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Inside This Issue:

Limitation of Liability Enforced in Arizona is Matter for Summary Judgment;

Economic Loss Doctrine Enforced in Nevada to Prevent Property Owner Recovery against Design Professional for Alleged Negligence ;

Economic Loss Doctrine Enforced in Indiana to Prevent Property Owner Recovery against Design Professional for Alleged Negligence and Negligent Misrepresentation;

•  Economic Loss Doctrine was no bar to Negligence Action against Design Professional in New York.

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Article 1
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Limitation of Liability Enforced in Arizona is Matter for Summary Judgment

The Supreme Court of Arizona held that a limitation of liability clause in a design professional contract is enforceable on a summary judgment motion, without need to have a jury review it, where the clause put a cap on liability in the amount of the fee but did not attempt to relieve the firm of all liability. Since the clause didn’t eliminate all liability, it was not an “assumption of the risk” clause subject to a state statute that would otherwise made enforceability of assumption of the risk clauses a matter for jury decision.  Such clauses, especially in commercial contracts, are not contrary to public policy and are, therefore, generally enforceable.  Unlike the clause in the Georgia case of Lanier v. Planners, this clause did not attempt to limit third party claims, but instead addressed only claims by the client against the design firm.  As such, the clause was not an indemnity clause and was therefore not subject to any anti-indemnity statute.

This decision is particularly important because the court distinguishes the Georgia decision that had caused so much concern for design professionals and their counsel, and it provides useful insight for drafting clauses to be enforceable.

In 1800 Ocotillo, LLC v. WLB Group, Inc., 196 P.3d 222 (Az, 2008), a surveyor entered into a contract with a developer to perform a survey to identify boundary lines and rights-of-way on land to be developer into a townhouse community.  The operator of a neighboring canal subsequently claimed an interest in a right-of-way that the surveyor failed to accurately show in its survey.  As a result of the discrepancy, the City of Phoenix denied the developer certain building permits.

The developer filed suit against Surveyor for alleged negligence in the preparation of the survey that caused Developer to incur increased costs from construction delays and additional engineering services and designs.  In response, Surveyor filed a motion for partial summary judgment arguing that its liability, if any, was capped in the amount of its fee pursuant to a limitation of liability (LoL)clause that read as follows:

“Client agrees that the liability of WLB, its agents and employees, in connection with services hereunder to the Client and to all persona having contractual relationships with them, resulting from any negligent acts, error and/or omissions of WLB, its agents and/or employees is limited to the total fees actually paid by the Client to WLB for services rendered by WLB hereunder.”

In an effort to avoid summary judgment, the developer argued to the trial court that the LoL clause was contrary to public policy.  The trial court rejected that argument and granted partial summary judgment limiting the potential liability to the amount of fees the surveyor had received.  This was appealed to the court of appeals which, although agreeing that the LoL clause didn’t violate public policy, nevertheless reversed the trial court summary judgment because it found the clause created a “defense of assumption of risk” and this was required by state statute to be submitted to the jury to decide whether to enforce.

The Supreme Court of Arizona reversed the court of appeals decision and issued a well reasoned decision that cites several other recent LoL decisions from other jurisdictions, and explains and reaffirms several important basic principles of contract law that have great significance for managing risks in contracts.

The court starts its analysis by noting that “Our law generally presumes, especially in commercial contexts, that private parties are best able to determine if particular contractual terms serve their interests.”

Next, the court notes that the LoL clause is not subject to the state’s anti-indemnity statute that provides:

“A covenant, clause or understanding in, collateral to or affecting a construction contract or architect-engineer professional service contract that purports to indemnity, to hold harmless or to defend the promissee from or against liability for loss or damage resulting from the sole negligence of the promissee or the promissee’s agents, employees or indemnitee is against the public policy of this state and is void.”

The concern of this anti-indemnity statute is it to avoid having a party shift ALL liability for its own negligence to another party.  The purpose of anti-indemnity statutes, explains the court, is primarily to prevent parties from eliminating their incentive to exercise due care.  “Because an indemnity provision eliminates all liability for damages, it also eliminates much of the incentive to exercise due care.”  In contrast, the LoL provision does not completely insulate the surveyor from liability but merely limits the amount of the liability.  As stated by the court:  “This provision in the [  ] contract does not completely insulate WLB from liability, as would an indemnity or hold harmless provision, nor does it require Ocotillo to defend WLB.  The provision merely limits liability.”

The court notes that “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….”   But the court did not find that to be the case here.

