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  • Liquidated Damages Clause and Waiver of Consequential Damages Clause Effectively Cap Damages Available against Design-Builder.
  • No Warranty of Design

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ARTICLE # 1
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Liquidated Damages Clause and Waiver of Consequential Damages Clause Effectively Cap Damages Available against Design-Builder

Contracts requiring a design-build engineering firm to supply “basic engineering packages” for licensing and technology transfer agreements for the design and construction of a processing plant for sodium hydroxide (caustic soda) contained a liquidated damages clause capping the engineer’s liability at 10 percent of its fee, and also contained a waiver of consequential damages clause waiving “special, indirect, incidental, or consequential damages of any kind.” In response to the project owner’s suit against the engineer for failure of the plant to achieve commercial production, the court enforced these clauses to limit the available recovery.

The plaintiff’s complaint against the contractor alleged breach of contract, misrepresentation and fraud. With regard to the counts of the complaint alleging misrepresentation and fraud, the court dismissed these because they were barred by the two year statute of limitations. In response to the defendant’s argument that the breach of contract claim should also be dismissed based upon the Waiver of Consequential Damages and the Liquidated Damages clauses, the plaintiff argued that the clauses should not be enforced because the clauses were unconscionable, were based on material misrepresentations, and were the product of mutual mistake.

The Waiver clause provided: “Article XV Waiver of Consequential Damages. In no event shall Seller [contractor] be liable to [owner] whether in contract, warranty, tort (including negligence or strict liability) or otherwise for any special, indirect, incidental or consequential damages of any kind or nature whatsover.”

The liquidated damages clause provided: “Article VIII Liquidated Damages. In the event that the Caustic Prill Unit fails to produce Caustic Soda beads during the performance test even though all the conditions described in Article VII hereof have been satisfied and despite [contractor’s] efforts to correct said failure, for each 5 percent or part thereof shortfall below the level warranted in Article VII, hereof, [contractor] will pay to [owner] an amount equal to 5 percent of the lump sum fee received by [contractor] for the failed Caustic Prill Unit. However, [contractor’s] maximum limit of liability under the Agreement as to any failed Caustic Prill Unit shall be 10 percent of the Lump sum fee received by [contractor] for the failed Caustic Prill Unit. These payments are the exclusive remedies provided to [owner] under this Agreement. Except as provided in the Article VII, Contractor shall have no other liability whether in contract, warranty, tort, or otherwise.”

The plaintiff, project owner, tried to get around the liquidated damages clause by arguing that it only applied in the event that the Unit failed the performance test. Since there was never a performance test, it argued the limitation clause had no effect. In interpreting the contract on this matter, the court explained that “the intention of the parties is a paramount consideration.” Intent must be ascertained from the contract document itself when the terms are clear and unambiguous. The court concluded that the clause makes clear that although the five percent cap appears to apply in the event of a performance test failure, the ten percent cap applies to any claim under the Agreement regardless of whether or not performance tests were performed. The court emphasized that “When combined with the extremely strong liability-limiting language of the entire clause, these phrases make clear that the intention of the parties was to limit [owner’s] recover under any circumstance to ten percent of the fee it paid to [contractor].”

The court also rejected the project owner’s argument that the clauses were “unconscionable” and should not be enforced. The court said that the test under Pennsylvania jurisprudence for unconscionability is “an absence of meaningful choice on the part of one of the parties together with contract terms which are unreasonably favorable to the other party.” It further explained that the principle underlying the concept is to prevent oppression and unfair surprise but that it is not intended to disturb the “allocation of risks because of superior bargaining power.” In other words, just because a party has greater bargaining power and negotiates a more favorable and even onerous deal does not make the deal unconscionable in the absence of oppression and unfair surprise. In commercial settings, explains the court, a limitation of damages clause will rarely be found unconscionable.

