underwriters at Lloyd’s London Subscribing to Policy No. 509/DL486507, 2017 WL 2821691, at *9 (N.D.W. Va. June 28, 2017) (“liquidated damages still must fall under the CGL policy’s property  damage definition”); St. Paul Fire & Marine Ins. Co. v. Amsoil, Inc., 51 F. App’x 602, 604 (8th Cir. 2002) (“economic loss which is not ‘property damage’ is not covered under a CGL policy”); Essex Ins. Co. v. Chem. Formula, LLP, No. 1:CV-05-0364, 2006 WL 5720284, *6 (M.D. Pa. Apr. 7, 2006) (“loss of profits, damage to commercial reputation, and loss of goodwill are not tangible property damage as defined by the policy”). Insurers often adopt this erroneous position in refusing to cover consequential damages.

The Ninth Circuit recently held that an award of attorneys’ fees to the prevailing plaintiff in an underlying lawsuit against a policyholder is covered under thepolicyholder’s CGL policy. Ass’n of Apartment Owners of Moorings, Inc. v. Dongbu Ins. Co., 731 F. App’x 713 (9th Cir. 2018) (construing Hawaii law). The court held that “in the context of the policy, the plain meaning of ‘damages’ encompasses the fees the Bradens incurred to vindicate their claim for water damage to their home, even if those fees are not a measure of that physical damage.” Id. The court also held that the attorney fee award was “because of” the covered property damage, holding “[t]his phrase, which is undefined, connotes a non-exacting causation requirement whereby any award of damages that flows from covered property damage is covered, unless otherwise excluded.” Id. Note, however, that other courts have concluded that an award of attorneys’ fees against the policyholder constitutes “costs” falling within an insurer’s defense obligation, rather than “damages” falling within its indemnity obligation. See, e.g., Prichard v. Liberty Mutual Ins. Co., 84 Cal. App. 4th 890, 911-912 (2000) (attorneys’ fees awarded against the policyholder fall within the scope of a carrier’s supplementary payments obligation because they are statutorily defined in California as costs, and therefore are not “damages” within the meaning of a CGL policy).

One issue that has not been extensively litigated is whether the determination of what damages are “because of” bodily injury or property damage is a question for the court as a matter of law, or one for the court or jury in its role as the fact-finder. The scope of an insurance company’s indemnity obligation (as opposed to its duty to defend, which is broader) often is dependent on the outcome of the underlying case. See, e.g., United Nat’l Ins. Co. v. Dunbar & Sullivan Dredging Co., 953 F.2d 334, 338 (7th Cir. 1992) (“[T]he duty to indemnify must await resolution of the underlying suits.”); Westfield Ins. Co. v. Sheehan Const. Co., 575 F. Supp. 2d 956, 960 (S.D. Ind. 2006) (“The Plaintiff’s duty to indemnify will depend upon the facts and outcome of the underlying Indiana state court action.”) Yet many courts deciding the coverage issue also have decided what damages they deem to be “because of” bodily injury or property damage, rather than leaving that issue for determination in the underlying case.

A recent case from Texas, however, separates the legal question of the meaning of “because of” from the factual question of what damages were “because of” bodily injury or property damage. See Kenyon Int’l. Emergency Srvs., Inc. v. Starr Indem. & Liab. Co., 2018 WL 3431853, at *1 (Tex. App. July 17, 2018). The case involved coverage for emergency services performed by Kenyon for Seaport Airlines after the crash of a Seaport plane, which included setting up a call center, providing first responders and mental health staff, and establishing a welfare support line. Seaport’s aviation policy issued by Starr provided coverage for all sums that the insured shall become legally obligated to pay as damages “because of” bodily injury or property damage. After Seaport went bankrupt and failed to pay Kenyon for the services Kenyon performed after the crash, Kenyon sued Starr seeking a declaratory judgment that Starr’s policy covered the services and recovery in equitable subrogation.

The court first held that, “[v]iewed in the light most favorable to Kenyon, at least some of the damages Kenyon seeks may include sums Seaport became legally obligated to pay because of bodily injury,” and, therefore, covered by the policy. Id. at *4. The court then held that “a fact issue [exists] as to whether the reason at least some of the post-crash emergency services were performed – and potentially had to be performed – was bodily injury sustained in the plane crash, or any and all claims related to bodily injury.” Id. The court reversed the trial court’s summary judgment for Starr and remanded for further proceedings, presumably a trial, on the question of which of the damages sought by Kenyon were “because of” bodily injury. Id.

