BILL ANALYSIS Ó
SENATE JUDICIARY COMMITTEE
Senator Hannah-Beth Jackson, Chair
2015-2016 Regular Session
AB 552 (O'Donnell)
Version: April 27, 2015
Hearing Date: July 14, 2015
Fiscal: Yes
Urgency: No
TH
SUBJECT
Public Works Contracts: Damages
DESCRIPTION
This bill would provide 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.
BACKGROUND
It is a well-established principle of contract law in
California, dating back to before the codification of the Civil
Code in 1872, that contract formation requires four basic
elements: "parties capable of contracting; their consent; a
lawful object; and, a sufficient cause or consideration." (Civ.
Code Sec 1550.) "Once entered into, a contract gives rise to an
obligation or legal duty, enforceable in an action at law." (1
Witkin, Summary of Cal. Law (10th ed. 2005) pgs. 58-59.) The
wrongful, unjustified, or unexcused failure to perform a
contract constitutes a breach of that duty, and the party to
whom that duty was owed may recover compensation in the form of
damages. (Summary of Cal. Law at 935; Civ. Code Secs. 3274,
3281.) "The basic object of damages is compensation, and in the
law of contracts the theory is that the party injured by a
breach should receive as nearly as possible the equivalent of
the benefits of performance." (Brandon & Tibbs v. George
Kevorkian Accountancy Corp. (1990) 226 Cal.App.3d 442, 455.)
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"The aim is to put the injured party in as good a position as he
would have been had performance been rendered as promised."
(Id.)
In general, California's measure of damages for breach of a
contract "is 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." (Civ. Code Sec. 3300.) As the language of
Section 3300 indicates, awards of damages for breach of contract
are limited to those damages that are typically foreseeable by
the parties at the time they formed their contract. "The
seminal case announcing this doctrine, still generally accepted
as a limitation on damages recoverable for breach of contract,
is Hadley v. Baxendale (1854) 156 Eng.Rep. 145." (George
Kevorkian Accountancy Corp., 226 Cal.App.3d at 455 [citations
omitted].)
Hadley v. Baxendale established that foreseeable damages for
breach of contract are of two types. "First, general damages
are ordinarily confined to those which would naturally arise
from the breach, or which might have been reasonably
contemplated or foreseen by both parties, at the time they made
the contract, as the probable result of the breach." (Id. at
455-56.) General damages would include, for example, the costs
associated with finding and purchasing replacement brandy on the
open market that, except for another party's breach, would have
been delivered under contract. "Second, if special
circumstances caused some unusual injury, special damages are
not recoverable therefor unless the circumstances were known or
should have been known to the breaching party at the time he
entered into the contract." (Id. at 455.) Special damages,
also known as consequential damages, would arise from that same
contractual breach involving undelivered brandy if, for example,
the parties to the delivery contract knew and understood that
the recipient had arranged to sell the brandy to a third party
at a profit. (See Morello v. Growers Grape Products Assn.
(1947) 82 Cal.App.2d 365 [holding that buyer's lost profits for
sale of undelivered brandy to third party could be awarded as
consequential damages].) "The requirement of knowledge or
notice as a prerequisite to the recovery of special
[consequential] damages is based on the theory that a party does
not and cannot assume limitless responsibility for all
consequences of a breach, and that at the time of contracting he
must be advised of the facts concerning special harm which might
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result therefrom, in order that he may determine whether or not
to accept the risk of contracting." (George Kevorkian
Accountancy Corp., 226 Cal.App.3d at 456 [citations omitted].)
This bill would render unenforceable 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 unless the consequential damages have been liquidated to
a set amount and identified in the contract.
CHANGES TO EXISTING LAW
Existing law provides that a contract is an agreement to do or
not to do a certain thing. (Civ. Code Sec 1549.)
Existing law states that formation of a contract requires:
parties capable of contracting; their consent; a lawful object;
and, a sufficient cause or consideration. (Civ. Code Sec 1550.)
Existing law specifies that for the breach of an obligation
arising from contract, the measure of damages, except as
provided, is 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. (Civ. Code Sec 3300.)
Existing law states that no damages can be recovered for a
breach of contract which are not clearly ascertainable in both
their nature and origin. (Civ. Code Sec 3301.)
