The contractual liability exclusion in a professional liability policy is often used by carriers to deny coverage for liability of the Insured design professional (DP) that arises out of the indemnification article of a contract. For example, if the DP agrees to indemnify for damages arising out of all performance instead of limiting the indemnity to damages to the extent caused by its negligence, the contractual liability exclusion applies and there would be no coverage for that. But what about a complaint by a client that alleges the DP breached its contract due to negligent performance of its professional services. Is a claim for such breach of contract action also denied coverage? A federal district court in Oregon decided that the answer is “no” when allegations of negligence are involved. Pinnacle Architecture, Inc. v. Certain Underwriters at Lloyd’s, 2021 WL 2418561 (U.S. D.C., Oregon 2021)
An architect signed a contract to provide professional services to design a psychiatric hospital. The client had executed a guaranteed maximum price (GMP) contract with a contractor to perform the construction. The GMP pricing was increased by change order due to changes in the construction that had to be made due to redesigns to meet requirements of the Oregon Administrative Rules (OARs). The revised design also failed to comply with the OAR requirements. The architect then advised its client that “it would be able to obtain waivers from the OAR to address” the issues. The Oregon Health Authority ultimately rejected some of the proposed waivers and this resulted in the Owner having to incur additional construction costs of over $1 million to complete the project in accordance with the OAR requirements.
Lifeway filed claims in Arbitration against the Architect for breach of contract (count I) and negligence (Count II). The breach of contract count alleged that the architect breached the contract “and fell below the standard of care required by the Contract by, among other things, failing to design the Project to meet the design requirements of the State of Oregon, including the OAR requirements for a licensed hospital.”
The negligence count of the complaint alleged that the architect “owed a duty to Lifeways to perform the design services for the Project in accordance with the ordinary standard of care for a licensed architect.”
Architect provided notice to its insurance carrier of the claim and instead of agreeing to defend the claim, the carrier stated there was no coverage under the Policy for the allegations because the breach of contract exclusion. The exclusion in question provided the following:
“We will have no obligation to pay any sums under this Coverage Part, including any damages or claim expenses, for any claim: … based upon or arising out of any actual or alleged breach of any contract or agreement, or any liability of others that you assume under any contract or agreement; however, this exclusion will not apply to any liability you would have in the absence of the contract or agreement.”
“[Insurance carrier] argues that the Exclusion applies because (1) all claims against Plaintiffs are based upon or arising out of the alleged breach of Plaintiffs’ contract with Lifeways, and (2) that all damages sought by Lifeways are based on the alleged breach of contract. Defendant also argues that the exception to the Exclusion does not apply because there are no allegations against Plaintiffs in the underlying action for potential liability absent the contract.” The court notes that “[Carrier] argues the negligence claim arises out of the Lifeways-Pinnacle Contract because the second supplement to the contract expressly requires Plaintiff’s to meet OAR design requirements.”
In response to the argument described above, the court found, “Defendant is correct that the [ ] Contract includes a specific obligation to meet OAR design requirements But Defendant misses that [Architect] would have owed Lifeways this, and other duties, even if the parties had not included this obligation in their contract.” “In Oregon, architects owe a professional duty of care to their client that exists independent of contractual obligations.” The court concluded:
“Here, the allegations in the Complaint and Amended Arbitration Agreement, without amendment, could impose liability under a tort or contract theory. As architects, Plaintiffs owed Lifeways a professional duty of care independent of the contract. Although the parties’ relationship arises out of the contact, Plaintiffs’ duty of care and potential liability does not arise out of the contract but is imposed by law and exists because of the nature of the parties’ relationship. Lifeways can clearly establish a breach of contract claim, but the allegations in the complaint also support a negligence claim, that could be broader than the alleged breach of contract.”
The final conclusion of the court was that the complaint “allegations state a claim for negligence which the Policy covers. The exclusion does not apply ….”
Risk Management Comment:
Most insurance policies have what is known as the contractual liability exclusion. It is generally understood that this exclusion addresses liability arising out of indemnification obligations where an Insured agrees to indemnity its client and others for liability the Insured would not have had under common law in the absence of the indemnity agreement. The “breach of contract” exclusion quoted by the court in the instant decision, however, appears to be broader than this. As interpreted by the Insurance carrier, the exclusion was broad enough to bar coverage for any breach of contract claim against an insured even if due to the Insured’s negligence. Defense counsel who have defended design professionals in breach of contract actions where insurance carriers have paid their attorneys fees are probably a bit surprised by this.
Many states have what is known as the economic loss doctrine that prevents design professionals from being sued for “negligence” when the negligent services were performed under a contract with the party bringing the suit. Instead, the injured party is required to file a breach of contract action against the design professional alleging that through its negligent acts, errors and omissions, the design firm breached the contract. When a plaintiff files a complaint containing both a negligence count and a breach of contract count, defense attorneys may file a motion to dismiss the negligence count, and assuming the motion is granted, the case then goes forward to trial only on breach of contract count.
There are numerous advantages to requiring suits to be based on breach of contract instead of negligence. The design firm may by good contract language have negotiated favorable terms and conditions that it wants to apply in defending itself in the suit. Since those are part of the contract, they may control the outcome of litigation on the breach of contract Count. But if a separate count can go forward on negligence, it may be possible that it stands apart from the contract language, and the design firm might, therefore, have greater liability than it would under the breach of contract Count of the complaint.
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 ConstructionRisk 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 Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932. This article is published in ConstructionRisk Report, Vol. 23, No. 7 (November 2021).
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