Contractual Limitations of Liability: The Evolution of a Risk Tool

Contractual limitations of liability are an important risk tool for design professionals today. These contractual provisions can operate as a way to control and mitigate losses in the event of a malpractice tort claim or in the event of a claim of some breach of contract. These provisions began to become common in the late 1970’s, and the initial focus in their use was to establish a specific maximum dollar amount of liability. Decades later, design professionals face a vastly different risk landscape, and the use of limitations of liability in contracts has evolved.

A Bit of History
The original contractual limitations of liability were frequently set at either $50,000 or the amount of the professional’s fees, whichever was greater. For example, simple report generating fees of perhaps $2,000 for a design professional would (in the $50,000 scenario) allow a recovery of some 25X of fees. Provisions such as these can still be found today, and continue to be enforced.

The underlying policy we see courts applying in determining whether or not the amount of the limitation is reasonable is this: does the amount create enough risk on the party benefitting from the limitation (the design professional) to create an incentive for the design professional to be careful? Put another way, is the amount of financial “pain” sufficient to incentivize due care?

Since the initial number of $50,000 originated in the 1970’s, more and more professionals now use “the greater of fees or $100,000” as a base limitation amount.

Let’s look for a moment at how this breaks down. If the design professional’s fees are $2,000 and the limitation is set at fees or $50,000, whichever is greater, then the design professional is running a worst case risk of liability at 25X of fees. If we look at this from the viewpoint of net impact on the bottom line, after expenses and taxes, perhaps the design professional would net $500. A $50,000 limitation is a risk of 100X the profit in the job.

As a rule, larger fees can justify larger assumptions of risk by the design professional. For example, a project with $500,000 in fees could look at a limitation of perhaps $1,000,000. Other factors must also be considered here: retentions/deductibles, insurance limits, contractual assumptions of liability, and the like. A singularly important risk to understand in today’s liability environment is the risk of third party claims, and the decreasing utility of limitations of liability provisions as risk mitigation tools in such circumstances.

The Issue of Limitations and Third Parties

Early on, limitations were set up to require clients to limit the liability of design professionals for all claims – client claims as well as third party claims. Court decisions hostile to these provisions (with some decisions characterizing them as stealth indemnities) have resulted in limitations becoming more and more focused on client vs. design professional claims, with third party claims being addressed less and less frequently.

For example, in the Georgia case of Lanier at McEver, L.P. v. Planners and Engineers Collaborative, Inc.2 the Georgia Supreme Court negated a provision in the design professional’s limitation of liability provision requiring the client to protect/indemnify the design professional from certain third party claims. The Court held that such a provision ran afoul of Georgia’s antiindemnity statute.3 In that case, with expenditures at trial having reached $250,000 and with ultimate remedy costs alleged to be somewhere in the area of $500,000 the issue was the
enforcement of a limitation applying to “all claims.” The limitation operated to set the liability limit at some $80,000. Although the design professional won at trial and in the Georgia Court of Appeals, the Georgia Supreme Court had other ideas. The state Supreme Court reasoned that since the cap was at $80,000 and the liability was already reaching $250,000 just for correction of the problem, any additional third party claims – even if caused solely by the design professional’s negligence –would be the obligation of the client. The Court found that the limitation of liability could operate as an indemnity for the sole neglect of the design professional. As a result, the language ran afoul of Georgia’s anti-indemnity statute. The rulings of the courts below enforcing the limitation were reversed.

Trends, the Restatement and the Economic Loss Doctrine

It may be possible to skirt the third party question by having the limitation structured in various ways (a “savings clause” exempting sole negligence from any limitation as to third parties, for example.) But many design professionals today simply have their limitations operate as between them and their clients, removing any third party issues.

Third party issues are a source of increasing potential risk for design professionals under the ALI’s Restatement Rule. The Rule allows a third party relying upon the design professional’s work – where the design professional knew of the reliance – to assert claims as though the third party was a client.4 Savvy design professional increasingly limit third party reliance and use, and mandate the use of Secondary Client Agreements. This is also vitally important in light of the continued erosion nationwide of protection against third party claims through the constriction of the Economic Loss Doctrine. These third party risk issues will be discussed in more detail in later articles. 

Returning to the idea of a limitation of liability, we should not conclude our discussion without at least a brief word on qualitative approaches to limits of liability. In addition to number-specific limitations (quantitative limitations), design professionals have also sought to use qualitative limitations. These are chiefly in the form of mutual waivers of consequential damages. This tool is increasingly common in large projects and can be a very beneficial provision, especially in situations where a design professional cannot secure quantitative limitation. Of course, such provisions are also useful for contractors. 

So, to sum up, limitations are a vital tool in the design professional’s risk management kit of risk management devices. Care must be taken to review the law of the state law governing the operation of the limitation, and awareness must be raised as to third party risks – both from the decreasing utility of limitations in that regard to the increasing number of potential third party claimants via the Restatement Rule and the demise of the Economic Loss Doctrine.

Consult with Your Locally Licensed Counsel
If you want to use a contractual limitation, ensure that you have the language drafted and periodically updated by your locally-licensed counsel. As we saw in the Lanier at McEver case discussed above, Courts can change the rules in a single case. New legislative and court actions can create sudden turns in what is workable language and what is not. If your practice is involved in more than one state, be sure and have lawyers in each state review your limitations provisions to see first if the state allows the enforcement of such limitations, and second, if limitations are enforceable, you should seek to determine whether or not your language conforms to any specific state law requirements for enforceability.

 

For more information, please contact Karl Duff at:
Professional Liability Consultants, LLC
2205 Riverstone Blvd. – Suite 108
Canton, Georgia 30114
Telephone: 770-345-3577
EMail: kduff@tempus-plc.com
(Dr. Duff is licensed to practice law in Georgia and Illinois)