Existing case law holds as a "well-recognized rule of law" that
recovery may be had for damages not covered by the general
liability for breach of contract, where facts are specifically
pleaded showing that the injury was one reasonably within the
contemplation of the parties. Special damages are such as
really took place, and are not implied by law, and are either
superadded to general damages arising from an act injurious in
itself or are such as arise from an act indifferent and not
actionable in itself, but injurious only in its consequences.
(Cohn v. Bessemer Gas Engine Co. (1919) 44 Cal.App. 85.)
This bill would state that the Legislature finds and declares
the following:
that, as a matter of public policy, it is in the best interest
of California taxpayers to ensure uniformity in the bidding
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and contracting process for public works construction projects
within the State of California;
that contractually imposing undefined and unlimited risk on to
public works construction contractors increases public works
construction costs because construction contractors must
account for the undefined and unlimited risk, which is
generally uninsurable, in their bids; and
that it is in the best interest of California taxpayers and
public works construction contractors for the Legislature to
establish clear guidelines for how liquidated damages and
consequential damages are expressed in a public works
contract.
This bill would provide 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.
This bill would define "public agency" to include the state, the
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.
COMMENT
1.Stated need for the bill
The author writes:
AB 552 makes unenforceable any public works contract entered
into by a public agency after January 1, 2016 that contains a
clause holding a contractor responsible for consequential
damages unless the damages are liquidated to a set amount in
the contract. The bill defines a public agency to include the
state, the Regents of the University of California, a city,
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charter city, county, charter county, district, public
authority, public agency, municipal utility, and any other
political subdivision or public corporation of the state.
When a contract is breached, it is common practice for one of
the parties in that contract to seek damages from the
breaching party. Some contracts will specify what damages may
be recoverable in the event of a breach. The vast majority of
public works contracts that speak to damages resulting from
breach call for a specific liquidated damage amount.
Liquidated damage amounts provide certainty for all parties
and force both sides of a contract to consider the various
fiscal implications and risks associated with a breach. When
a contract is silent on damages for a specific kind of breach,
any party may seek consequential damages, damages arising from
the consequences of a breach, from the breaching party. Some
public works contracts contain clauses calling for
consequential damages upon a breach, but in these instances
the contract will commonly contain a maximum limit or other
set amount to provide some certainty to contractors and the
companies tasked with insuring the project.
Having a measurable penalty is extremely important for
insurers providing surety bonds for projects. Contractors
will generally pay periodic premiums to a surety company in
exchange for providing a guarantee to anyone hiring the
contractor that the surety company will pay if the contractor
fails to meet their contractual obligations . . . Recently,
some public agencies have adopted policies requiring unlimited
consequential damages as penalties for project delays in their
public works contracts . . . The further adoption of these
provisions creates numerous problems for contractors. First,
insurance companies have difficulty insuring contractors for
these damages since they do not know how much a contract could
cost them. Second, small and mid-size contractors do not have
the financial capacity to expose themselves to undisclosed and
possibly unlimited damages. Finally, prime contractors can
have problems securing subcontractors to complete projects,
since damages will often pass through to subcontractors when a
breach occurs. These issues ultimately result in higher costs
due to reduced competition and increased insurance costs.
2.Providing Certainty in Public Works Projects
As the author notes above, some recent public works construction
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contracts drafted by public agencies in California apparently
include clauses assigning liability for consequential or special
damages to contractors. Of the examples provided to the
Committee, these clauses range from brief assertions that
contractors shall be liable for consequential damages to lengthy
clauses purporting to assign liability for a host of acts,
including acts normally sounding in tort. On their face, many
of these "consequential damages" clauses resemble indemnity
agreements. Indemnity is the allocation of liability among
parties to a contract. The Civil Code defines indemnity as "a
contract by which one engages to save another from a legal
consequence of the conduct of one of the parties, or of some
other person." (Civ. Code Sec. 2772.) While it may not be
unusual for parties to agree via contract to indemnify each
other for various acts through clauses similar to these,
liability for consequential damages - a type of contract remedy
for breach - is not the same as an agreement to indemnify.