Policyholders should consider it a best practice to scrutinize any argument by an insurance company that consequential damages are not covered because they are not bodily injury or property damage. Where those damages arise “because of” covered bodily injury or property damage, they may well be covered.

Contractual Waiver of Consequential Damages

David Adelstein | Florida Construction Legal Updates | December 1, 2018

Contractual waivers of consequential damages are important, whether they are mutual or one-sided.  I believe in specificity in that the types of consequential damages that are waived should be detailed in the waiver of consequential damages provision. Standard form construction agreements provide a good template of the types of consequential damages that the parties are agreeing to waive. 

But, what if there is no specificity in the waiver of consequential damages provision? What if the provision just states that the parties mutually agree to waive consequential damages or that one party waives consequential-type damages against the other party?  Let me tell you what would happen.  The plaintiff will argue that the damages it seeks are general damages and are NOT waived by the waiver of consequential damages provision.  The defendant, on the other hand, will argue that the damages are consequential in nature and, therefore, contractually waived.   FOR THIS REASON, PARTIES NEED TO APPRECIATE WHAT DAMAGES ARE BEING WAIVED OR LIMITED, AND POTENTIALLY THOSE DAMAGES NOT BEING WAIVED OR LIMITED, WHEN AGREEING TO A WAIVER OF CONSEQUENTIAL DAMAGES PROVISION!

Interestingly, this issue appeared in the recent case, Keystone Airpark Authority v. Pipeline Contractors, Inc., 43 Fla. L. Weekly D2601d (Fla. 1stDCA 2018).   Here, a plaintiff sued a contractor and engineer for defects to an airplane hangar and taxiways.  The plaintiff claimed the engineer’s negligence through its failure to supervise the work as contractually required which resulted in defective construction.  The plaintiff claimed that the engineer was responsible for the costs to repair the airplane hangar and taxiways.   The engineer argued under a waiver of consequential damages provision that read:

“Passero [engineer] shall have no liability for indirect, special, incidental, punitive, or consequential damages of any kind.”  

The engineer argued that the damages the plaintiff was seeking due to its failure to supervise was excluded under the waiver of consequential damages provision in the contract.  The plaintiff argued that such damages are general damages and not barred.  The trial court, as affirmed by the appellate court, held that the damage was barred because the damage was consequential.  In doing so, the court examined the definitions of the types of damages:

General damages are ‘those damages which naturally and necessarily flow or result from the injuries alleged. . . . General damages  ‘may fairly and reasonably be considered as arising in the usual course of events from the breach of contract itself. Stated differently, [g]eneral damages are commonly defined as those damages which are the direct, natural, logical and necessary consequences of the injury.

In contrast, special damages are not likely to occur in the usual course of events, but may reasonably be supposed to have been in contemplation of the parties at the time they made the contract. They consist of items of loss which are peculiar to the party against whom the breach was committed and would not be expected to occur regularly to others in similar circumstances.  In other words, general damages are awarded only if injury were foreseeable to a reasonable man and . . . special damages are awarded only if actual notice were given to the carrier of the possibility of injury. Damage is foreseeable by the carrier if it is the proximate and usual consequence of the carrier’s action.

[C]onsequential damages do not arise within the scope of the immediate buyer-seller transaction, but rather stem from losses incurred by the non-breaching party in its dealings, often with third parties, which were a proximate result of the breach, and which were reasonably foreseeable by the breaching party at the time of contracting. The consequential nature of loss . . . is not based on the damages being unforeseeable by the parties. What makes a loss consequential is that it stems from relationships with third parties, while still reasonably foreseeable at the time of contracting. 

Keystone Airpark Authority, supra (internal citations and quotations omitted).

Based on these definitions, the court agreed that the repairs to the hangars and taxiways were not special damages as “[i]t cannot be said that repairs stemming from improperly supervised construction work are unlikely to occur in the usual course of business.”  Keystone Airpark Authority, supra.   Such damages did not involve special circumstances for which the plaintiff would be required to give the engineer actual notice. 

