Infotech and the Law: Consequential and punitive damages -- Should you be worried?

Richard Rector

Companies entering the federal market for the first time are often concerned about potential liability for consequential or punitive damages in connection with breach of a federal contract. These companies have heard horror stories about the occasional, huge award of damages against a contractor, typically in a state court, and they want to know if there is similar risk on federal contracts.

The good news is that, for the most part, federal contractors face little risk of liability for punitive damages connected with a breach of contract. There is relatively limited risk that such contractors would be held liable for consequential and incidental damages related to a breach.

The law of contracts generally seeks to compensate the injured party, not punish the wrongdoer. This applies equally to federal contracts. There are few cases in the past 40 years in which the federal government has sought punitive damages against a prime contractor, except in cases where the contractor's conduct involved either a tort or criminal conduct.

Accordingly, there is little risk that a contractor would be held liable for punitive or exemplary damages for breach of a federal contract. When a contract is breached, courts generally seek to place the non-breaching party in as good a position as the party would have been absent the breach.

Like any contract party, the federal government generally is entitled to breach damages unless another remedy is dictated either by law or the terms of the contract. There are three significant ways, however, in which the federal government's right to breach damages may be limited.

First, many federal contracts contain limitation of liability clauses. These clauses are not broad limitations of liability, as many companies include in their commercial contracts. Nonetheless, the clauses effectively cap a contractor's liability at its insurance level for "loss of or damage to property of the government" that occurs after acceptance and is caused by defects or deficiencies in the supplies or services.

Depending on which clauses a contract includes, this limitation also can apply to the supplies and materials delivered under the contract, which can be significant for high-value items.

Second, a contractor's liability may be limited if it is delivering a commercial item. The limitation of liability clause that appears in commercial-item contracts expressly says the contractor will not be liable for consequential damages resulting from any defect in accepted items, unless the contractor warrants that it will be liable for such damages. Since few, if any, contractors provide such warranties, consequential damages for defective products or services are, as a practical matter, not available in commercial-item contracts.

Finally, federal contracts typically include a broad range of standard contract clauses that provide for specific adjustments and other remedies for contractor deficiencies or non-performance. In certain situations, such as warranties or liquidated damages, these clauses plainly provide "exclusive" remedies for non-performance. In these instances, the government is limited to specific remedies set forth in the contract clause, and consequential damages are not available.

As a result of these limitations, the rigorous standards of proof applied to consequential damages and the government's duty to mitigate damages upon breach, there are relatively few reported cases in the last 40 years in which the federal government has sought and obtained significant consequential damages from a contractor. Thus, absent unusual circumstances, the risk is small that a federal contractor would be held liable for such damages in connection with a breach of contract. *

Richard Rector is a partner in the Government Contracts Group of Piper Marbury Rudnick & Wolfe LLP in Washington. His e-mail address is richard

.rector@piperrudnick.com.

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