Contract formation fundamentally involves consenting parties
reaching a mutual agreement to perform or not perform certain
acts. If contracting parties fail to perform what they had
mutually agreed to, breach of contract has occurred. Damages
for breach are generally limited to that which was "reasonably
within the contemplation of the parties as a probable result of
a breach at the time the contract was formed." (Brandon & Tibbs
v. George Kevorkian Accountancy Corp. (1990) 226 Cal.App.3d 442,
457.) California courts have explained, "[w]here two parties
have made a contract which one of them has broken, the damages
which the other party ought to receive in respect to such breach
of contract should be such as would fairly and reasonably be
considered either arising naturally, i.e., according to the
usual course of things, from such breach of contract itself, or
such as may reasonably be supposed to have been in the
contemplation of both parties, at the time they made the
contract, as the probable result of the breach of it." (George
Kevorkian Accountancy Corp., 226 Cal.App.3d at 456 [quoting
Hadley v. Baxendale, 156 Eng.Rep. at 151].)
However, when parties enter into a contract with an
understanding that breach would result in unusual or special
costs or harms to one of the parties, the remedy for breach is
typically enlarged to include those special costs. "[I]f the
special circumstances under which the contract was actually made
were communicated by the plaintiff to the defendant, and thus
known to both parties, the damages resulting from the breach of
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such contract, which they would reasonably contemplate, would be
the amount of injury which would ordinarily follow from the
breach of contract under these special circumstances so known
and communicated." (Id.) Thus, in a construction contract, if
a contractor knew that delays in completion of a building
project would cause unusual damages to a contracting party, such
as forcing that party to pay additional storage fees to store
items that the parties understood would be moved into the new
building upon timely completion, those additional fees would be
the proper subject of a suit to recover special or consequential
damages.
This bill would follow Hadley v. Baxendale and the litany of
California cases reaffirming its holding by requiring
consequential damages clauses, if included in public works
projects, to state with specificity the amount that may be
recovered upon breach. Consequential damages, unlike broader
agreements to indemnify other parties for future or undefined
wrongs, are based on identifiable and definable harms that will
result from the breach of a contract. By definition, these
harms are known and contemplated by the parties during contract
formation, and as such should be quantifiable when the parties
draft the terms of a contract. Specifying the proper level of
recoverable damages after breach for these unique harms will
help parties understand the consequences of a breach and the
degree of risk they undertake when entering into public works
contracts.
3.Effect of Including Unenforceable Consequential Damages Clause
The plain meaning of this bill would appear to render
unenforceable 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, unless the
consequential damages have been liquidated to a set amount and
identified in the contract. Normally, when a contract contains
an unlawful provision, California law directs that it be
interpreted in a matter that preserves its operability without
undermining the intent of the parties. Civil Code Section 1643
states that "[a] contract must receive such an interpretation as
will make it lawful, operative, definite, reasonable, and
capable of being carried into effect, if it can be done without
violating the intention of the parties." The California Supreme
Court has held that "it will not be supposed that the parties
entered into agreements contemplating a violation of the law.
On the contrary, it will be deemed that they intended a lawful,
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rather than an unlawful, act, and their agreements will be
construed, if possible, as intending something for which they
had the power to contract." (Barham v. Barham (1949) 33 Cal.2d
416, 429.) Consequently, unless evidence to the contrary
dictates a different result, it is likely that a reviewing court
would strike an offending consequential damages provision from a
public works contract before rendering the entire contract
unenforceable.
4.Liquidated Damages Distinguished
Where breach of a contract could result in damages that are
impractical or extremely difficult to quantify, parties may
agree ahead of time upon an amount presumed to be the actual
amount of damages sustained by an aggrieved party. These agreed
upon estimates of damages are known as "liquidated damages."
Liquidated damages provisions are useful for parties who need to
account for harms that cannot clearly be known in advance of a
breach, such as damages resulting from lost economic activity.
Civil Code Section 1671 authorizes the inclusion of liquidated
damages provisions in contracts and states that they will be
held as valid measures liquidating the damages for a breach
"unless the party seeking to invalidate the provision
establishes that the provision was unreasonable under the
circumstances existing at the time the contract was made."
(Civ. Code Sec. 1671(b).) Indeed, California law requires state
contracts to contain "a provision in regard to the time when the
whole or any specified portion of the work contemplated shall be
completed, and [to] 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."
