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Limitation of liability clauses can be effective protection

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It is not uncommon for design professionals to negotiate limitation of liability clauses in their professional services contracts. These clauses typically limit the damages recoverable from the design professional, either under breach of contract, warranty or negligence claims to a capped amount.

Courts are routinely asked to enforce such provisions when, as a result of the negligence or mistake of a design professional, another party sustains damages. A recent 2017 case in Colorado, “Taylor Morrison v. Terracon Consultants,” points out the value of such clauses.

In Taylor Morrison, a housing developer secured a verdict at trial against a geotechnical engineer for $9.5 million. The engineer was responsible for soil testing and compliance with local codes and specifications for a large residential housing development.

After the project was built, the homes sustained substantial drywall cracking which was attributed to soil issues that the developer maintained should have been discovered and addressed by the geotechnical engineer. The engineer defended the claim in part based on a clause in its professional services agreement which limited its liability to $550,000 (or its fee, whichever was greater) for a breach of contract or negligent work.

Although the developer claimed that the engineer’s negligence was “willful and wanton,” and that the amount of the engineer’s liability insurance exceeded the $550,000 contractual liability cap, the appellate court ultimately enforced the liability cap and held that the engineer could not be liable for any amount exceeding $550,000.

CONSISTENT ENFORCEMENT

The enforcement of the limitation of liability clause in the Taylor Morrison case is consistent with Pennsylvania and New Jersey law on this subject.

In Valhal Corp. v. Sullivan Associates, a developer retained an architect to perform a site feasibility study for a property on which the developer wanted to build a large building.

Based on the study, the developer bought the property but later learned that the architect’s study had failed to disclose that there was a building height restriction applicable to the property. As a result, the developer claimed losses exceeding $2 million.

However, the professional services agreement contained a limitation of liability clause which capped any damages against the architect at $50,000 or the amount of the fee (in this instance $7,000), whichever was higher.

Ultimately, the federal appellate court enforced the limitation of liability clause, capping liability at $50,000.

NEGOTIATED

The Valhal case has been followed by several courts in Pennsylvania and New Jersey.

The rationale behind enforcing such limitation of liability provisions is that they are typically negotiated in commercial contracts between sophisticated commercial parties, and should be enforced as long as the amount of the liability cap relative to the cost of performance is not so low as to remove the incentive of the party to perform.

So, for example, if in the Valhal case the amount of the fee had been $20,000 and the amount of the liability cap had been only $10,000, it is likely that a court would not have enforced the cap because to do so would have discouraged the design professional from performing its obligations without a significant penalty.

In Marbro v. Borough of Tinton Falls, the New Jersey Superior Court Appellate Division followed Valhal.

EXCULPATORY CLAUSES

Courts see limitation of liability clauses in construction or professional services contracts differently from purely exculpatory clauses. A limitation of liability clause limits the amount or type of damage for which a party may be liable.

In contrast, an exculpatory clause, such as a broad form indemnity provision, completely exculpates a party from any liability, even if the exculpated party was itself negligent or otherwise responsible in whole or in part.

Generally, courts are hostile to exculpatory clauses. To be enforceable, they must be between private parties in a nonconsumer context, be clear and unambiguous, and not violate a stated public policy of the state in which they are applied.

Even so, exculpatory clauses will be strictly construed by the courts, and their meaning and breadth will generally not be expanded beyond the express language used in the agreement.

CONSEQUENTIAL DAMAGES

Another classic example of a damages limitation clause is a mutual waiver of consequential damages, which is found in standard American Institute of Architects construction contracts.

Using the standard language, the parties agree, mutually, that they will not claim against each other consequential damages for breach of contract. Classic examples of consequential damages are loss of profit beyond direct losses within the breached contract, damage to reputation, loss of income from related businesses, and increased overhead.

It is not unusual for parties to define what they mean by “consequential damages” in a contract that contains a waiver of claims for such damages.

The proper use of damages limitations clauses in professional services and construction contracts can be quite beneficial in defining risk and limiting liability to the parties.

Andrew B. Cohn is a partner in the construction law group at Kaplin Stewart, a Blue Bell and Philadelphia law firm. He represents developers, contractors, subcontractors and design professionals in construction related transactional and litigation matters. He can be reached at acohn@kaplaw.com or 610-941-2549.

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