It is not unusual for parties to enter into contracts that contain mutual waivers for recovery of consequential damages.
Items that are often considered as “consequential damages” include lost profit/revenue and damage to business, all of which can amount to enormous dollars. Contractors and designers are unwilling (and many are unable) to absorb the risk of consequential damages, even if their poor performance might have caused them.
Even if there is a contractual waiver of consequential damages, that does not end the debate, as there can be a major conflict over whether the damages arising from a problem are “consequential” or “direct damages,” where the contractual waiver does not apply.
Further reading:
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In a recent decision, the U.S. District Court for the Middle District of Florida, in Orlando Health Inc. v. HKS Architects Inc., concluded that repair and remediation costs for design errors caused by a design professional’s deficient plans were direct – not consequential – damages. Therefore the mutual waiver of consequential damages could not protect the design professional against the owner’s claimed damages.
The case
The dispute arose from the design and construction of a six-story hospital in Lake Mary, Florida. Orlando Health Inc. contracted with HKS Architects Inc. for the planning, architectural, and engineering services on the project.
The contract culminated in plans for a 317,185-square-foot hospital tower, as well as other elements of work. As part of the contract, Orlando Health and HKS waived “consequential damages for claims, disputes, or other matters in question, arising out of or relating to (the) Agreement.”
HKS subcontracted with BBM Structural Engineers Inc. for the structural engineering services for the project. BBM’s tasks included responsibilities in the schematic design, design development, construction documents, and construction administration phases of the project. The subcontract also included a waiver of consequential damages.
Shortly after construction began, multiple structural failures were discovered due to design errors and omissions in the structural engineering plans. The first failure appeared on the second floor of the hospital, where the slab was cracking at each column line.
The cracking occurred because a full second layer of reinforcing steel (known as top mat rebar) was not included in the structural engineering plans. HKS admitted that the reason the top mat rebar was not installed was that it was not clearly called for in the drawings.
The second defect involved a cantilevered overhang on the third and fourth levels of the north tower of the hospital. BBM admitted that its design was inadequate to support the cantilevered overhang. The third and fourth issues requiring remediation were caused by deficiently designed structural beams. Demolition and rebuilding were required to correct some of these failures.
Orlando Health contended that by committing these errors, HKS failed to meet the required standard of care, resulting in a structurally unsound and defective construction – and therefore a breach of contract. Orlando Health sought about $5 million in damages against HKS for the costs of the repairs and remediation.
HKS and BBM both argued that the damages sought by Orlando Health were all consequential damages and thus recovery was waived under the contract. Ultimately Orlando Health sued HKS in a Florida federal district court, prompting HKS to bring BBM in as a third-party defendant. HKS and BBM promptly filed a motion for summary judgment on the grounds that the damages were consequential and waived.
The ruling
In considering the motions, the court stated that the contract did not define what “consequential damages” meant and that “the parties now look to the Court to fill in this definitional gap for them.” The basic dispute was whether the damages Orlando Health was seeking were “direct damages,” and therefore not barred by the contractual waiver, or “consequential damages” that were so barred.
The court looked to other Florida precedent that defined “consequential damages” as damages that “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 … .”
The court noted that this definition most commonly includes lost profits, reputational damage, rental expenses, and loss of use. On the other hand, under Florida law, “direct damages” are commonly defined as damages that are the direct, natural, logical, and necessary consequences of an alleged injury – or in this case, negligent design.
Prior Florida precedent described “direct damages” as those damages that “may fairly and reasonably be considered as arising in the usual course of events from the breach of contract itself.”
HKS and BBM’s argument relied heavily on the opinion in Keystone Airpark Authority v. Pipeline Contractors Inc., a 2019 Florida state court opinion that HKS and BBM argued sent “shock waves” through the industry when it was rendered.
The district court concluded that HKS and BBM were suggesting that the Keystone decision drastically broadened the conventional understanding of what constitutes consequential damages. However, upon closely reading the case, the district court found that it actually undermined the position taken by HKS and BBM.
In Keystone, the owner (an airpark) hired a contractor to build airplane hangars and taxiways and separately hired an engineering firm to inspect and monitor the construction work. The contract between the owner and engineering firm contained a waiver of consequential damages.
After construction, the hangar slabs and taxiways began to deteriorate. The owner sued the contractor and the engineering firm, alleging that the contractor used substandard material for stabilization underneath the structures and the engineering firm failed to detect this error. The owner sought to recover the costs to remove, repair, and replace the hangars, taxiways, and underlying subgrade.
Both the trial and appellate courts in Keystone concluded that as to the engineering firm, the repair costs were consequential damages because they were not the direct or necessary consequence of the engineering firm’s alleged failure to properly inspect, observe, monitor, and report problems with the construction work.
Stated differently, these courts concluded that the contractor could have completed the job correctly without the engineering firm performing its duties under the contract. As a result, “the need for repair did not arise within the scope of the immediate transaction” between the engineering firm and the owner but rather stemmed from the losses incurred by the owner in its dealings with the construction contractor.
HKS and BBM attempted to draw a parallel between their situation and that of Keystone, arguing that the costs Orlando Health incurred to pay for repairs stemmed from its dealings with third-party contractors and consultants and did not arise within the scope of the immediate transaction between them and Orlando Health.
The district court disagreed and did not find these factual scenarios analogous. In Keystone, the contractor caused the damages that needed to be repaired. In this case, the damages were caused by deficiencies in the structural engineering plans for which HKS and BBM were responsible.
To support its position, Orlando Health argued that the contention by HKS and BBM that these repair costs were “consequential” rather than “direct” damages was a novel one in the industry. The district court agreed, finding no case where such an argument was made by an architect or engineer who was sued based on repair costs due to defective plans.
In fact, the district court cited several cases where “similarly situated (design professionals) in some cases have conceded that such costs are direct damages that fall outside a consequential-damages waiver.”
The district court concluded its decision by stating:
Based on the definitions of the relevant terms and the facts of this case, the Court finds that Orlando Health’s costs of remediation and repair are not consequential damages that were waived in the Agreement. HKS was contractually obligated to provide plans, including structural engineering plans, for the construction of a hospital in a large project coordinated among many sophisticated parties. The costs of remediation and repair did not “result indirectly from” HKS’s plans, nor did they arise from “dealings with third parties” in either the more “traditional” sense (such as lost profits or loss of reputation) or the causative way described by the Keystone Airpark court. Instead, the costs to repair and remediate are the “direct, natural, logical … and necessary consequences of” HKS’s deficient plans. Thus, recovery of these damages is not barred by the consequential-damages waiver in the Agreement.
Takeaways
This case was of high interest to the authors, as we find more and more disputes over whether damages are “consequential” or “direct” in our law practices. One point made by the district court bears repeating – it is always beneficial to provide examples of what might constitute “consequential damages” in the contractual waiver of these damages.
All industry forms do this, and it helps highlight what the parties intended when they signed the contract. It is hard to believe that a design professional hired to design a project would successfully persuade an owner to include as “consequential damages” the type of damages experienced in this case.
This case is also an important reminder of the result of the Keystone decision. In that decision, the design professional’s role was observation and inspection, not design. While the design professional may have been negligent in doing so, the Keystone courts found that the consequential-damages waiver was applicable – saving the design professional from substantial damages.
This is a prime example of why parties want consequential-damages waivers in their contracts. One can only imagine the minimal fee paid to the Keystone inspecting design professional compared with the costs to correct the construction deficiencies.
