Liability Limitations in Today's Contracts

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Design professionals, contractors and other service providers in the construction industry are increasingly seeking disclaimers of damages and limits of liability in their contracts with upstream parties in the chain of contracting. Owners are not the only ones who should be sensitive to these clauses. Prime architects and general contractors also are being asked by lower-tier parties to accept some of the risk of failure.

Following is a summary of the most popular limitations and disclaimers that often escape the upstream parties' attention or priority list. As with any contract clause, the enforceability of the clause and its scope of excluded damages will vary with the language used.

Waiver of consequential damages

Because of its inclusion in the AIA contract forms, the waiver of consequential damages clause is the most common disclaimer debated today. The goal is to prevent liability for items like lost profits, lost sales or replacement services when things go wrong during construction or after completion.

For example, if a school must be repaired because of construction or design defects, payment for portable school buildings used during repairs would be resisted by the offending party if it obtained a consequential damages waiver in its contract. Other examples of damages that may be avoided by a consequential damages waiver include lost rents or temporary replacement housing in the residential industry, lost sales from store closures or reduced foot traffic in the retail sector, or lost production in the manufacturing industry.

Consequential damages also can arise from late completion of a construction project. In many contracts, including the AIA form construction agreements, consequential damages arising from delay during construction are compensable under the contract's liquidated damages clause, which typically specifies prospectively a dollar amount of damages for every day of delay in project completion. However, if the contract does not contain a liquidated damages clause, or if delays are incurred post-completion (such as in repairs or warranty work), the waiver of consequential damages clause may prevent any claim for lost revenue from delays.

Consequential damages like those described above can amount to significant dollars, and in some cases can match or exceed the direct cost of repairing defective construction.

Limitation of liability

Limitations of liability are typically broader than waivers of consequential damages and seek to limit liability for all types of damages (whether consequential or direct) to a specified total dollar amount. In some contexts, like geotechnical engineering and inspection services, the dollar limit of liability requested may be the amount the provider is paid under its contract. In other cases, the limit may equal the amount of insurance carried by the service provider.

No principal liability

Professional service providers often seek to include clauses that waive all liability against the individual principals and employees of the company. The assets of the company, therefore, are the only assets available to pay for a court judgment or settlement. When these clauses are employed, the assets of the company (including the insurance policy) merit greater scrutiny.

Special purpose entities

If the service provider or project developer has formed a special purpose entity for the project, the assets of that company will usually be the only available assets to pay for damages. Parent or affiliate companies, or members of a limited liability company, can be tapped for damages only if the "corporate veil" of the special purpose entity can be pierced. Piercing the veil is a difficult hurdle under the law of most states.

Lower-tier parties justify waiver and limitation clauses on the ground that full liability for their mistakes is too great when compared to their likely project profits. They also argue that such waivers are "standard."

Owners and other upstream parties argue that regardless of profit margins or what may be included in standard form created by the lower tier's own trade organization, the risk of defective performance should always fall on the party committing the defects. Upstream parties also argue that waivers and limitations can strip the owner of the proceeds of the providers' insurance policies, which the upstream parties typically pay for directly or indirectly.

Principal and employee liability and special purpose entities are different animals but bear the same scrutiny by both parties at the contracting stage. While many parties assume they would not pursue personal assets from each other in the event of a problem, in some cases the personal assets, or the assets of related entities, are needed for meaningful recovery of damages. For this reason, personal or affiliate entity guarantees are sometimes obtained.

Because the damages waived under these clauses can be significant, and can sometimes equal or exceed the recoverable (non-waived) damages, upstream parties should carefully consider the wisdom of accepting them.

Originally published in the Oregon Daily Journal of Commerce, May 2011.

Key Contributors

Eric A. Grasberger
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