Jason Ebe | Snell & Wilmer
In this author’s experience, the most effective contract terms are those that mirror the parties’ business expectations and negotiations and allocate risk in a fair and balanced manner. Some advocates treat contract negotiations as they do litigation, always seeking to gain an advantage over their opponent. However, lopsided risk allocation can increase the risk of litigation, as parties may act or fail to act on their belief, sometimes erroneous, that they are shielded from liability for their conduct. When one party to a transaction belatedly recognizes that it was unreasonably disadvantaged to the unjust benefit of another, the disadvantaged party may be more motivated to bring a claim to attempt to balance the playing field, including, in some cases, asserting additional causes of action for breach of good faith and fair dealing, fraud, and other claims in an attempt to do an end around the contractual provisions. Negotiating a fair and balanced contract in the first instance promotes good behavior by all parties to the contract and enhances the likelihood of project success with minimal or no disputes.
The foregoing applies particularly with respect to contractual limitations of liability. These clauses modify the common law application of liability exposure, in effect providing that even if one party harmed another, the relief to which the party harmed is limited by some artificial cap. In many states, such contractual limitations of liability are enforceable on the grounds of freedom of contract. Some states limit enforcement of a contractual limitation of liability as to the wrongdoer’s sole negligence or intentional wrongful conduct, but contractual limitations of liability for ordinary negligence are generally enforceable.
Note, however, this article is not aimed at negotiating an “enforceable” limitation, but rather an “effective” limitation, which promotes dispute avoidance and mitigation. In this author’s experience, most project participants would prefer to avoid a dispute than position for the paper advantage in litigation.
Common industry templates include enforceable and effective limitations of liability. For example, the American Institute of Architects A201 General Conditions have included a mutual waiver of consequential damages dating back to 1997. The ConsensusDocs 200 includes a similar mutual waiver, though notably the ConsensusDocs waiver carves out losses covered by required insurance. In other words, consequential damages covered by insurance are not waived by contract. Both templates include provisions for liquidated damages, which are themselves limitations of liability as to unexcused contractor delay. And both templates include indemnity clauses to address claims brought by third parties. Other AIA and ConsensusDocs templates for design professionals, subconsultants, design-builders, construction managers and subcontractors included similar provisions. But none include outright total caps on liability, evidencing that such caps have not yet become the industry norm.
Despite this, limitations of liability are common in design agreements and to a slightly lesser extent construction contracts. The concept of the cap itself is not offensive to the notion of balanced risk allocation, after all it is fair for parties to take on contracts and price their fees based on anticipated risk, which should not be unlimited. However, some parties attempt to oversimplify the limitation, for example simply by stating that the design professional’s or contractor’s total liability shall be capped at some dollar value, or fraction or multiple of the total contract price or the fee. For example, does the cap apply equally to first-party and third-party claims? If both, the innocent party could be left with significant residual liability from a third-party claim for which the innocent party would otherwise be entitled to indemnity. What about insurance? What if there is more available insurance than the cap? Requiring high insurance limits may be thwarted by a low liability cap. And how does the cap impact the injured party’s ability to also seek relief against lower tiered subconsultants or subcontractors who may be secondarily if not primarily responsible for the loss? All of the foregoing considerations can be addressed with thoughtful drafting.
In the author’s view, a fair and balanced contractual limitation of liability could include the following:
- For indemnity for third-party claims, no limitation;
- For first-party claims for which there is available insurance, and/or the claims may be flowed down to subconsultants or subcontractors, the limits of available insurance and recovery against such subconsultants or subcontractors; and
- For first-party claims for which recovery from available insurance and against responsible subconsultants and subcontractors has been exhausted, the prime contractor’s (or prime design professional’s) fee.
The foregoing provides for a balancing and allocation of risk that does not leave any party unfairly burdened by risk that it cannot reasonably control. Of course, every project, team and circumstances are unique, and consideration must be given to each. As a general tip, however, consider asking whether the proposed clause still seems fair if you switched sides of the negotiating table mid-negotiation. If the answer is ‘no way would I sign this’, the clause is likely unbalanced, and any short terms satisfaction of papering the contract to your advantage may be quickly erased come the dispute resulting from the inequity of risk. In the event the parties’ mutual aspiration is successful project delivery with minimal or no claims, a fair and balanced limitation of liability is the way to go.
Footnote
1. The views expressed are those of the author, and not necessarily the firm or his colleagues.
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