Inside this Issue

A1 - Economic Loss Doctrine Does Not Bar Contractor’s Negligence Claim against Architect Since There was no Contract (New Jersey law)
A2 - Limitation of Liability Clause Enforced - $70K Limit on $4.2 Million Claim
A3 - Limitation of Liability Clause Enforced – Even in Face of Allegations of Gross Negligence

Article 1

Economic Loss Doctrine Does Not Bar Contractor’s Negligence Claim against Architect Since There was no Contract (New Jersey law)

See similar articles: Code Compliance | Economic Loss | Privity of Contract

A construction contractor under contract to a city housing authority was not barred by the economic loss doctrine from pursuing a negligence claim against the architect that designed the project under separate contract with the owner. This is because under New Jersey law, the court concluded that the doctrine only applies if there is a contract between parties, and it is intended to prevent a party to a contract from using tort law to change the bargain they agreed to by contract. In SRC Construction v. Atlantic City Housing Authority, 2013 WL 1309450 (D. N.J. 2013), the United States District Court denied the architect’s motion for summary judgment because it found the economic loss doctrine would have only been applicable if the contractor had a contract with the architect.

Among the negligence claims by the contractor against the architect were the following: (1) failing to provide building permits; (2) submitting drawings to the Building Department that were deemed non-code compliant; (3) failing to respond in a timely manner to RFI’s; and (4) providing defective verbal approval of change orders that were later rejected by the owner. The contractor alleges that these matters caused delays that caused it to “incur additional costs.”

Economic Loss Doctrine

In reviewing whether New Jersey courts would apply the economic loss doctrine in this matter, the court noted that case precedent in the New Jersey courts that has applied the economic loss doctrine did so when the plaintiff and defendant were in a contractual relationship. Previous court decisions, “emphasized that the economic loss doctrine operates to bar tort claims where a plaintiff ‘simply [seeks] to enhance the benefit of the bargain she contracted for.’”

The court rejected the architect’s argument that even if privity of contract is generally required in order to enforce the economic loss doctrine in New Jersey, it should nevertheless be applied in this case because the contractor had a contract with the project owner and was essentially attempting to use a tort claim against the architect to improve the benefit of its contract bargain with the owner. A number of New Jersey court decisions have, in fact, held that the economic loss doctrine barred a plaintiff’s negligence claim even in the absence of a direct contractual relationship between the parties. The key to those decisions, however, was that the plaintiffs could have invoked contractual remedies in their contract with another defendant in the case. But the court cited other decisions that do not seem to hinge on whether there was a contract involved, but rather consider whether the tort (negligence) claim is really a contract claim in disguise. As put by the court, “the reason for foreclosing a tort claim is not simply because a contract claim exists, but rather, that the tort claim is not really a tort claim at all, it is a contract claim in tort claim clothing.” But here, where there was no contract there could be no contract claim, “and therefore any tort claim asserted cannot possibly be a contract claim in tort clothing.” For these reasons, the court concluded that the economic loss doctrine would not extend to bar the contractor’s negligence claim.

Comment: The reasoning of the courts applying New Jersey law in a manner to apply the economic loss doctrine to only those situations where there is also a contract claim is unfortunate. Other state jurisdictions apply the doctrine regardless of whether there is a contract involved. Of course, there are also states that will not apply the economic loss doctrine at all. This is one area where it is important to know the nuances of the applicable state law.

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. 15, No. 9 (Sept 2013).

