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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!

About the author: Article written by J. Kent Holland, Jr.,  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 founder and president of a consulting firm, ConstructionRisk, LLC, 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. 5, No. 2 (Mar 2003).

Copyright 2003, ConstructionRIsk.com, LLC