The plaintiff also argued that, pursuant to a state statute, shareholders of “professional corporations” are “personally and fully liable and accountable for any negligent or wrongful act or misconduct” that the shareholder commits while rendering services on behalf of the professional corporation.  Another statute cited by the plaintiff provides that each member or employee of the firm that performs the services on behalf of the firm “shall remain personally liable for any results of the negligent or wrongful acts, omissions or misconduct committed by him.”   The court rejected plaintiff’s argument that these statutes were intended to prevent professionals from limiting their liability where the engineering firm was not a “professional” corporation.  It was a traditional corporation and the statutes did not apply to it.

It is important to note that the court here reviewed and considered the decision in the recent Georgia limitation of liability case of Lanier v. Planners & Engineers,  663 S.E.2d 240 (2008) which had in turn referred to the lower appellate court decision in 1800 Ocotillo.   The key, according to the court, was that unlike the Georgia case, the LoL clause at issue here did not contain any reference to limiting liability for third-party claims brought by the general public.  Important for understanding how future cases might be reviewed in Georgia , the Arizona Supreme Court notes: “Lanier also distinguished , and apparently approved, the liability-limiting clause is Valhal, which is virtually identical to the provision at issue here.”

The court rejected the plaintiff’s argument that the LoL constituted an assumption of the risk clause that was governed by a state statute that limited the applicability of such assumption of the risk clauses.  The court stated that the statute must be correctly interpreted to apply only to clauses that relieve a defendant of “any” duty, and that where such a harsh result in possible because all such duty has been eliminated, a jury must be permitted to decide whether the clause is enforceable.

The key decision by the Supreme Court in this LoL case is that the LoL does not create such a harsh result as to constitute an assumption of the risk clause that must go to the jury for determination.  In fact, the court noted: “Moreover, the benefits of such agreements in allowing parties to prospectively allocate potential losses in excess of the cap would be largely lost if their enforceability turned in every case on after-the-fact jury determinations.”

Risk Management Notes: Several important lessons are learned from this decision including:

(1)  Keep the limitation of liability clause and any indemnity clause totally separate and apart;

(2)  Don’t attempt by the LoL clause to relieve the firm of all liability or to cap the liability so low as to make it unenforceable;

(3)  Make the LoL clause apply to actions against any principal, officer, agent and employee of the corporation as well as to the corporation itself.

In addition, it is probably also prudent to introduce the clause with a phrase such as “To the fullest extent permitted by law.”

Finally, it is important that the clause clearly state that the LoL applies to all causes of action including breach of contract, breach of warranty, and tort, including negligence.  

About the author: All articles in this issue of the ConstructionRisk.Com Report are written by J. Kent Holland, a construction lawyer located in Tysons Corner, Virginia,  with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners.  He is also founder and president of ConstructionRisk, LLC, a consulting firm providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk.com Report, Vol. 11 No. 4 (April 2009). 

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Article 2

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Economic Loss Doctrine Enforced in Nevada to Prevent Property Owner Recovery against Design Professional for Alleged Negligence

The Nevada Supreme Court answered “yes” to the question of whether the economic loss doctrine applies to preclude negligence-based claims against design professionals, such as engineers and architects, who provide services in the commercial property development or improvement process, when the plaintiffs seek to recover purely economic losses.  As the term “economic loss” was used by the court, it means “the loss of the benefit of the user’s bargain . . .  including  . . . pecuniary damage for inadequate value, the cost of repair and replacement of [a] defective product, or consequent loss of profits, without any claim of personal injury or damage to other property.”  In considering the purpose of the economic loss doctrine, the court stated that it is to shield defendants from unlimited liability for all economic consequences of a negligent act to keep the risk of liability reasonably calculable.  Further, the court found that the purpose of the doctrine is furthered by applying it to preclude the professional negligence claim at issue here that involved geotechnical services.

In the case of Terracon Consultants v. Mandalay Resort Group, 125 Nev. Adv. Op No. 8 (March 26, 2009), Mandalay Resort and Casino in Las Vegas entered into a contract with Terracon Consultants whereby the consultant was to provide geotechnical engineering advice about the subsurface soil conditions and recommend a foundation design for the property.  Based upon its soil analysis and the anticipated weight of the building, the consultant predicted a certain amount of settling and made recommendations accordingly.  Settling exceeding what was anticipated and the County believed this presented a potential danger to the resort’s structural integrity and therefore required Mandalay to repair and reinforce the foundation before proceeding with construction.

