What is the Consequence of Consequential Damages?
Many contracts have a provision like this: Neither party will be responsible or held liable for any consequential, special, or incidental losses or damages.
What exactly does it mean?
In contract law, if the other party breaches the contract (i.e., doesn’t do what he or she is obligated to do), you will have some costs, losses or damages. In contract law, you are entitled to recover the damages that are a reasonably foreseeable consequence of the breach. You are not entitled to receive compensation for damages that are not reasonable or remote. Sometimes, contracts attempt to limit more remote situations in the contract text. These provisions are known as limitations of liability.
Unless there is fraud or egregious contract (and not just a breach of contract) you are also not entitled to punitive damages or pain and suffering. Punitive may sound like “punish” which is what it means. In North Carolina, punitive damages are awarded "to punish a defendant for egregiously wrongful acts and to deter the defendant and others from committing similar wrongful acts."
Contract damages may include:
Direct damages: The damages that you reasonably expect to arise from the breach in question, without taking into account your special circumstances.
Incidental damages: Incidental costs are costs that arise due to the breach of the contract. Such costs may include:
Inspection of items
Transportation or storage of defective items
Expenses or commissions incurred in connection with delivery delays
Consequential damages: Consequential damages occur when you have a special situation that will be caused by a breach, and the other party knows that this situation could occur. If you are buying something for immediate resale at a profit, you might be able to recover your lost profit if the seller knew of your second transaction. Or, if you are supplying goods or services to someone that has a penalty for late performance, or a bonus for early performance, your breach might cause you to pay consequential damages in the form of the penalty or bonus that is affected by your breach.
Why do contracts limit consequential damages? Often sellers of goods or providers of services want to limit their damages in case of a breach. One way to do that is to agree that if there is a breach, the recovery will be limited to direct damages only. The seller’s main breach worry is that the buyer won’t pay. It is often more beneficial to the seller than the buyer to limit consequential damages.
Should you agree to this limitation? In every contract, it is important to assess the risk. Limitation of liability is not useless “boilerplate,” but has real consequences to both parties. It is important to think about what the risks are in a specific situation, and what is fair if something goes wrong. The damages should be tailored to the specific risks of breach. One approach is to carefully list the major risks of project and make express provision for the types and amount of damages in case of a breach. Other solutions are to limit the total amount of damages, or to insure for specific risks.