Article 2

Limitation of Liability Clause Enforced - $70K Limit on $4.2 Million Claim

See similar articles: Economic Loss | Equal Bargaining | Exculpatory | Limitation of Liability

An architect’s contract containing a limitation of liability clause (LoL) was enforced to grant a partial summary judgment limiting the architect’s liability to $70,000 in the face of a $4.2 million claim for damages due to structural problems that required a nearly completed hotel to have to be demolished. The U.S. Court of Appeals for the Seventh Circuit, in the case of Sams Hotel Group, LLC v. Environs, Inc., 716 F.3d 432 (7th Cir. 2013), held the limitation of liability clause in question applied to claims arising out of the indemnitor’s own negligence, and that it was not relevant that the clause had not specifically referenced the indemnitor’s “own” negligence, in contrast to negligence in general. In this case, the court explained the distinction between an exculpatory clause that removes all liability from a party, in contrast to an LoL clause that allows damage – even if only nominal in comparison to the total damages claimed. Applying Indiana law, the court stated that parties have freedom of contract and that “includes the freedom to make a bad bargain.” To allow the plaintiff to get out from under the bargained for LoL clause here, said the court, “would permit an end-run around Indiana’s economic loss rule and [plaintiff’s] own contract with [the design professional].”

The Limitation of Liability Clause

The design professional here was to be paid a flat fee of $70,000 for its services. The limitation of liability clause of the contract provided:

“The Owner agrees that to the fullest extent permitted by law, Environs Architects/Planners, Inc. total liability to the Owner shall not exceed the amount of the total lump sum fee due to the negligence, errors, omissions, strict liability, breach of contract or breach of warranty.”

When the hotel was merely complete, structural problems were discovered which resulted in condemnation of the building by the county building department and ultimately the demolition of the building. At the trial based on allegations that the designer was negligent and breached its contractual obligations, the court found the designer was liable for breach in several ways – none of which were detailed in the appellate court decision. The trial court granted partial summary judgment limiting the amount of damages that could be recovered by the plaintiff to the $70,000 amount specified in the limitation of liability clause.

The developer argued that the limitation of liability clause could not be enforced despite the fact that it had knowingly and willingly agreed to its terms with the architect. It argued that “the provision did not refer specifically to a limit on damages for Environ’s own negligence,” but instead must be understood to cover only Environ’s liability for negligence of third parties.

Court Decision

The question to be decided on appeal was whether an LoL clause in a professional services contract that generally refers to liability for “negligence” and breach of contract was enforceable in favor of the breaching party even though the clause did not specifically refer to that party’s own negligence. Because the Federal Circuit predicted that the Indiana Supreme Court would say yes, it affirmed the U.S. District Court’s summary judgment in favor of the architect.

As a first point, the court stated that the contract was not a consumer contract or a contract of adhesion, but rather was between two sophisticated business entities of equal bargaining power who were aware of the risks involved in designing and building a hotel. No one disputed that the parties signed the contract with knowledge and understanding of its terms. The developer didn’t argue that the limitation of liability clause contravened law or public policy or was ambiguous. Its only argument was that it should be excused from the terms of its bargain because the language didn’t refer explicitly to the architect’s own negligence.

This argument by the developer relied primarily on cases that would completely indemnify or exculpate a defendant for its own negligence. For those types of clauses to be enforceable, the court explained that under Indiana law they must clearly and unequivocally” manifest a commitment by the one party to pay for damages caused by the other party’s own negligence. But an indemnification clause is not the same as a limitation of liability clause, and the court stated that because they serve different purposes they must not be analyzed alike.

As explained by the court,

“Limitation of liability clauses … do not operate as insurance the way that indemnification clauses do. They also do not entirely prevent one party to the contract from bringing a claim against the other, as exculpatory clauses do. Limitation of liability clauses serve to establish a contractual ceiling on the amount of damages to be awarded if a plaintiff prevails in later litigation between the contracting parties. We agree with SAMS that when a clause limits a party’s liability to only nominal damages, a limitation of liability clause can be as harsh as a full exculpatory clause would be. This would be particularly true if the plaintiff were an unsophisticated individual or if the plaintiff had been bound to the provision through a contract of adhesion. But SAMS and Environs were sophisticated commercial entitles that know the risks and freely bargained for the terms of the contract, including the limitation of liability clause. SAMS did not unwillingly agree to the limitation of liability clause or assume these risks. To the extent it suffered a harsh result, it cannot blame the general nature of limitation of liability clauses.”