Mandalay sued Terracon for damages alleging that it sustained damages as a result of breach of contract, breach of covenant of good faith and fair dealing, and professional negligence.  Terracon moved for partial summary judgment on the professional negligence claim arguing that the claim was barred under the economic loss doctrine.  In opposition to the motion, Mandalay argued the doctrine did not apply to negligence claims against design professionals or contractors who solely provide services.

Previous decisions by the Nevada court have enforced the economic loss doctrine.  What the plaintiff sought here, however, was for the court to determine that an exception to the doctrine should apply to allow negligence-based actions against professionals that provide design-related services in the commercial property development or improvement process.  In deciding whether to make such an exception, the court analyzed the policy considerations for the doctrine.  As explained by the court, “the doctrine expresses the policy that the need for useful commercial activity and the desire to make injured plaintiff’s whole is best balance by allowing tort recovery only to those plaintiffs who have suffered personal injury or property damage.”

When economic loss occurs as a result of negligence in the context of commercial activity, the court states that “contract law can be invoked to enforce the quality expectations derived from the parties’ agreement.”  Another consideration behind the economic loss doctrine, explains the court, is “balancing the disproportion between liability and fault…. To that end, cutting off tort liability at the point where only economic loss is at stake without accompanying physical injury or property damage ‘provides . . . incentives and disincentives to engage in economic activity or to make it safer.’  On the other hand,  imposing unbound tort liability for pure financial harm could result in ‘incentives that are perverse,’ such as insurance premiums that are too expensive for the average economic actor to afford.  For these reasons, courts have been reluctant to impose tort liability for purely financial harm.”

In conclusion, the court held that the economic doctrine applied to preclude Mandalay ’s professional negligence claim.  “Contract law is better suited to resolve professional negligence claims” in the context of commercial activity engaged in by architects and engineers.  The courts notes that “as in this case, contracting parties often address the issue of economic losses in contract provisions.”   Significantly, the court concluded: “We perceive no significant policy distinction that would drive us to permit tort-based claims to recover economic losses against design professional, such as architects and engineers, who provided their professional services in the commercial property development and improvement process, when we have concluded that such claims are barred under the economic loss doctrine if brought against contractors and subcontractors involved in physically constructing improvements to real property.”

One final point made by the court was that even if the loss was allegedly foreseeable, “we do not read the rule as necessarily being dependent on foreseeability notions.”   For the foregoing reasons, since Mandalay suffered only economic loss without any attendant personal injury or property damage, the court held the economic loss doctrine barred Mandalay from proceeding with its negligence-based claim.

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Article 3

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Economic Loss Doctrine Enforced in Indiana to Prevent Property Owner Recovery against Design Professional for Alleged Negligence and Negligent Misrepresentation

Indianapolis Public Library’s negligence complaint against two engineering firms that were subconsultants to the prime architect was held to be barred by the economic loss doctrine because the alleged damages were purely economic and there had been no personal injury or damage to property outside of the project.  Major voids were found in concrete beams and columns in a parking garage under construction.  The Library sued the architect with whom it had a contract, and settled it that suit.  The Library then filed a separate against the structural engineer, Thornton Tomasetti Engineers (TTE), and also a small civil engineering firm, CCL, alleging negligence had caused damages and expenses between $40 million and $50 million.  CCL had been retained to perform 12 site visits to determine whether the project was in general conformance with construction standards.  CCL’s fee for services was only $12,000.  Neither TTE nor CCL were under contract to the Library.  They performed their services under subcontract to the prime architect.

According to the court, the damages claimed by the Library arose from repairs that were undertaken in the parking garage.  The court concluded: “[T]he various costs involving the project delay settlements, additional construction management services, extra architectural and engineering services, and legal fees, are all consequential losses that arose from the issues related to the design and construction of the project.  Therefore, it is apparent that the damages claimed by the Library are ‘economic losses’ and are not recoverable in tort.”

In The Indianapolis-Marion County Public Library v. Charlier Clark & Linard, P.C., and Thornton Tomasetti Engineers, 2009 Ind. App. Lexis 183 (Feb 6, 2009), the plaintiff sought to avoid the economic loss doctrine by arguing that it should not be applied in cases where a plaintiff has a direct claim against a design professional outside the realm of a contract, and where the alleged acts and omissions cause an imminent risk of danger to the safety of others.  Further, the Library argued that the doctrine should not apply where there are allegations of misrepresentation, and it should not apply where the defendant provides only services and not a tangible product.   The court addressed each of these arguments, beginning with a basic explanation of the purpose served by the economic loss doctrine.