BUT… these damages were CONSEQUENTIAL:

[T]he cost of repair here did not constitute general damages, either, because the damages were not the direct or necessary consequence of Passero’s [engineer] alleged failure to properly supervise the construction work.  The contractor could have completed the job correctly without Passero’s supervision.  Thus, the need for repair did not arise within the scope of the immediate transaction between Passero and the Airpark.  Instead, the need for repair stemmed from loss incurred by the Airpark in its dealing with a third party – the contractor.  While these damages ‘were reasonably foreseeable,’ they are consequential and not general or direct damages.

The appellate, however, certified the following question of great public importance:

WHERE A CONTRACT EXPRESSLY REQUIRES A PARTY TO SUPERVISE CONSTRUCTION WORK AND TO DETERMINE THE SUITABILITY OF MATERIALS USED IN THE CONSTRUCTION, BUT THE PARTY FAILS TO PROPERLY SUPERVISE AND INFERIOR MATERIALS ARE USED, ARE THE COSTS TO REPAIR DAMAGE CAUSED BY THE USE OF THE IMPROPER MATERIALS GENERAL, SPECIAL, OR CONSEQUENTIAL DAMAGES?

Thus, there could be a ruling in future from the Florida Supreme Court relating to construction industry, specifically relating to the damages associated with a supervising architect or engineer.

Court Denies Recovery of Public Adjuster Fees in Breach of Contract Action

Ashley Harris | Property Insurance Coverage Law Blog | December 16, 2018

In Kingshill Hospitality, Inc. v. American Economy Insurance Company,1 the policyholder’s hotel was damaged by a fire. Three days later the policyholder hired a public adjuster to assist in submitting its insurance claim. A dispute arose regarding the amount of loss and the policyholder filed suit for breach of contract.

As part of the damages claimed, the policyholder sought recovery of the public adjuster fee as consequential damages. The insurance carrier moved the court to strike the claim for consequential damages, which the court granted.

The policyholder argued that “it had to retain the services of an insurance claims professional (Public Adjuster) to pursue its claim.” The court disagreed, reasoning that consequential damages are “[l]osses that do not flow directly and immediately from an injurious act but that result indirectly from the act,” and here, the policyholder hired the public adjuster only three days after the fire occurred and before the insurance carrier made a coverage determination. The court concluded:

Because these costs were incurred in May – before the alleged breach occurred when American Economy partially denied coverage on June 1 – Kingshill’s public adjuster expenses cannot be categorized as consequential damages.

While not relevant under the facts of this case, the court noted:

If an insured believes that its insurer is not attempting to settle a claim in good faith and hires a public adjuster to refute the damage estimate or coverage determination proferred by an insurer, such expenses could be considered consequential damages. And under those facts, the consequential damages would be extracontractual damages that could only be recovered in a bad faith action, pursuant to QBE Ins. Corp. v. Chalfonte Condominium Apartment Ass’n, Inc., 94 So.3d 541 (Fla. 2012).

It should be noted that courts in Florida have found that consequential damages can be recovered in a breach of contract action.2 Here, however, where the public adjuster was hired before a dispute arose regarding the loss or coverage, the public adjuster fees were not recoverable.
________________________________
1 Kingshill Hospitality, Inc. v. American Economy Ins. Co., No: 5:18-cv-520, 2018 WL 6427681 (M.D. Fla. Dec. 5, 2018).
2 See e.g.Trident Hospitality Florida, Inc. v. American Economy Ins. Co., No.: 6:08-cv-289, 2008 WL 11334515 *2 (M.D. Fla. May 30, 2008) (“Plaintiff is entitled to consequential damages if it can prove that damages ‘were within contemplation of the parties when the contract was formed.’” Citing Martin v. Monarch Life Ins. Co., No. 94-1182, 1995 WL 127157, at *1 (M.D. Fla. Mar. 21, 1995)).

Federal Court in Pennsylvania Analyzes Which Types of Damage are Barred by Contractual Waiver of Consequential Damages

Kristopher Berr | Pepper Hamilton LLP | January 26, 2017

Jay Jala, LLC v. DDG Construction, Inc., No. 15-3948, 2016 US Dist. LEXIS 150969 (E.D. Pa. Nov. 1, 2016)

Jay Jala, LLC was the owner of a motel construction project in Allentown, Pennsylvania. DDG Construction, Inc. was the contractor.  The project was delayed during construction and, four months after the specified completion date, DDG abandoned the project.  Jay Jala terminated DDG for default, completed the project, and initiated this action.

