You May Be Able to Limit “Consequential Damages" in Your Contracts

Despite best efforts to reduce expectations to a written contract, one can rarely estimate with much accuracy the creative ways a complaining party will claim he has been damaged by an alleged breach. The textbook case from the 19th century in Hadley v. Baxendale arose when a smith delivered a crankshaft too late, and the miller sued not only for the value of the crankshaft, but for all the lost profits caused by the delay - a tenfold increase!

These downstream injuries are called "consequential" damages, as opposed to the "direct" damages (e.g., the value of the crankshaft). The good news: these wild and wooly consequential damages may be limited by agreement.

California Civil Code § 3300 allows plaintiffs to recover both kinds of damages, providing for recovery in "the amount which will compensate the party aggrieved for all the detriment proximately caused thereby, or which, in the ordinary course of things, would be likely to result therefrom."

Direct damages naturally arise from the breach, such as the cost of a replacement crankshaft, or the cost of hiring a different contractor or professional. (See Brandon & Tibbs v. George Kervorkian Accountancy Corp. (1990) 226 Cal.App.442, 455-56.)

Consequential damages, on the other hand, do not flow immediately from the breach, but follow as some consequence of it, which might be unusual so long as they were reasonably contemplated by the parties, such as lost profits or a real-estate collapse.

While few California cases address the issue, Perini Corp. v. Greate Bay Hotel & Casino (N.J. 1992) 610 A.2d 364 remains a seminal consequential-damages case. When hotel construction fell behind, the hotelier sued the contractor for four-months of lost profits. The delay resulted only from a nonessential ornamental facade, and even though the contractor's take was only $600,000, it was held liable for a whopping $24 million.

The court held that liability was appropriate because the casino repeatedly told the contractor that time was of the essence and that delays would result in lost profits from the summer tourist season. Had the parties contemplated otherwise in their contract, the contractor would not have been liable for these downstream, consequential damages.

By expressly stating in the written agreement that the parties do not contemplate liability for consequential damages, parties can prevent being held liable for surprising and upsetting circumstances.