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Contract Guide and Course for Design Professionals – module 5 of 9. An AIA Continuing Education Course by J. Kent Holland, J.D. Discussion of the following contract clauses: Inspection, Site Observation, Limitation of Liability, and Waiver of Consequential Damages. Slides: Contracts for Design Professionals by C-Risk – Module 5

Video Transcript

Hello. This is Kent Holland, with Construction Risk LLC. Today we’re going to do another module in, “The Contract Guide for Design Professionals.” It’s my pleasure to be with you today. Thank you for tuning in.

Inspection Clause

Alright, let’s get started today. This is an AIA registered course. The first clause that we’ll talk about today is another clause that deserves special attention in the contract is the term inspection. If you see the term inspection versus site observation or monitoring the site, these are things that you need to take a look at. The use of the word inspection could cause the owner or a court to conclude that the design firm is required to actively inspect the contractors work for full compliance with all the details of the plans and specs

An example of a problematic clause would be something like the following: Design professional shall make visits to the site to inspect the progress and quality of the executed work of the contractor and sub-contractors, and to determine if such work is proceeding in accordance with the contract documents. The design professional shall keep the owner informed of the progress and quality of the work and shall exercise the utmost care and diligence in discovering and promptly reporting to the owner any defects or deficiencies.

That clause had a number of problems. Let’s just walk through some of the issues that we see. First, we should be limiting the design professional’s role to site observation or to site monitoring reporting what was actually observed and what the design firm has actual knowledge of. The AIA has good language and the B101-2007 document at article 3.6.2.1. It’s a little bit long but I’m going to read through this with you. I’m going to put it up on a slide right now because it’s so important. I really appreciate this language. It is language that we should try to use because what it does is it effectively makes a very objective standard of whether or not the design firm completed its responsibility for site observation within the standard of care. There’s no guarantee made that you’re going to observe everything and find all the problems with the contractor’s work because indeed, you can’t.

On a typical project, the design firm is only out there for an occasional site visit. Maybe once a week, maybe a couple of times a week, maybe not even that often. Obviously not there enough to see every issue of the construction and to know whether the contractor met every detail of the plans and specifications or whether something inadvertently got covered or buried before the design firm saw. What the AIA has done is effectively said, “The duty is not to go out and inspect and find all of the problems. The duty is to, if it becomes known to the design firm that there’s a problem, then it gets reported to the owner.” So it becomes an actual knowledge standard.

Let’s look at the language. “The architect shall visit the site at intervals appropriate to the stage of construction or as otherwise required in section 4.3.3 to become generally familiar with the progress and quality of the portion of the work completed. And to determine, in general, if the work observed is being performed in a manner indicating that the work when completed will be in accordance with the contract documents. However, the architect shall not be required to make exhaustive or continuous on-site inspections to check the quality or quantity of the work. On the basis of the site visits, the architect shall keep the owner reasonably informed about the progress and quality of the portion of the work completed and will report to the owner (1) known deviations from the contract documents and from the most recent construction schedule submitted by the contractor and (2) defects and deficiencies observed in the work.”

Now with regard to inspection, sometimes it really is inspection services that are being performed by the design professional and that’s a different story. If the term inspection is used it should be well defined in the contract. Define it narrow.

Limitation of Liability

Let’s turn now to the clause of limitation of liability. Limitation of liability is a terrific tool to help manage the risks undertaken by a design professional particularly on a project where the fee is quite small in comparison to the risk being undertaken. For an example, a design firm that does a property condition report for typically $2,500 turns around and gets sued by a project owner for $3 million. Or the firm that does an environmental site assessment, again for $2,500. It’s not uncommon that you have multi-million dollar suits against those design firms. You can’t justify putting your neck out for that kind of risk and liability when you’re being paid such a small fee. Courts understand that.

There’s a wealth of case law around the nation supporting limitation of liability clauses. The key is to making them enforceable. They should be not hidden in the contract. They should be obvious. Same size font as other language in the contracts. Some people like to make it bigger so it really stands out. The amount of liability should not be so small that a court thinks it’s nominal and not sufficiently punitive. Typically, I might say the liability is going to be limited to the fee or $50,000 whichever is greater. Or it might be some percentage of a fee. In the worst case scenario you might say, “We’ll limit our liability to the amount of insurance coverage required by the contract.”

We’ll talk about each of these issues. First, I’m going to put up a sample from the EJCDC contract, where the EJCDC has no LOL clause. I’m not going to read this whole thing, it’s very long. But I just want to put it up on the screen for you to take a quick look at this. Now I’m going to put up a good example of an Limitation of Liability clause. This is one that I’ve devised over time, and have had success getting it into contracts. I think it covers a lot of important issues. Let’s just read through this together.

“Limitation of liability. To the fullest extent permitted by law, the total liability in the aggregate of the design professional, the design professional’s officers, directors, partners, employees, agents, and sub-consultants to the client, and anyone claiming by, through, or under the client for any claims, losses, costs, or damages whatsoever arising out of, resulting from, or in any way related to this project or agreement from any cause or causes including but not limited to negligence, professional errors and omissions, strict liability, breach of contract or breach of warranty shall not exceed the total compensation received by the design professional or $50,000 whichever is greater. The client may negotiate a higher limitation of liability for a reasonable additional fee which is necessary to compensate for the greater risk assumed by the design professional.”

That Limitation of Liability clause covers a lot of territory. First, you notice that it has a language to the fullest extent permitted by law. The reason we use that language is that if a court were to deem that this language of this LOL clause was somehow unenforceable, perhaps the court thinks it violated the anti-indemnity statute of a state. That happened in Georgia a few years ago. This type of a clause will allow the court to say, we will revise the clause downward to make it enforceable to the extent that the law would allow. We’ll honor the intent of the parties but we won’t throw out the entire contract clause. We’ll refine it, if you will, to pull it down to what the state law would allow. It’s important to use that language to the fullest extent permitted by law.

