In the last few years, as a result of the decline in the commercial real estate market and the economy in general, architects and engineers with an instinct for survival have sought ways in which to reduce costs and share liability risks of a project with the owner. One contractual approach to reduce liability is for the design professional to negotiate with the owner a contractual limitation on the design professional's liability.
A limitation of liability clause, unlike a disclaimer or waiver, does not release the architect or engineer from any liability to the owner, but instead apportions the potential liability between the parties. Once strongly disfavored by the courts, the recent trend is for the courts to uphold limitation of liability clauses for design professionals if the owner is of equal or greater sophistication and the limitation is bargained for between the parties.
Elements of a Limitation of Liability Clause
A typical limitation of liability clause contains four main elements: (1) the party who is benefiting from the limitation of its liability; (2) the party agreeing to limit its own recovery for someone else's negligence; (3) the type of claims to which the limitation applies; and (4) the amount of the limitation.
1. Party Receiving the Benefit of the Limitation
Illustration: "Design Professional and its consultants, partners, agents and employees shall not be liable..."
In this case, obviously it is the design professional and its consultants who are receiving a benefit by the owner's agreement to limit its recovery.
2. Party Agreeing to Limit its Recovery
Illustration: "Neither the Design Professional ... shall be liable to the Owner ..."
It is important to note that a limitation of liability clause does not reduce the liability of the design professional to third parties (such as injured workers) who are not a party to the owner/design professional agreement. Rather, it reduces the liability for claims by the owner against the design professional.
3. The Claims or Liabilities to Which the Limitation Applies
Illustration: "...for any and all claims, losses, expenses, injuries, or damages arising out of or any way related to this Project or this Agreement by reason or any act or omission, including breach of contract or negligence not amounting to a willful or intentional wrong..."
Whereas an indemnity provision under the laws of most states prevents a design professional from obtaining an indemnification against claims arising from its own negligence, a limitation of liability clause covers any direct claims by the owner against the design professional based upon the negligence of the design professional.
4. The Amount of the Limitation
Illustration 1: "...shall not exceed the total compensation received by Design Professional under this Agreement..."
Illustration 2: "...shall not exceed the total amount of $_________."
Illustration 3: "...shall not exceed the total sum paid on behalf of or to the Design Professional by its insurers in settlement or satisfaction of Owner's claims under the Terms and Conditions of the Design Professional's insurance policies applicable thereto ..."
Illustration 4: "...shall not exceed the total compensation received by Design Professionals under this Agreement, or the sum of $_________, whichever is greater ..."
Limitation of liability clauses typically limit the design professional's liability to one of the following: (i) the design professional's compensation under the Agreement; (ii) a stipulated sum of money; (iii) available insurance coverage; or (iv) a combination of two or more of the above.
5. Limitation of Consequential Damages
Illustration: "...shall not be liable to the Owner for any special or consequential damages, including but not limited to, lost profits, loss of use, and costs of replacement, caused by the Design Professional's negligence, breach of contract, or any other cause whatsoever ..."
Another form of limitation which the design professional may be able to negotiate successfully is an exclusion of any recovery by the owner of consequential or special damages. For example, the design professional may be concerned on a particular project about damages associated with lost profits or revenue, or loss of use, if the completion of construction is delayed.
Enforceability of a Limitation of Liability Clause
In general, the law permits parties possessing relatively equal bargaining power to elect to limit the liability of one party to other. Several courts have ruled that a design professional may limit its liability to the owner provided that:
It should be recognized that state courts will have to decide as cases arise whether there exists "public policy" considerations prohibiting the enforcement of a design professional's limitations of liability. The following courts recently have addressed the validity of limitation provisions on a design professional's liability and found there to be no "public policy" prohibiting the enforcement of such provisions (the Illinois courts have not yet rendered a decision on this issue):
Gibbs, Inc., II v. Law Engineering, Inc., (4th Cir. 1992); Georgetown Steel Corp. v. Union Carbide Corp., 1992 Dist. Lexis 017669 (D.S. Car. 1992); Markborough California, Inc. v. The Superior Court of Riverside County, 227 Cal.App.3d 705 (Calif. 1991). Nonetheless, because the validity of limitation of liability clauses has not been decided in many states, it is important to recognize that even a carefully drafted clause has no guarantee of surviving judicial scrutiny.
How to Draft an Enforceable Limitation Clause
The key to the design professional's drafting of an enforceable limitation of liability clause is the recognition that the clause will be closely scrutinized by the courts if a dispute arises and all doubts will be resolved against the design professional seeking to enforce the limitation.
Therefore, it is necessary to make certain that the clause clearly and unambiguously expresses the parties' intent in limiting the design professional's liability. In addition, the clause should be set in bold face print, italicized, or placed apart from the rest of the text on the page on which it appears so that the owner is aware of its existence.
