BILL ANALYSIS Ó
AB 552
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Date of Hearing: April 21, 2015
ASSEMBLY COMMITTEE ON JUDICIARY
Mark Stone, Chair
AB 552
(O'Donnell) - As Amended March 26, 2015
As Proposed to be Amended
SUBJECT: Public works contracts: damages
KEY ISSUE: Should a public CONTRACT that requires a contractor
to pay consequential damages specify a fixed amount of damages,
instead of holding the contractor liable for open-ended
consequential damages?
SYNOPSIS
When a breach of contract delays completion of a construction
project, the non-breaching party may recover consequential
damages (CDs) from the breaching party for any losses indirectly
caused by the breach and reasonably foreseeable at the time the
contract was made. Because the indirect consequences of delay
are potentially unlimited and difficult to prove, construction
contracts often contain a liquidated damage (LD) provision to
limit liability for and make it easier for all parties, as well
as sureties, to assess risk. Indeed, state law requires state
construction contracts to contain an LD provision that specifies
a fixed sum which the contractor must pay for each day beyond
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the contracted completion date. While LD provisions are common
in construction contracts, CD provisions are relatively rare.
Where CD clauses exist at all in construction contracts, it is
often to specify that there is "no liability" for CDs. Indeed
LD clauses for delay are often intended as a substitute for
difficult to prove CDs resulting from delay. Recently however,
the author and sponsor claim, some public agencies have included
CD clauses in contracts that make the contractor liable for
potentially unlimited consequential damages with no set amount
or even a range of amounts, even though these same contracts may
contain LD clauses that require the contractor to a pay a fixed
daily amount for delays. While CD clauses in public contracts
are still not the norm, the author provided the Committee with
evidence that such clauses are common enough that surety bonders
have informed contractors and public agencies that they cannot
underwrite public contracts with open-ended CD clauses, or can
only provide bonds at higher prices. In response to such
concerns, some public agencies, the Committee is informed, have
already removed open-ended CD clauses from all of their
contracts. But apparently several have not. This bill would
provide that if a public contract contains a clause making the
contractor liable for CDs, the amount cannot be open-ended. In
other words, if there is a CD clause, the damages must be
liquidated to a set amount and identified in the contract. This
bill is supported by several contractors' associations. The
original version of the bill was opposed by the California State
Association of Counties (CSAC) and the League of California
Cities (League). CSAC no longer opposes the bill as it is
proposed to be amended today. The Committee is uncertain as to
whether today's amendments will remove the League's opposition.
The bill, as introduced, passed out of the Assembly
Accountability and Administrative Review Committee on a 9-0
vote. Author amendments to be taken in this Committee are
reflected in the analysis.
SUMMARY: Provides that if a public contract contains a
consequential damages clause it must specify a set amount.
Specifically, this bill:
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1)Provides that a public works contract entered into on or after
January 1, 2016, that contains a clause requiring a contractor
to be responsible for consequential damages, is not
enforceable unless the consequential damages have been
liquidated to a set amount and identified in the public works
contract.
2)Defines "public agency" for purposes of the above to include
the state, Regents of the University of California, a city,
charter city, county, charter county, district, public
authority, municipal utility, and any other political
subdivision or public corporation of the state.
3)Makes findings and declarations relating to the need for clear
and uniform guidelines relating to liquidated damages in
public contracts.
EXISTING LAW:
1)Provides that for a breach of contract the proper measure of
damages, except where otherwise provided by statute, is the
amount which will compensate the party aggrieved for all the
detriment proximately caused by the breach, or which in the
ordinary course of things, would be likely to result from the
breach. (Civil Code Section 3300.)
2)Provides that a provision in a contract liquidating the
damages for the breach of the contract is valid unless the
party seeking to invalidate the provision establishes that the
provision was unreasonable under circumstances existing at the
time the contract was made. (Civil Code Section 1671 (b).)
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3)Requires every state contract to contain a provision in regard
to the time when the whole or any specified portion of the
work contemplated shall be completed, and shall provide that
for each day completion is delayed beyond the specified time,
the contractor shall forfeit and pay to the state a specified
sum of money, to be deducted from any payments due or to
become due to the contractor. The sum so specified is valid as
liquidated damages unless manifestly unreasonable under the
circumstances existing at the time the contract was made.
(Public Contract Code Section 10226.)
FISCAL EFFECT: As currently in print this bill is keyed fiscal.
COMMENTS: According to the sponsor, the California Construction
Employer Association, this bill responds to the practice of some
public agencies to use construction contracts that include both
liquidated and consequential damages. Liquidated damages are
specific sums of money stipulated by the parties and written
into the contract as the amount of damages to be recovered by a
party in the event of a breach by the other party.