The liability is both on this project and in the aggregate. In other words, they can’t come at you on one claim and then hit you on four more related claims and say, “Well, I get $50,000 on each one of these related claims.” No, your aggregate amount of liability was $50,000 for that client. That’s an important provision. Notice that it says that it applies to all these different causes of action whether it’s negligence, professional errors and omissions, strict liability, breach of contract or breach of warranty. I probably should put in there any kind of a tort action, because torts could be beyond negligence. It might be negligent misinterpretation, fraud, and things of that nature.

This Limitation of Liability needs to be as expansive as possible because the court will only apply the clause to the very specific causes of action that you identified in the clauses. So there are cases where the clause said that the limitation of liability will be limited for breach of contract. The court has applied it to breach of contract but then said, “you didn’t apply it to negligence in the contract, therefore the negligence count can still go beyond the $50,000.” Or, ironically, it’s been written in the contract to say it applies to only the negligence actions and it doesn’t mention the breach of contract. So the court said, well it applied to negligence but not the breach of contract. So be careful to really specify every clause of action.

The other thing that I like is to say that it’s going to be a fee or some other amount whichever is greater. I’ve had occasion where my fee, literally, was $2,500 for my client. When we went in to enforce the LOL provision by way of a summary judgment motion, the court was very impressed with the fact that we didn’t limit the liability to the $2,500 fee but that we gave $25,000, which was the greater of the fee. And the court said to the plaintiff’s attorney, essentially, “Sir, you’re telling me that you want me to revise this contract when it’s said right here, just as this one does at the end, that you could have negotiated for a higher amount? You’re trying to make this design firm be your insurance company without paying them for it.” They agreed to a $25,000 limitation of liability, which is 10 times greater than their fee. The court was very impressed and granted us partial summary judgment on that basis.

There’s a problem in the consensus docs 240 again and I want to draw your attention to this. There is a prohibition upon certain LOL clauses in design professional contracts. And section 3.5 of that contract states that the architect engineer is prohibited from entering into an agreement with a design professional that includes any limitation of liability, at least without the prior written approval of the owner. You shouldn’t be having to go to a project owner to say, “May I negotiate this into my sub-contract arrangement with a design professional?”

What you do between engineers and architects and those sub-contract relations should be your business. I see no excuse for this clause requiring to go and get owner’s approval. The consensus docs 240 also provides that the owner shall be considered the intended beneficiary of the performance of the design professional’s services. That could support a direct claim by the owner against the design professional. I would strike that out, where it’s saying that they’re going to be a direct beneficiary of the performance of the services. It gives them rights to go against the sub-consultant, possibly, that they otherwise would not have.

Waiver of Consequential Damages

The limitation of liability clause has sort of a sub part. That would be waiver of consequential damages. This should not be merged with the LOL clause. It should be kept separate and apart. It is a total stand alone clause. SO you can have an LOL without waiving consequential damages, or you could have a waiver of consequential damages without having a limitation of liability clause. The waiver of consequential damages clause is used in AIA contracts, like the A-201 for construction, as well as the B-101 and others for design professionals. The EJCDC has a clause at 6.10.8 that provides for mutual waiver and it reads as follows:

“To the fullest extent permitted by law, the owner and engineer waive against each other and the other’s employees, officers, directors, members, agents, insurers, partners, and design professionals, any known claims for, or entitlement to special, incidental, indirect, or inconsequential damages arising out of, or resulting from, or in any way related to the project.”

Those clauses are a good way to mutually waive these consequential damages. Those types of waivers are upheld and I reported on a recent court decision out of Maryland, out of the federal court there applying the waiver of consequential damages clause of a contract in a design professional contract between the design firm and a contractor and the court said that because the contractor had agreed to that waiver it was not entitled to recover any of the economic type damages caused by the design firm’s errors, if you will. I won’t go into that more today, but again, if you were to go to my website and just put in the topic, consequential damages or waiver of consequential damages, that court decision will pop up and my whole analysis of that decision.

Another thing we can do with a waiver of consequential damages clause is try to add a few terms into that clause to make it clear what consequential damages include because the term itself is not a well defined, clearly defined term universally. If you were to ask someone what it means to be consequential damages, you’re probably going to get, if you ask two attorneys, you’re going to get almost half a dozen different answers. I’ve gone and tried to research it in different states to find out how I can argue that what the consequential damages are. I wish there were a nice, neat definition, but it’s not always so.

The clause that I’m going to put up now makes an effort to define some of those elements of consequential damages. I’m not going to read the whole clause, but I’m going to put up the clause and just show you one of the paragraphs that’s important. You’ll see the clause starts off “Notwithstanding anything in disagreement to the contrary” Then we drop down to the middle of the clause and it says, “Special or consequential damages, as used herein shall include but not be limited to, loss of capital, loss of product, loss of use on any system or other property or any other indirect special or consequential damage, whether rising in contract, tort including negligence, warranty, or strict liability.”

That clause, I think, gets us closer to being able to explain to a court that these indirect and consequential damages include these types of loss of capital, loss of product, et cetera. You could also, if dealing with a shopping center, you might say lost rents, lost profits. If you’re dealing with stadiums you might say, failure to open on time. So these are all consequential damages that can be defined.

Thank you for joining me today. I hope you enjoyed this session that we did on risk management. If you would like to contact me, I am putting a slide up here at the end that has my name, phone number, email address, and website information. Don’t hesitate to call me or contact me, particularly if you would like continuing education credits. We’ll explain how that can be accomplished. Thanks. Look forward to seeing you again.