Once the negligence claim had been dismissed by the trial court based on the applicability of the economic loss rule, the developer’s only claim was for breach of contract. The court found it unjustifiable under the law for the developer to prevail on the breach of contract theory but avoid the contractually agreed upon LoL. As concluded by the court,

“If SAMS could prevail on its argument that the limitation of liability clause in the parties’ contract should be jettisoned because it does not meet the specificity standard required to limit negligence claims by contractual terms, that result would permit an end-run around Indiana’s economic loss rule and SAMS’s own contract with Environs.”

For these reasons, the court affirmed the partial summary judgment in favor of the architect.

Comment

The limitation of liability clause in this contract specifically named the various causes of action to which it would be applied, including negligence, breach of contract, and breach of warranty. It is prudent to list out the causes of action rather than to draft the clause more generically to just say it applies to any and all causes of action. If the clause in this contract had been written generically like the one discussed in the next article, it is quite likely that the court would have found merit to the developer’s argument that the clause was unenforceable since it did not specifically address damages arising out of the architect’s own negligence.

This decision provides a useful analysis contrasting an LoL clause and an indemnification or exculpatory clause, and explains why an LoL clause may be enforceable in circumstances where a full exculpatory clause would not be.

Article 3

Limitation of Liability Clause Enforced – Even in Face of Allegations of Gross Negligence

See similar articles: Exculpatory | Gross Negligence | Limitation of Liability

Where a limitation of liability clause in a design professional contract would limit a homeowner’s claim against its designer to the total fee for services, the plaintiff sought to avoid the affects of the clause by asserting that the designer had acted with gross negligence in drafting plans that resulted in their home being constructed almost two feet lower than applicable regulations pertaining to flood plains allowed. The appellate court, in Saja v. Keystone Trozze, LLC, 106 A.D.3d 1168 (NY 2013), found in favor of the designer. It affirmed the summary judgment that had been granted by the trial court to the designer, and found that the allegations of the plaintiff failed to raise a question of fact as to whether the designer was grossly negligent. This was because “the conduct alleged does not evince the necessary reckless indifference to the rights of others that would render the limitation of liability clause unenforceable.”

The limitation of liability (LoL) clause in the contract, as quoted by the court, provided in relevant part that the plaintiff “agree[d], to the fullest extent permitted by law, to limit the liability of [designer] … to [plaintiffs] … for any and all claims, losses, costs, damages or any nature whatsoever or claims expenses from any cause or causes, so that the total aggregate liability of [designer] … shall not exceed [its] total fee for services rendered on this project.”

The court explained that “As a general rule, parties are free to enter into contracts that absolve a party from its own negligence or that limit liability to a nominal sum.” But the court further explained that “As a matter of public policy, however, exculpatory or limitation of liability clauses are not enforceable in the face of grossly negligent conduct.” The issue, therefore, was whether the allegations of gross negligence were sufficient to abrogate the limitation of liability, and the court found the allegations lacking in that regard.

Comments on the Limitation of Liability Clause

The court interpreted and applied the limitation of liability clause to apply to both negligence and breach of contract claims, even though the clause was somewhat generic in stating that the limitation would apply to “any and all claims, losses, costs, damages of any nature whatsoever for claims expenses from any cause of causes….” Courts in other jurisdictions might require that the LoL clause be written to specifically name the types of causes of action to which it applies, such as torts, negligence, breach of contract, breach of warranty, and strict liability.

The court also did not address the dollar amount of the LoL that was limited to fees, and whether it evaluated its sufficiency under the circumstances. Courts in some jurisdictions may have considered whether the fees caused the LoL to be so nominal as to be unenforceable.

When drafting LoL clauses, many commentators have suggested that it is prudent to specify all the types of actions to which it may be applied, and to also set the LoL amount at something that is deemed significant and not merely nominal. If fees are rather small, for example, it may be prudent to specify that the LoL will equal the amount of the fees, or $________, whichever is greater.

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ConstructionRisk.com Report (September 2013)