Guy Randles, The Daily Record Newswire
One of the hottest issues in private contract negotiations these days is the question of limitation of liability (LOL) clauses. Owners understandably want recourse for their damages in the event of substandard performance by their contractors and design professionals. Just as understandably, contractors and design professionals want protections on projects where risks may be disproportionate to the compensation offered for assuming such risks. Balancing the contractual demands between these two competing goals is often a contentious process without any “right” answer.
The question of whether and what kinds of liability limitations may be appropriate on any given project is more of a business judgment than a legal question. A party’s perception of what might be “fair” in the way of liability limitations is often a function of whose economic ox is being gored, who has bargaining leverage, and what market pressures are.
While there may not be one right answer to the question of what limitations of liability provisions are appropriate, there is no mistaking the fact that such limitations can have real consequences. The recent Seventh Circuit Court of Appeals case of SAMS Hotel Group LLC v. Environs Inc. is a reminder of how powerful such provisions can be.
SAMS hired Environs to design a six-story hotel in Fort Wayne, Ind. Due to irreparable structural defects, the hotel building had to be demolished without even opening. Although SAMS estimated that its damages due to the negligent design were greater than $4.2 million, its recovery was limited to $70,000 – the amount of Environs’ fee.
The LOL clause in the Environs design contract stated: “the owner agrees that to the fullest extent permitted by law, Environs Architects/Planners Inc.’s total liability to the owner shall not exceed the amount of the total lump sum fee due to negligence, errors, omissions, strict liability, breach of contract or breach of warranty.”
The owner tried mightily to avoid the effect of the LOL provision, arguing that it should apply only to breach of contract claims and not claims independent of the contract such as those for negligence. The owner also argued that the LOL provision was unenforceable because it did not explicitly state that the clause limited claims for Environs’ own negligence.
However, the court rejected both arguments, noting its willingness to enforce the terms of commercial contracts between sophisticated parties.
The court did not address how the LOL clause had been inserted into the contract. Specifically, there is no mention of whether the clause had been actively negotiated or whether there were project circumstances that led the owner to agree to a limitation so favorable to the architect. In any event, the court did not hesitate to enforce the clause as written.
As this case demonstrates, LOL clauses can provide powerful protections to their beneficiaries. However, they sometimes give a false sense of security.
The same is not necessarily true for third parties to the contract. For instance, a contractor or design professional who negotiates limited exposure by contract to an owner may still face unlimited exposure to successor owners, tenants or other third parties on negligence theories. Particularly in states such as Oregon that have diluted or abandoned the “economic loss rule,” beneficiaries of LOL clauses may face unexpected and unlimited liability to parties other than those with whom they have contracted.
For parties wanting protections from third-party claims, simple LOL from the owner is not enough. To be protected from such third-party claims, commitments from the owner for indemnity and insurance coverage may be the minimum required.
Another example of exposure exceeding a negotiated LOL can arise in the subcontracting context. For example, contracts for the construction of production facilities in particular frequently have limitations of liability, because there is a potential for catastrophic damages in the event of delays.
Subcontracts on such projects typically have flow-down clauses making terms of the prime contract applicable to the subcontractor’s work. Subcontractors would normally expect that any LOL enjoyed by the prime contractor against the owner would also apply to direct claims the owner might attempt to make against the subcontractor. Typically, a subcontractor would not expect more liability exposure than the prime contractor, but this may or may not be true based upon the language of the prime contract and the subcontract and the ability of the owner to make a direct claim against the subcontractor under the case law that applies in the project’s location.
Limitation of liability considerations are a real minefield and a continuing challenge to stakeholders trying to strike the right balance between risk and reward.
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Guy Randles is a member of the Stoel Rives construction and design group, and a member of the Oregon and Washington state bars. Contact him at 503-294-9288 or at garandles@stoel.com.