In this case, the owner claimed that it was a small unsophisticated Indian company that trusted “an American behemoth” when its president flew to Philadelphia to sign the deal. It made no changes to the contract and did not seek counsel to assist with its negotiation. Although the court described this as a “sympathetic picture,” the court concluded that the scenario did not suggest any lack of meaningful choice. In its conclusion with regard to this issue, the court said, “There is nothing in the record to suggest unfair surprise…. The clauses were not hidden boilerplate. The one point which gives this Court pause is whether a ten percent cap creates an adequate incentive to perform. However, there is no indication that the profit margin was any higher than ten percent. Therefore, [owner] has not demonstrated unconscionability.” Mistry Prabhuda Manji Eng. Pvt. Ltd. v. Raytheon Engineers & Constructors, Inc., 213 F.Supp.2d 20 (U.S D.C., Massachusetts, 2002).
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Risk Management Note: This case provides valuable insight into the judicial interpretation and application of contract clauses that purport to limit liability of engineers and contractors. There is a striking similarity in the project owner’s arguments with those that have been raised in so many other reported cases. This decision should be a reminder to every commercial entity entering a contract for the design or construction of a project that, generally speaking, courts will enforce the terms of the contract that result from arms-length negotiations between two commercial entities. This is true even if one of the parties was significantly smaller than the other and did not have equal bargaining clout. The key, as explained by this court, is whether the damage limitations would be unconscionable. In my own legal practice, I have had more than one client tell me that they wanted to ignore my advice and sign onerous contracts in which they would to be giving away substantial rights to the other party – with the expectation that they could convince a court that they signed the contract as a result of duress, coercion or unequal bargaining position and that the clause should be void as against public policy or as unconscionable. My advice has been that a court would not be impressed with their arguments for much the same reasons stated by the court in this case. Plus, my clients have had competent legal assistance with their contracts and this makes their chances of getting a court to let them out of a bad deal even more unlikely. Note, however, that the court provides significant pointers in drafting an enforceable limitation of liability clause, when it states that the clause in this case was not “hidden boilerplate” and that the question of whether a ten percent cap creates an adequate incentive to perform gave the court pause. I typically advise clients to make clauses such as indemnification, limitation of liability (LoL), and waiver of consequential damages clear and pronounced in the contract. If an LoL clause might be subjected to close judicial scrutiny it may even be advisable to have your client separately initial or sign their name beside the clause so they cannot later claim they were surprised to learn of its presence in the contract. In addition, you should be careful to make the LoL amount reasonable. If it is too small in comparison to the size of the fee or the significance of the potential damages that could occur, a court may refuse to enforce it. Most important of all, the decision of this court demonstrates the value of seeking contract language where appropriate to limit the liability or the types of damages that can be recovered.

For additional articles on this subject, see the article archive section of our website, or purchase our book: “Construction Law and Risk Management: Case Notes and Articles.” The book will be advertised in one of the next issues of this newsletter.

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ARTICLE # 2
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No Warranty of Design

In response to a plaintiff’s suit against an engineer alleging breach of an express warranty, a court held that the complaint must be dismissed because the record revealed no express warranty, and if the service was performed negligently the cause of action must be based in negligence rather than warranty. The engineer had been retained to provide professional services with respect to the design of a sludge treatment facility. In analyzing the allegations contained in the plaintiff’s complaint, the court stated that those allegations could not be construed as asserting either a negligence or a breach of contract claim. Citing several New York court decisions, this court stated as a matter of law that “no warranty attaches to the performance of a service.” Whatever representations were made by the engineer in its contract did not, in the opinion of the court, rise to the level of guaranteeing a particular result.

Another count of the plaintiff’s complaint alleged that the engineer had committed fraud and intentional misrepresentation. The court held that this aspect of the complaint also had to be dismissed because before a plaintiff can pursue such a theory it must first demonstrate that it was prevented by the defendant’s fraud from pursuing normal available remedies for negligence or breach of contract. In other words, the plaintiff would have to show that it had been diverted from pursuing those other remedies by its reliance upon the defendant’s alleged misrepresentation. Or as explained by the court, “Stated another way, a fraud claim in this regard ‘is sustainable only to the extent that it is premised upon one or more affirmative, intentional misreprentations – that is, something more egregious than mere concealment or failure to disclose additional damages, separate and distinct from those generated by the alleged malpractice.” In this case, the court found that the allegations pertaining to intentional misrepresentation and those pertaining to professional malpractice are based on the same factual allegations, namely that the engineer designed a facility “that it knew would not be adequate for its intended purpose and, in so doing, misrepresented the adequacy of the underlying design.” The damages sought under both counts of the complaint are also essentially identical. For the foregoing reasons, the appellate court held that the complaint should have been dismissed by the trial court. Rochester Fund Municipals et al. v. Amsterdam Municipal Leasing Corporation, 296 A.D.2d. 785, 746 N.Y.S.2d 512 (2002).
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Risk Management Note by Kent Holland: Why is it that project owners, and even contractors, seem increasingly to be throwing the kitchen sink into their complaints against design professionals? As result of complaints alleging fraud, breach of warranty and breach of performance guarantees, professional liability insurance carriers are either delayed or disabled from quickly resolving the complaints. Instead, they get bogged down for years in arbitration or litigation, and perhaps even worse, the very allegations defeat the ability of anyone to recover under the policy.

