In footnote 71 of the titular construction law case Zachry Construction Corp. v. Port of Houston Authority of Harris County, which primarily focused on the enforceability of no damages for delays clauses, the Texas Supreme Court wrote: “Delay damages are consequential damages.” The Court then left it at that, with no more discussion or analysis of why it considered delay damages to be consequential damages. Therefore, whether or not delay damages are actually consequential damages or are in fact direct damages is still less than clear. There are arguments going in both directions and given the fact insensitivity of consequential damages, there still is no bright-line rule.

Liability Limitations Generally

The typical limitation of liability clause focuses on a category of damages or the amount of damages. For our purposes, as far as categorical damage limitations go, the most common example is the waiver of consequential damages. Mutual waivers of consequential damages are common in AIA contract form documents and other national industry contract forms such as ConsensusDOCS and the Design-Build Institute of America.

Generally, Texas law recognizes and protects a broad freedom of contract. Moreover, Texas recognizes that there can be no contractual freedom without contractual enforcement.  Therefore, Texas, by-in-large, recognizes the enforcement of limitation of liability clauses, including waivers of consequential damages. However, there are certain circumstances wherein Texas courts will not allow the use of a limitation of liability provision. These circumstances include the following: void as against public policy, unconscionability, and ambiguity.

1. Void as Against Public Policy

Texas allows parties to enter into contracts as they see fit, unless; however, the contract violates the law or public policy.  Usually, an agreement to limit liability will not violate public policy if there is no disparity of bargaining power between the parties. In other words, if there are no circumstances which inhibit one party’s freedom of choice, the limitation of liability provision is enforceable.

In the context of construction litigation, a public policy argument is very unlikely to prevail in court. If the operative issue in a public policy analysis as to the enforceability of a limitation of liability provision is choice, the party seeking to enforce the provision can very likely argue that there was always a choice for the party seeking to avoid enforcement, i.e. not enter into the transaction.

2. Unconscionability

If a contract or provision is unconscionable, it is unenforceable. Unconscionability includes two aspects—procedural and substantive. “Procedural unconscionability” refers to the circumstances surrounding the adoption of the provision while “substantive unconscionability” refers to the fairness of the provision itself. In the past, numerous Texas courts that have addressed the issue have required a dual showing of both aspects of unconscionability in order to show overarching unconscionability. However, some Texas courts that had addressed the issue had permitted a showing of either aspect of unconscionability to be sufficient in order to show overarching unconscionability.

Nonetheless, Texas courts review the following standards for evaluating unconscionability (and public policy arguments): (1) the entire atmosphere in which the agreement was made, the bargaining process the parties went through, and whether there is such a disparity in bargaining power between the parties that one party is forced to agree to the exculpatory provision; (2) the fairness of the contractual provision by determining whether there are legitimate commercial reasons that justify its inclusion in the agreement; and (3) conspicuousness.

Texas courts routinely enforce limitation of liability provisions when challenged on unconscionability grounds.

3. Ambiguity

Ambiguity is an affirmative defense in Texas. If a contract can be given a certain or definite legal meaning or interpretation, then it is not ambiguous and it will be construed as a matter of law. However, when a contract’s meaning is uncertain and doubtful or it is reasonably susceptible to more than one meaning, then it is ambiguous. When a contract contains an ambiguity, the issue of the meaning of the contract becomes a question of fact.

Limitations of liability, when read in conjunction with other typical clauses such as indemnity provisions and insurance-related provisions, can give rise to concerns of ambiguity. For example, if a contract includes a simple limitation of liability that sets a monetary cap and also includes typical indemnity and insurance provisions, an ambiguity may arise given the interaction of those clauses. This same issue, however, would likely not affect a waiver of consequential damages provision.

Direct Damages v. Consequential Damages

Contract damages in Texas are either direct or consequential.

1. Direct Damages

Direct damages compensate the plaintiff for the loss that is conclusively presumed to have been foreseen by the defendant from his wrongful act. Courts often refer to direct damages as flowing naturally and necessarily from the wrong. If some damage element is specifically accounted for in the parties’ contract, the damages are by their very nature direct. Put differently, direct damages are those inherent in the nature of the breach of the obligation between the parties.

2. Consequential Damages

Consequential damages also result “naturally” but “not necessarily” from the defendant’s breach. They are not recoverable unless the parties contemplated, at the time the parties entered into the contract, that such damages would be the “probable result of the breach”. Damages are classified as consequential if they “require the existence of some fact beyond the relationship of the parties.”

The recovery of consequential damages, even if there is a waiver of consequential damages provision, is extremely fact intensive and revolves around the entire contract as a whole. In any case, recovery of consequential damages turns on the question of foreseeability. Consequential damages are recoverable only if they are foreseeable and directly traceable to the wrongful act and result from it. This foreseeability requirement is a fundamental prerequisite to the recovery of consequential damages for breach of contract.

In the absence of a consequential damages waiver, foreseeability is important because it decides whether un-waived consequential damages are recoverable. Generally, Texas courts’ foreseeability analysis includes a mixture of both objective (“arise generally”) and subjective (“known/communicated”) reasoning, and Texas courts have yet decide whether to use an objective standard, a subjective standard, or both.  In cases where the parties have waived consequential damages, the courts focus on whether damage elements are direct or consequential (because that is dispositive). These analyses frequently get conflated because all damages must be foreseeable to be recoverable. However, if a court is evaluating whether any damage is foreseeable, the damage will likely be consequential.

Summary

Direct damages are natural and according to the usual course of things. Furthermore, direct damages are conclusively presumed to have been foreseen by the breaching party, flow naturally and necessarily from the breach, and inherent in the nature of the breach. If a category of damages is expressly referenced in a contract, then the damages are direct.

Consequential damages, on the other hand, arise from (1) a special circumstance, which is known or communicated to the breaching party; or (2) if a special circumstance is not known or communicated, then the damages would arise generally and in the great multitude of cases. Consequential damages flow naturally but not necessarily from the breach. They are recovered only if contemplated by the parties at the time they entered into the contract. For consequential damages to be awarded (barring a waiver provision), there must be an existence of some fact beyond the mere existence of the parties. The loss must be foreseeable and directly traceable to the wrong act.

There is no clear rule as to how to decipher between one or the other. When drafting waivers of consequential damage provisions, it is important to specifically detail what consequential damages the parties intend to waive, such as loss income, loss of reputation, utility charges, insurance costs, loss of concurrent contracts, and the like. Having clearly defined damages the parties intend to waive in the contract will hopefully take the guess work out of the Court’s hands if it comes to litigation.

The attorneys in our Austin and Dallas offices are available to answer any questions you may have. Please contact us at info@gstexlaw.com.

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