As explained by the court, “the economic loss doctrine has three general purposes:  (1)  to maintain the fundamental distinction between tort law and contract law; (2) to protect commercial parties’ freedom to allocate economic risk by contract; and (3) to encourage the party best situated to assess the risk [of] economic loss, the commercial purchaser, to assume, allocate, or insure against that risk.”

In Indiana , an “economic loss” includes, according to the court, consequential losses, such as lost profits, rental expense, diminution in value, and lost time.  Damage to the product itself, including costs of its repair or reconstruction, is an economic loss even though it may have a component of physical destruction.

The Library argued that the economic loss doctrine applies, at most, to construction activities and not professional services.  It asserted that negligence claims should not be barred because a structural engineer owes professional duties akin to those owed by attorneys, accountants, and physicians.   In support of this argument, the Library cited a Florida case of Moransais v. Heathman, 744 So.2d 973 ( Fla. 1999) that held that negligence actions against “professionals” are not barred under the economic loss doctrine.  That case concluded: “We also hold Florida recognizes a common law cause of action against professionals based on their acts of negligence despite the lack of a direct contract between the professional and the aggrieved party.”

The Indiana court rejected the reasoning of the Florida case and concluded “the claim brought by the Library against the appellees with whom it was not in privity is precisely the type of action that Indiana law does not support.”  Further the court cited other Indiana case precedent for the proposition that third parties that are not in privity with a professional cannot recover in negligence unless certain recognized exceptions or conditions exist.

One such exception to the economic loss doctrine is when an architect creates a condition that is imminently dangerous to third persons, and injury has resulted.  That exception does not apply to the situation at bar, however, since there was no physical injury or damage to property.  According to the court, “there was no accident, injury, or collapse of any structure on the property.”  The only possible physical damage would have been the destructive testing on the structures and rip out of existing work.  These were not “natural occurrences of sudden harm caused by defective design.”

In response to the Library’s question of whether it had to wait until catastrophic failure of the garage before suing the design professionals for negligence, the court responded that the answer is “yes,” and that, “In our view, without recognizable personal injury or property damage, the fact that the Library made repairs to insure the structural integrity of the building is not relevant to the Library’s negligence claims.”  This, however, did not compel the Library to wait for a catastrophic event before doing repairs and suing those with whom it had a contract.  And that is precisely what the Library did when it repaired the garage and sued the architect and others with whom it was in privity.

As far as the Library’s argument that claims against the design professionals should proceed under a negligent misrepresentation exception to the economic loss doctrine, the court stated that no statutory or common law authority in Indiana recognizes negligent misrepresentation allegations as an exception to the economic loss doctrine’s applicability to traditional negligence claims.  In any event, the Library did not sue the design professionals with a separate count based on negligent misrepresentation – they sued solely for negligent performance of professional services.    For these reasons, the court affirmed the trial court’s grant of summary judgment in favor of the design professionals.

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Article 4

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Economic Loss Doctrine was no bar to Negligence Action against Design Professional in New York

In a New York case involving a collapsed retaining wall, a co-op complex filed a complaint against a design firm that had been monitoring and maintaining the wall, and that firm in turn brought a third party action against another engineering firm (“MRCE”) that had several years earlier designed and implemented certain corrective measures for the stability of wall under a contract with N.Y. State Department of Law and issued a report to the Department concerning the wall’s condition which report was included in the public offering plan for the co-op.   During the course of its monitoring of the wall, the second engineer recommended immediate remedial action because it found the wall was moving rapidly and had visible cracks and.  Unfortunately, the wall collapsed before the recommended remedial action could be taken.  In its third party action, the engineer sought contribution from MRCE – and alleged in the complaint a list of specific bases for the complaint.

The appellate court affirmed the trial court decision that the third party complaint met the state statutory requirements of alleging a “substantial basis in law to believe that the performance, conduct or omission complained of . . . was negligent….”  An expert affidavit was filed in support of the third party complaint.   The court also affirmed the trial court decision that MRCE owed a duty of care to the co-op since there was a relationship between them “approaching privity” even though there was no actual contract between MRCE and the co-op.  Finally, the court affirmed that the engineer’s third party claim was not barred by the economic loss doctrine, “since, as a design professional, MRCE ‘may be subject to tort liability for failure to exercise reasonable care, irrespective of [its] contractual duties.”  Castle Village Owners Corp. v. Greater New York Mutual Insurance Company, 868 N.Y.S.2d 189 (Dec. 2008).

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ABOUT THIS NEWSLETTER & A DISCLAIMER

This newsletter Report is published and edited by J. Kent Holland, Jr., J.D. 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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