The contract provided that the parties “waive Claims against each other for consequential damages arising out of or relating to this Contract.” During litigation, DDG stipulated that it breached the contract but moved for partial summary judgment, arguing that Jay Jala’s damages were consequential, and thus waived.

The question presented by DDG’s motion was: “what distinguishes available direct damages from the consequential damages waived by the contract?” The Court reasoned that the distinction turns on whether the damages represent the loss of DDG’s performance (direct damage), or the loss of something collateral (consequential damage).  The Court then undertook to determine which of Jay Jala’s damages “was a separate business arrangement that [Jay Jala] made” and which damages represented something Jay Jala “had to pay in an effort to replace the performance [DDG] failed to provide.”

Utilizing this distinction, the Court granted DDG’s motion with respect to Jay Jala’s damages for: pre-purchased insurance premiums for operation of the completed motel, costs for additional months of advertising the motel, and additional months of furniture, fixtures and equipment leasing expenses. The Court reasoned that under the contract, DDG was not required to cover any of these costs, and thus these losses were not incurred to replace any portion of DDG’s performance.  Instead, each related to a separate business arrangement made by Jay Jala, and was therefore covered by the waiver of consequential damages.

But, the Court denied DDG’s motion with respect to three of Jay Jala’s claims. With respect to Jay Jala’s “project completion fee,” the Court understood that term to encompass Jay Jala’s overhead during the period when it acted as its own contractor following DDG’s breach.  The Court reasoned that if Jay Jala had hired a replacement contractor, that contractor’s fee, including overhead, would have been recoverable as direct damage.  The fact that Jay Jala itself acted as completion contractor did not bar recovery.

Next, the Court held that Jay Jala could recover utility costs it paid during the months following DDG’s breach. The contract expressly required DDG to pay monthly utility costs until completion of the project.  Therefore, utility costs were direct damages because Jay Jala’s payment of those costs replaced a portion of DDG’s expected contract performance.

Finally, the Court held that Jay Jala could recover as direct damage the additional months of construction loan interest it paid following DDG’s breach. The Court reasoned that because DDG agreed to construct the project within a specified period of time, it necessarily agreed that Jay Jala should incur only a specified amount of construction loan interest and, therefore, the additional interest was a direct damage.

For ease of reference the Court’s holding is represented in chart form below:

Direct Damage   Consequential Damage
Project Completion Fee Additional Months of Motel Insurance Premiums
Utility Costs Contractor had Contractually Agreed to Pay Additional Months of Advertising Costs
Additional Months of Interest on Construction Loan Additional Months of Furniture, Fixtures and Equipment Lease

To view the full text of the court’s decision, courtesy of Lexis®, click here.

Direct vs. Consequential Damages – What is the Difference, Really?

Stan Martin | Commonsense Construction Law LLC | November 3, 2016

Many people, even while negotiating the terms of a contract “mutual waiver of consequential damages” clause, fail to appreciate the distinction between direct and consequential damages. A federal district court judge in Pennsylvania has penned a thoughtful decision on this issue, worth noting.

The project was construction of a new Motel 6, and the contractor stopped work before it was complete, but already late. Hoping for a fall 2014 opening, the Motel 6 owner finally opened in the spring of 2015, using others to finish. The subsequent dispute has focused on damages, and specifically what damages are allowed as “direct” damages and what damages are barred by a contract clause prohibiting “consequential” damages.

The court first noted that foreseeability is not the standard:

[I]t is true in some sense that predictability is relevant to determining whether damages naturally flow from a breach and are considered direct or indirectly result and are considered consequential. But that definition has never been very instructive for analyzing particular damages, and foreseeability is the limit of all contract damages, not the distinction between direct and consequential damages. [citations omitted]

Quoting from a federal appellate decision, the court noted –

“Rather than turning on foreseeability, the difference between direct and consequential damages depends on whether the damages represent (1) a loss in value of the other party’s performance, in which case the damages are direct, or (2) collateral losses following the breach, in which case the damages are consequential.” Atl. City Associates, LLC, v. Carter & Burgess Consultants, Inc., 453 F. App’x 174, 179 (3d Cir. 2011). “Direct damages refer to those which the party lost from the contract itself—in other words, the benefit of the bargain—while consequential damages refer to economic harm beyond the immediate scope of the contract.” Id. (quoting Penncro Assocs., Inc. v. Sprint Spectrum, L.P., 499 F.3d 1151, 1156 (10th Cir. 2007))

Further, “direct damages are the costs of a plaintiff getting what the defendant was supposed to give — the costs of replacing the defendant’s performance. Other costs that the plaintiff may not have incurred if the defendant had not breached, but that are not part of what the plaintiff was supposed to get from the defendant, are consequential.”