Consequential damages, which may or may not be referenced in the
contract, allow the non-breaching party to recover damages not
only for the value of the non-performed part of the contract,
but for any losses that flow from the consequences of breach, so
long as such consequences were reasonably foreseeable at the
time the contract was made.
This bill, as proposed to be amended, would simply provide that
if a public contract contains a clause making the contractor
liable for CDs, the amount cannot be open-ended. The bill would
not prevent a public agency from seeking CDs, nor would it
require a public agency to include a CD clause in its contract.
Rather, the bill provides that if the public agency opts to
include a CD clause in the contract, then CDs must be liquidated
at a set amount and identified in the contract.
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The Legacy of Hadley's Mill: The law governing a party's
ability to recover CDs still owes a great deal to the 19th
century English case of Hadley v. Baxendale 156 Eng. Rep. 145
(1854). Hadley, the owner of a mill, needed to replace a worn
out crankshaft. The manufacturer that Hadley hired to build a
new crankshaft asked Hadley to deliver the old crankshaft to its
facility, so that it could use the old crankshaft as a model for
constructing the new one. Hadley hired Baxendale, a common
carrier, to deliver the crankshaft to the manufacturer. Because
Baxendale was late in delivering the crankshaft to the
manufacturer's facility, the facility was late in getting the
new crankshaft to Hadley. As a result Hadley had to close down
his mill for several days and failed to meet orders, all the
while continuing to pay his idle workers. Hadley sued Baxendale
to recover his lost profits. While the trial court ruled in
favor of Hadley and granted damages for the lost profits caused
by the delay, Hadley's damage award was overturned on appeal.
While the court conceded that the losses were caused by
Baxendale's breach, Hadley was not entitled to damages for lost
profits because they were not "reasonably foreseeable"
consequences of Baxendale's delay. Because Baxendale did not
know that Hadley would need to suspend operations until the new
crankshaft arrived, it was reasonable for him to assume that an
experienced mill operator would have anticipated that
crankshafts wear out after a time and had a spare crankshaft
around, or had made some other arrangement to keep the mill
running. Had Baxendale known that the mill would be closed
until the new crankshaft was delivered, he would have been
liable for the lost profits. But Hadley never informed
Baxendale of any "special circumstances." The still-accepted
rule of Hadley is that consequential damages are only available
where (1) the injury was a consequence of the breach and (2) the
result was reasonably foreseeable at the time when the contract
was made or the breaching party had knowledge of the "special
circumstances" that made the damages a natural consequence of
the breach.
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For contractors and the bonding companies that underwrite them,
"consequential damages" (CDs) are especially troublesome because
they are unpredictable and potentially unlimited. One of the
more common sources of CDs in construction contracts is the
failure of the contractor to complete the project on time.
Depending on the length of the delay and the nature of the
project, delays can result in lost profits and lost revenues
that may exceed the value of the contract. When a breach of
contract delays completion of a construction project, the
non-breaching party may recover CDs from the breaching party for
any losses indirectly caused by the breach and reasonably
foreseeable at the time that the contract was made. Because the
indirect consequences of delay are potentially unlimited and
difficult to prove, construction contracts often contain a
liquidated damage (LD) provision to limit liability for delay or
at least make it easier for the parties to assess risk. Indeed,
state law requires state construction contracts to contain an LD
provision that specifies a fixed sum that the contractor must
pay for each day beyond the contracted completion date.
While LD provisions are common in construction contracts, CD
provisions are relatively rare. When CD clauses are included in
construction contracts, it is often to specify that there is "no
liability" for CDs. However in recent years, say the author and
sponsor, some public agencies have included CD clauses in their
contracts which make the contractor liable for potentially
unlimited consequential damages, even though these same
contracts may contain LD clauses that require the contractor to
a pay a fixed daily amount for a delay. While CD clauses in
public contracts are still not the norm, the author provided the
Committee with evidence that such clauses are common enough that
surety bonders say they cannot underwrite public contracts with
open-ended CD clauses, or can only do so at higher prices. In
response to such concerns, some public agencies, the Committee
is informed, have already removed open-ended CD clauses. But,
apparently, several have not.
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Bill Does Not Prevent Public Agencies from Seeking Consequential
Damages: Both proponents and opponents of this bill inform the
Committee that CDs in public construction contracts are
relatively rare, although some proponents claim that their use
is increasing. (The Committee is not aware of anything other
than anecdotal evidence in support of this claim.) In any
event, as noted above, CD provisions are common enough that
surety bond issuers have informed contractors and public
agencies that they cannot reasonably underwrite them, especially
when such contracts are open-ended without setting a fixed
amount. According to the sponsor, the purpose of this bill is
not to prevent a public agency from seeking consequential
damages - which it can do with or without a CD clause - but only
to require that CDs effectively be capped if they are included
in the contract. If a public agency can recover CDs whether or
not they are referenced in the contract, it raises questions
about why public agencies would insist on including them and why
contractors would object when they are included. The answer to
these questions may have something to do with Hadley v.
