Parties to construction and design contracts routinely rely on limitation of liability clauses to curb their potential financial exposure in the event aproject does not go as expected.
Recently, some courts have stepped in the path of private parties seeking to limit liability by refusing to enforce these clauses. Other courts have upheld such clauses as a necessary part of certain financial transactions.
The juxtaposition of the two trends has created confusion in the industry and placed an increased burden on contractors and designers and their legal counsel to either draft limitation of liability clauses more carefully or price the risk of large potential liability into their contracts.
Limitation of Liability Clauses
Limitation of liability clauses do not always focus on financial limits. Frequently, the clause seeks to limit the types of claims parties can bring against each other (e.g., limiting claims based on implied warranty). In some cases, the clause seeks to limit the time in which parties can make claims, such as barring claims not brought within one year of a project’s completion.
Most frequently, however, limitation of liability clauses contemplate a financial limitation to one party’s ability to recover financial damages. Often, especially with contracts for professional services, the liability is limited to the amount of the professional’s fee. Other times, the parties limit liability to the amount of insurance proceeds, or negotiate a certain number appropriate in light of the party’s contribution to the project, its fee and the possibility for large damages.
As a general rule, courts have upheld the mutual agreements of parties to limit their liability to each other. A few recent cases, however, have cast doubt on the future of limitation of liability clauses.
Historical Trends
During the last 15 years, courts that have struck limitation of liability clauses used state-specific anti-indemnity statutes as the sword to pierce the limitation of liability shield. In the 2006 case Omaha Cold Storage Terminals, Inc. v. The Hartford Ins. Co. and the 1994 case City of Dillingham v. CH2M Hill Northwest, Inc., the courts determined it was against the public policy of the state or a specific state anti-indemnity statute to allow a party to contract away responsibility for its own negligent or intentional actions.
Naturally, as more states have passed anti-indemnity legislation, more courts have struck down limitation of liability clauses.
Invalidating Clauses
In one case, the Georgia Supreme Court used the state’s anti-indemnity statute to invalidate a contract clause limiting the liability of an engineer to the amount of the engineer’s total fee for the project. The court refused to enforce the limitation clause because Georgia law prohibited a party from contracting away liability for its own sole negligence.
The court determined that the limitation of liability clause violated Georgia law because it shifted all liability for damages above the engineer’s total fee to the developer, regardless of “the origin of the claim or who is at fault.” Indeed, the developer would be obligated to pay all damages above the threshold amount of the engineer’s fee caused by the engineer and awarded to a third party. Such a circumstance was tantamount to an indemnity for the engineer’s sole negligence, the court found, and as a result the clause was invalid.
Upholding Clauses
To the contrary, the Arizona Supreme Court recently upheld a limitation of liability clause despite the state’s anti-indemnity statute.
The court was persuaded by the business realities of the construction world, stating, “It is possible that a limitation of liability provision could cap the potential recovery at a dollar amount so low as to effectively eliminate the incentive to take precautions.”
However, because the liability was limited to the amount of the consultant’s fees, which “undoubtedly were [the firm’s] main reason for undertaking the work,” the firm had a “substantial interest in exercising due care because it stands to lose the very thing that induced it to enter into the contract in the first place.”
In 2008, the North Carolina Court of Appeals upheld a limitation of liability clause in a contract between a surveyor and contractor. In
Blaylock Grading Co. v. Smith, the court found the limitation of liability clause was different and distinct from an indemnity provision; therefore, North Carolina’s anti-indemnity statute did not apply.
Parties in some states need not worry about the enforceability of limitation of liability clauses. In California, for example, the anti-indemnity statute expressly allows parties to agree “to the allocation, release, liquidation, exclusion, or limitation as between the parties of any liability (a) for design defects, or (b) of the promisee to the promisor arising out of or relating to the construction contract.”
Lessons Learned
While it is certainly difficult to predict how courts will view limitation of liability clauses in the future, lessons learned from these recent cases can help parties draft enforceable clauses. Specifically, parties should consider the following:
- Limitations of liability are more likely to withstand scrutiny than waivers of liability.
- Limitations for liability based on intentional acts are less likely to be upheld.
- Draft a limitation of liability clause, not an indemnity clause. Know the differences, review the relevant anti-indemnity statutes, and make sure both parties understand that the clause limits liability and does not require an indemnification of third parties.
- Make the level of limitation proportionate to the party’s participation in the project.
- Consider the possibility that a limitation may not be enforceable. Consider pricing the contract to reflect the risk of a large potential liability, as well as purchasing additional insurance to cover the worst case scenario.