Let’s think about this rationally. Professional liability policies cover NEGLIGENT acts, errors and omissions. They do not cover intentional misrepresentations and fraud. They do not cover breach of contract that arises out of anything other than negligence. And they do not cover breaches of warranty or guarantees. Consequently, when plaintiffs sue design firms based on any allegations other than negligence, they are throwing a monkey wrench into the works. They are waiving giant red flags to insurance carriers. They are begging for trouble. (Note: Despite the general premise stated above, there may be some instances when complaints alleging design firm fraud, bad faith, or contract interference are necessary and appropriate, as when the design firm, without knowledge of the contractor, has signed a contract with the project owner making it responsible for all construction change order costs exceeding the project budget, and the design professional proceeds, as the owner’s agent, to deny all change orders and proper claims for equitable adjustment. That can be the subject for a future article)

What about the contract language that creates uninsurable risks? More and more project owners are inserting into their contracts with design firms obligations for the design firm to warrant or guarantee its services, to guarantee cost estimates, to indemnify the owner against all claims and frivolous complaints by anyone, regardless of whether there was any negligence on the part of the design professional. Such language creates uninsurable risk and has the potential to cause much confusion when it comes to analyzing whether there is any insurance coverage available. If a plaintiff asserts that the design firm has liability based upon a contractual obligation that is not related to negligence, the insurance carrier will decline coverage and will likely even decline to defend the case where there is no potential recovery available under the terms of the policy. So, why do owners do this? I believe it is largely because they are being misguided and misadvised by well meaning, but sometimes ill-informed attorneys.

During one contract negotiation where I was advising a design professional, the attorney for the project owner insisted that we agree to a clause requiring the design firm to perform its services consistent with “the highest standard of care exercised by a nationally recognized consulting firm.” I explained that this elevated standard of care was uninsurable. It would be contrary to the well-being of the design firm, and it would also be bad for the project by causing an uncooperative and litigious attitude for all involved. Finally, it would potentially delay or even prevent the project owner from recovering damages under the professional liability policy which contained exclusions for contractual liability and warranties. When the attorney wouldn’t be persuaded by my reasoning, I pulled out my trump card. I suggested that in the event that the insurance carrier relied upon one of its exclusions under the policy that I had specifically warned him about (e.g., exclusions for contractual liability and express warranty) to deny coverage for a claim brought against the design firm by the project owner, it would be interesting to see if the owner could recover under the attorney’s malpractice policy for negotiating a contract that created unnecessary insurance problems.

Insurance companies like DPIC, CNA/Schinnerer, Zurich, and ARCH have been consistently, and for many years, providing contract reviews, giving lectures, teaching workshops, and writing articles and papers, explaining that the insurance covers negligence only and that the contracts need to avoid creating uninsurable contractual liability and warranties. With all this information out there, does there not become a standard of care applicable to those representing project owners on construction projects to know how professional liability insurance works and to advise their clients accordingly so as to facilitate the recovery of insurance proceeds under the policy.

And yet, we continue to read about, and deal with, plaintiffs that waste time and resources by filing complex complaints filled with uninsurable claims, when they could make their lives so much easier by keeping their contracts and their litigation focused on the one thing that matters most, and that is whether the design professional committed a NEGLIGENT act, error or omission. We even have associations of owners  that are creating their own standard form contracts that would create uninsurable risks for design firms along the lines described above.

Having reached a point of genuine frustration with the direction we seem to be heading with contracts and litigation, I am perhaps taking a stronger stand than might be politically correct. But I think it is time to take a stand.

Your comments and criticisms of this article are welcome. I think I may create on my ConstructionRisk.com website, a new section titled: “Contracts Hall of Shame.” It will highlight contract terms and conditions that I find to be particularly unacceptable and inappropriate. If you have an example or two that you would like to have included, please e-mail them to me. If you want to express your opinion or comment (pro or con) about this article, please e-mail your comment to me at kent@ConstructionRisk.com. I reserve the right to publish all such comments either on my website or in a future issue of this newsletter. By submitting a comment you are authorizing my use and republication of the comment. Go ahead, stand up and be counted!

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ABOUT THIS NEWSLETTER & A DISCLAIMER

This newsletter Report is published and edited by J. Kent Holland, Jr., J.D., a construction lawyer and risk management consultant for environmental and design professional liability.  The Report is independent of any insurance company, law firm, or other entity, and is distributed with the understanding that ConstructionRisk.com, LLC, and the editor and writers, are not hereby engaged in rendering legal services or the practice of law.  Further, the content and comments in this newsletter are provided for educational purposes and for general distribution only, and cannot apply to any single set of specific circumstances. If you have a legal issue to which you believe this newsletter relates, we urge you to consult your own legal counsel. ConstructionRisk.com, LLC, and its writers and editors, expressly disclaim any responsibility for damages arising from the use, application, or reliance upon the information contained herein.

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