Applying those standards to the current dispute, the court held that costs of completion, including a project manager’s fee, would be direct costs. Utility costs were also direct costs, being tied to what the contractor had agreed to cover during construction. On the other hand, lost income, and costs of advertising and insurance (in this instance, insurance for operating the hotel), were not part of what the original contractor was obligated to provide, and so would be considered consequential. Trickier were questions about extended rental of storage units holding furniture, fixtures and equipment which were to be installed in the hotel, and costs of financing. The former were considered consequential, but incremental interest costs incurred monthly during the period of delay were considered as direct damages. (The contract had standard AIA language, which includes the word “financing” among the list of potential costs or damages being waived by the owner. The court concluded that that word in context refers to replacement financing or line of credit financing, and not to already-existing construction loan monthly costs.)

To sum up, the court distinguished between “a loss in value of the other party’s performance” and “collateral losses following the breach,” to distinguish between direct and consequential damages. Something to keep in mind during the next contract negotiation. The case is Jala v. DDG Constr., 2016 U.S. Dist. LEXIS 150969 (E.D. Pa., Nov. 1, 2016) (LEXIS subscription required).

. A federal district court judge in Pennsylvania has penned a thoughtful decision on this issue, worth noting.

The project was construction of a new Motel 6, and the contractor stopped work before it was complete, but already late. Hoping for a fall 2014 opening, the Motel 6 owner finally opened in the spring of 2015, using others to finish. The subsequent dispute has focused on damages, and specifically what damages are allowed as “direct” damages and what damages are barred by a contract clause prohibiting “consequential” damages.

The court first noted that foreseeability is not the standard:

[I]t is true in some sense that predictability is relevant to determining whether damages naturally flow from a breach and are considered direct or indirectly result and are considered consequential. But that definition has never been very instructive for analyzing particular damages, and foreseeability is the limit of all contract damages, not the distinction between direct and consequential damages. [citations omitted]

Quoting from a federal appellate decision, the court noted –

“Rather than turning on foreseeability, the difference between direct and consequential damages depends on whether the damages represent (1) a loss in value of the other party’s performance, in which case the damages are direct, or (2) collateral losses following the breach, in which case the damages are consequential.” Atl. City Associates, LLC, v. Carter & Burgess Consultants, Inc., 453 F. App’x 174, 179 (3d Cir. 2011). “Direct damages refer to those which the party lost from the contract itself—in other words, the benefit of the bargain—while consequential damages refer to economic harm beyond the immediate scope of the contract.” Id. (quoting Penncro Assocs., Inc. v. Sprint Spectrum, L.P., 499 F.3d 1151, 1156 (10th Cir. 2007))

Further, “direct damages are the costs of a plaintiff getting what the defendant was supposed to give — the costs of replacing the defendant’s performance. Other costs that the plaintiff may not have incurred if the defendant had not breached, but that are not part of what the plaintiff was supposed to get from the defendant, are consequential.”

Applying those standards to the current dispute, the court held that costs of completion, including a project manager’s fee, would be direct costs. Utility costs were also direct costs, being tied to what the contractor had agreed to cover during construction. On the other hand, lost income, and costs of advertising and insurance (in this instance, insurance for operating the hotel), were not part of what the original contractor was obligated to provide, and so would be considered consequential. Trickier were questions about extended rental of storage units holding furniture, fixtures and equipment which were to be installed in the hotel, and costs of financing. The former were considered consequential, but incremental interest costs incurred monthly during the period of delay were considered as direct damages. (The contract had standard AIA language, which includes the word “financing” among the list of potential costs or damages being waived by the owner. The court concluded that that word in context refers to replacement financing or line of credit financing, and not to already-existing construction loan monthly costs.)

To sum up, the court distinguished between “a loss in value of the other party’s performance” and “collateral losses following the breach,” to distinguish between direct and consequential damages. Something to keep in mind during the next contract negotiation. The case is Jala v. DDG Constr., 2016 U.S. Dist. LEXIS 150969 (E.D. Pa., Nov. 1, 2016) (LEXIS subscription required).