Because the parties must have the opportunity to negotiate a limitation of liability clause for it to be enforced, it is helpful to maintain records of drafts of the agreement and correspondence relating to the negotiation of the limitation.
How to Negotiate a Limitation of Liability Clause
From the design professional's vantage point, every owner/architect or owner/engineer agreement would contain a limitation of liability clause if the owner would consent to sharing the potential liability for faulty design work on a project. Unfortunately, the world the design professional faces is a far crueler place. There are, however, a number of strategies that can be employed to convince an owner that if a limitation of liability clause is not in the owner's best interest, at least it is fair.
First, it is a fact of life that the owner and not the design professional receives most of the long term financial benefit for a successful project, whereas the design professional receives a one time fee which is often disproportionately small in relation to the potential risk he/she has assumed. If the owner is made aware of the discrepancy between the risk and the reward for the design professional, the owner may be willing to limit the design professional's liability to the design professional's available insurance coverage or a specific dollar amount. This is particularly so in design/engineering projects where the potential liabilities typically can bankrupt a firm. Such is the case with certain environmental remediation projects.
Second, the design professional can argue that he/she has purchased E&O coverage to protect the owner against any faulty design, and if the insurance is not sufficient to pay all liabilities, the damages would have to be catastrophic, in which event the design professional's firm will not possibly be able to cover such losses. In other words, the owner realistically does not look beyond the insurance of the design professional except in circumstances where the design professional could not pay for catastrophic losses. Telling an owner that you are unwilling to "bet your company" for a $50,000 fee may persuade the owner to share a portion of the risk by limiting his recovery to available insurance coverage. Moreover, the design professional can argue that the limitation of liability does not give the design professional free rein to act carelessly because he/she remains liable, rather the extent of such liability is limited to an amount consistent with the financial reward for proper performance of the work.
Third, the design professional can offer the owner an option if the owner appears unwilling to provide a limitation as to its recovery: "either provide a limitation of liability or pay the design professional an additional fee to assume the full risk of any liabilities on the project relating to its design." This approach has been upheld as valid by the courts and, in addition to creating an option for the owner, may provide evidence that the limitation of liability was freely negotiated if a dispute later arises.
Limitation of Liability
(To The Amount of Fee or Stipulated Sum)
The Design Professional, and its consultants, partners, agents and employees, shall not be liable to the Owner, whether jointly, severally or individually, in excess of the compensation paid to the Design Professional under this Agreement, or in excess of the sum of $_______, whichever is greater, as a result of any act or omission not amounting to a willful or intentional wrong.
Limitation of Design Professional's Liability
(Limited to Available Insurance or Specified Sum)
Design Professional shall procure and maintain insurance polices with such coverages and in such amounts and for such period of time as required by and set forth in this Agreement. Owner hereby agrees that to the fullest extent permitted by law Design Professional's total liability to Owner for any and all injuries, claims losses, expenses or damages whatsoever arising out of or in any way related to the project or this Agreement from any cause or causes including but not limited to Design Professional's negligence, errors, omissions, strict liability, breach of contract or breach of warranty (hereafter "Owner's claims") shall not exceed the total sum paid on behalf of or to Design Professional by Design Professional's insurers in settlement or satisfaction of Owner's claims under the terms and conditions of Design Professional's insurance policies applicable thereto. If no such insurance coverage is provided with respect to Owner's claims, then Design Professional's total liability to Owner for any and all such uninsured Owner's claims shall not exceed $________.
Limitation of Design Professional's Liability
(Limited to Dollar Amount)
Owner hereby agrees that, to the fullest extent permitted by law, Design Professional's total liability to Owner for any and all injuries, claims, losses, expenses or damages whatsoever arising out of or in any way related to the project or this Agreement from any cause or causes including but not limited to Design Professional's negligence, errors, omissions, strict liability, breach of contract or breach of warranty shall not exceed the total amount of $________.
Limitation of Liability for Consequential and certain Other Damages
(Consequential Damages Limitation)
Owner hereby agrees that to the fullest extent permitted by law, Design Professional shall not be liable to Owner for any special, indirect or consequential damages whatsoever, whether caused by Design Professional's negligence, errors, omissions, strict liability, breach of contract, breach of warranty or other cause or causes whatsoever, including but not limited to, loss of use of equipment or facility, and loss of profits or revenue.
Stephen G.M. Stein, Esq. and Marc E. Odier, Esq. Stein, Ray & Conway ("SRC") is one of the largest firms in the United States exclusively devoted to construction law. SRC represents many of the country's largest owners, design professionals and contractors in contract formation, risk management and insurance, business counseling, and dispute resolution. SRC has handled some of the country's highest profile design and construction cases.
The information in this and all other RISK Administration and Management Company articles is intended for information purposes only and does not constitute legal advice. For legal advice and assistance, please contact competent counsel in the jurisdiction of your professional practice.