In commercial and contract disputes, financial experts are frequently engaged to measure the economic damages suffered by a party due to an alleged harmful act, including a breach of contract or a performance failure. These damages are often calculated as
- Actual damages
- Liquidated damages
- Consequential damages
Not all damages are the same and each has a distinct purpose in compensating for losses.
In this post, we explain the differences between the types of damages — a critical understanding for anyone involved in contracts and legal disputes, including legal counsel, businesses and individuals.
Actual Damages
Actual damages, also known as direct damages, are generally the most straightforward form of compensation since these are costs incurred by the claimant directly because of a breach of contract. These are damages that “naturally flow” from a defendant’s wrongful act.[1]
To claim for actual damages, a party must
- prove that they incurred the losses through records or estimates of the actual costs and
- demonstrate that the losses were primarily caused by the breach of contract (i.e., these costs would otherwise not have been incurred).
In a construction contract dispute, these types of damages could include the costs to repair or replace damaged or defective work or costs to complete a project if a contractor is terminated for cause.
Liquidated Damages
Liquidated damages are based on a pre-agreed amount that is included as a term within a contract, particularly in the construction industry. In these cases, the parties agree to the amount of compensatory damages associated with particular types of breaches (such as delays in performance).[2] Liquidated damages are often used when the actual damages are difficult to measure or foresee.[3] In other words, a liquidated damages provision is intended to make the impacted party whole for intangible losses which are otherwise difficult to calculate.
As opposed to actual damages, liquidated damages are determined at the time of the contract formation and are payable if one party breaches the agreement. The contractual rate must be a reasonable estimate of the actual or anticipated costs. In fact, courts may reject a liquidated damages claim if it is determined to be punitive rather than compensatory (in excess of a reasonable estimate of the actual costs).[4]
Types of costs typically covered by a liquidated damages provision include:
- Business losses such as lost profits due to construction delays
- Increased financing or interest costs
- Additional inspection costs
- Extended jobsite overhead costs
Since the amount of liquidated damages is fixed at the time the contract is executed, a party does not necessarily need to prove the amount of the damages incurred in order to make a claim. Claims are typically made with a time-impact or delay analysis to demonstrate the period of time that the breach affected the claimant and the contractual rate for liquidated damages is applied to that period. Regardless if actual damages exceed or fall short of the liquidated damages, the claimant’s recovery is limited to the amount of liquidated damages as defined by the contract.[5]
In a dispute involving a liquidated damages claim, the financial expert’s role may include an analysis of the types of costs being claimed to determine whether those costs are included within the liquidated damages clauses and/or an assessment of certain costs to determine if they may be claimed separately as actual or consequential damages. The financial expert may also determine the reasonableness of the liquidated damages claim by evaluating overhead and operational costs.
Consequential Damages
Consequential damages are indirect damages suffered by a party which flow from the alleged harmful act, such as a breach of contract. These are differentiated from liquidated damages as they are not directly tied to the act, but instead are a consequence of that act.[6] In a breach of contract case, both parties must have been able to reasonably foresee or contemplate the consequential damages at the time they entered into the contract.[7] These damages would not have occurred but for the alleged harmful act and may include lost profits, loss of business opportunity or reputational harm.
Some contracts include full waivers of consequential damages. In these cases, the claimant relies on claims for actual and liquidated damages to remedy any losses.
Breaking it Down: A Case Study
Each case will have its own facts, circumstances and contract provisions that should be taken into account. To illustrate the differences in these damage types, consider a construction defect found on the construction of a new retail outlet, which results in a 30-day delay in opening the outlet.
In this example, the financial expert calculates the costs and damages incurred by the owner of the retail outlet as a result of the contractor’s defective work and the delayed project completion date, as follows:
Actual Costs: In this example, actual (or direct) damages are the costs to repair the defective work due to poor workmanship. The owner would be able claim actual damages totaling $100,000.
Liquidated Damages: The contract contains a liquidated damages provision for $1,000/day, which specifically indicates that in the event of a contractor-caused delay, the owner may claim liquidated damages for the increased construction management costs and construction loan financing costs resulting from the delay.
The amount of liquidated damages is calculated by multiplying the contractual rate of $1,000/day by the duration of the delay. For a 30-day delay, the owner would claim liquidated damages totaling $30,000. In this case, despite actual costs for increased construction management and loan financing of $32,000, the claim for liquidated damages is limited to the $30,000 amount allowed by the contract.
Consequential Damages: Finally, to calculate the amount related to consequential damages, the financial expert would have reviewed the owner-contractor agreement to understand the types of costs covered by the liquidated damages provision and calculated any costs not already reimbursed as liquidated damages.
In this example, the owner had an expected completion date that would allow tenants to move in and open its stores; however, the outlet’s anticipated opening was delayed by 30 days. Due to the delay caused by the contractor, the owner was financially impacted by the lost profits it would have otherwise earned had business operations commenced on time. The financial expert would quantify the owner’s lost profits due to the delay in business operations. In this case, the owner would be able to claim consequential damages totaling $50,000 since lost profits were not included in the liquidated damages.
Experts are Key to a Fair Settlement
A financial expert provides both the technical expertise and the objective analysis needed to ensure that economic damages are calculated accurately, reasonably and fairly. Depending on the facts and circumstances of the case, actual damages, liquidated damages or consequential damages may be calculated. A financial expert’s involvement helps ensure that damages are appropriately quantified and that the financial impact of the alleged harm is not overestimated or underestimated.
For more information on calculating damages in contract disputes in construction, please contact Cristal Brun or Brad Brusick. To learn more about VERTEX’s Forensic services or to speak with an Expert, call 888.298.5162 or submit an inquiry.
References
[1] Callahan, Cushman, Carter, Gorman and Coppi. Proving and Pricing Construction Claims. 4th Edition, Chapter 1, p. 21.
[2] Weil, Lentz, and Evans. Litigation Services Handbook: The Role of the Financial Expert. Sixth Edition, Chapter 4.4, p. 4.15.
[3] Weil, Lentz, and Evans. Litigation Services Handbook: The Role of the Financial Expert. Sixth Edition, Chapter 4.4, p. 4.15.
[4] Callahan, Cushman, Carter, Gorman and Coppi. Proving and Pricing Construction Claims. 4th Edition, Chapter 1, p. 21. Weil, Lentz, and Evans. Litigation Services Handbook: The Role of the Financial Expert. Sixth Edition, Chapter 4.4, p. 4.15.
[5] Callahan, Cushman, Carter, Gorman and Coppi. Proving and Pricing Construction Claims. 4th Edition, Chapter 1, p. 61.
[6] Weil, Lentz, and Evans. Litigation Services Handbook: The Role of the Financial Expert. Sixth Edition, Chapter 4.4, p. 4.14.
[7] Weil, Lentz, and Evans. Litigation Services Handbook: The Role of the Financial Expert. Sixth Edition, Chapter 4.4, p. 4.14.