Baxendale. While an express CD clause in a contract might not
be dispositive, it would seem to help the agency meet its burden
of showing that the CDs were "reasonably foreseeable" and that
the contractor had knowledge of the agency's "special
circumstances." This also explains why contractors would not
want a CD clause included in a contract unless the CDs were
liquidated at a set amount. It is important to stress, however,
that this legislation is not intended to prevent public agencies
from recovering CDs. Public agencies may opt to exclude CD
provisions from construction contracts and still be entitled to
CDs, which remain recoverable even if they are not expressly
provided for in the contract. The agency would need to prove,
however, that the CDs were caused by the breach and were
reasonably foreseeable at the time when the contract was made.
ARGUMENTS IN SUPPORT: According to author, "some public
agencies have adopted policies requiring both liquidated damages
and unlimited consequential damages as penalties for project
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delays in their public works contracts. . . . While some of
these [public agencies] have reversed their decision on pursuing
these provisions due to difficulty finding contractors willing
to agree, others have not."
In addition to noting the "troubling trend" of public agencies
using LD provisions and unlimited CD provisions, the
Construction Employers Association (CEA), the bill's sponsor,
argues that CDs "are not a standard form of damages for
construction contracts because they are difficult to define,
quantify, or ascertain." Like many of the proponents of the
bill, CEA stresses that CD provisions in recent public agency
contracts are "uninsurable because sureties will not issue
open-ended policies. Instead," CEA continues, "construction
contracts have historically addressed consequential damages for
delay using a stipulated Liquidated Damage . . . amount."
Finally CEA argues that the impact of CD provisions is not
"borne exclusively by general contractors;" in fact, CD
provisions "chill participation by subcontractors, especially
small contractors," in part due to rising costs and in part due
to the fact that most delays are caused by subcontractors and
damage provisions in the general contract are passed through
subcontractors.
The California Concrete Contractors Association (CCA) argues
that, unlike liquidated damages, which are insurable, defined in
the contract and intended to cover actual projected damages,
consequential damages provisions are "uninsurable, open-ended
and speculative." Their inclusion in public contracts, CCA
contends, "raises construction costs, chills participation by
mid and mall sized contractors and subcontractors, and increases
litigation costs." CCA notes that "liquidated damages have been
the contractual standard for addressing delay damages for
decades and we do not believe there is a need for this practice
to be changed."
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ARGUMENTS IN OPPOSITION (To Pre-Amended Version): The League of
California Cities (League) opposed the bill as introduced, and a
considerable portion of its letter addressed the provisions that
will no longer be included in the bill as proposed to be
amended. However, the League would presumably object to the
remaining provision of the bill as well. The League argues that
by "requiring that all consequential damages be liquidated, AB
552 would limit the ability of public agencies to ensure that
the costs associated with a contractor's non-performance or
under-performance could be collected. . . AB 552 would remove
important tools public agencies use to ensure that public works
projects be completed on time, and to protect taxpayer dollars."
The City of Sacramento opposes the bill for substantially the
same reasons.
[NOTE: It is unclear at the time of this writing if the
proposed amendments remove the opposition of the League, or the
City of Sacramento. The California Association of Counties
(CSAC) informed the Committee that they originally planned to
oppose the bill, but dropped their opposition in light of the
proposed amendments. However, CSAC made it clear to the
Committee that it reserves its right to oppose the bill in the
future based on its ongoing analysis of the potential
consequences of the bill.]
Proposed Author Amendments: The author will take the
amendments listed below in this committee. In addition to
deleting a subdivision that would have required all public works
contracts to contain liquidated damages in order to be
enforceable, the amendments also revise subdivision (b) to
better reflect to author's intent to only require CDs to be
fixed at a set amount if the public agency opts to include a CD
clause. It was not the author's or sponsor's intent to say that
CDs could only be recovered if they were included in the
contract and liquidated. In other words, if a public agency
opts not to include a CD clause, it can still recover if it can
show that the CDs were caused by the breach and were reasonably
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foreseeable at the time the contract was entered into.
- On page 2 delete lines 17 through 29 and insert:
(a) Any public works contract entered into on or after January
1, 2016, that contains a clause requiring a contractor to be
responsible for consequential damages is not enforceable unless
the consequential damages have been liquidated to a set amount
and identified in the public works contract.
- On page 2 line 30 change "(c)" to (b)
- On page 2 line 32 delete "public agency"
REGISTERED SUPPORT / OPPOSITION:
Support
Construction Employers' Association (sponsor)
California Concrete Contractors Association
California Surety Federation
Opposition
California State Association of Counties (to pre-amended
version)
League of California Cities (to pre-amended version)
Analysis Prepared by:Thomas Clark / JUD. / (916) 319-2334
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