(Pub. Contract Code Sec. 10266.)
Liquidated damages provisions may be appropriate mechanisms for
capturing special or consequential damages that are identifiable
during contract formation but not easily quantified. This bill
would not preclude the ability of public agencies to include
liquidated damages provisions in their public works contracts,
nor make provisions for identifiable consequential damages that
are difficult to quantify by including these damages within a
liquidated damages clause.
5.No Application Absent Consequential Damages Clause
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The Cities of Sacramento and Thousand Oaks, writing in
opposition, state: "[b]y 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."
Similarly, the California School Boards Association states:
"[b]y forcing public agencies, such as local educational
agencies (LEAs), to include in contracts the specific dollar
value of consequential damages . . . the bill threatens the
ability of public agencies to recover consequential damages."
The California Special Districts Association, also in
opposition, states:
This bill threatens to void many commonly used contract terms
which state specific recoverable damages that could be
classified as "consequential damages." Public works contracts
contain many items which pertain to damages for breach.
Because it can be difficult to determine whether a particular
breach has caused "consequential damages," AB 552 could lead
to uncertainty as to which contract items should include a
liquidated damages amount in order to prevent the provisions
being voided.
To address the concern about the potential invalidation of
clauses that, though not directly involving consequential
damages, may nonetheless be interpreted as falling within this
bill's liquidation requirements, the author offers the following
set of amendments. These amendments would limit the scope of
consequential damages covered by this bill to only "delay
damages," which would be defined as damages incurred by a public
agency for each day after the date on which the work was to be
completed by the contractor pursuant to the public works
contract." These amendments would also limit the bill's scope
to cover only those public works contracts that contain a clause
expressly requiring a contractor to be responsible for delay
damages.
Author's Amendments :
On page 2, line 7, after "risk" insert "associated with delays
in completion of public works"
On page 2, line 8, strike "costs" and insert "costs."
On page 2, strike lines 9 through 10
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On page 2, lines 13 through 14, strike "how liquidated damages
and consequential damages are expressed" and insert "imposing
delay damages"
On page 2, line 31, strike "requiring" and insert "that
expressly requires"
On page 2, line 32, strike "consequential" and insert "delay"
On page 2, line 33, strike "consequential" and insert "delay"
On page 2, between lines 34 and 35, insert: (b) "Delay
damages," as used in this section, means damages incurred by
the public agency for each day after the date on which the
work was to be completed by the contractor pursuant to the
public works contract. Delay damages shall not include
damages incurred by a public agency after the filing of a
notice of completion or, in the absence of a notice of
completion, the acceptance by the public agency of the public
work as complete.
On page 2, line 36, strike "(b)" and insert "(c)"
On page 3, below line 2, insert: (d) This section shall not
be construed to limit a right or remedy that the public agency
has to enforce the express terms of the public works contract,
except for delay damages.
Support : Air Conditioning Sheet Metal Association; Air
Conditioning & Refrigeration Contractors Association; Associated
Builders and Contractors of California; Associated General
Contractors; California Association of Sheet Metal and Air
Conditioning Contractors' National Association; California
Chapters of the National Electrical Contractors Association;
California Concrete Contractors Association; California
Legislative Conference of the Plumbing, Heating, and Piping
Industry; California Surety Federation; Construction Employers'
Association; Finishing Contractors Association of Southern
California; United Contractors; Wall and Ceiling Alliance
Opposition : California School Boards Association; California
Special Districts Association; City of Sacramento; City of
Thousand Oaks
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HISTORY
Source : Construction Employers' Association
Related Pending Legislation : None Known
Prior Legislation : AB 1314 (Pescetti, Ch. 875, Stats. 1999)
prohibited local entities from requiring a contractor to assume
responsibility for the completeness and accuracy of
architectural or engineering plans and specifications on public
works projects, except on designated design-build projects.
Prior Vote :
Senate Governmental Organization Committee (Ayes 13, Noes 0)
Assembly Floor (Ayes 79, Noes 0)
Assembly Appropriations Committee (Ayes 17, Noes 0)
Assembly Judiciary Committee (Ayes 10, Noes 0)
Assembly Accountability and Administrative Review Committee
(Ayes 9, Noes 0)
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