Many experienced design professionals practicing in today’s litigious society unfortunately have been exposed to some type of legal claim or, in the very least, the threat of a claim. While most claims for professional negligence or malpractice are covered by professional liability insurance, the amounts in controversy often exceed the limits of available insurance coverage, thereby leaving the design professional vulnerable to personal exposure. Further, even when claims are fully covered by the underlying insurance policies, the amounts expended by insurance carriers on such claims all too often result in an increase to insurance premiums. The constant threat of personal exposure and increased insurance premiums unnecessarily diverts the design professionals’ focus from their practice. In order to protect their bank accounts and achieve peace of mind, design firms should consider the inclusion of limitation of liability clauses in their project agreements.
Before considering whether to negotiate a limitation of liability clause into a project agreement, the design professional should have an understanding of the definition and purpose of such a clause. A limitation of liability clause is a contractual provision that caps the amount of damages that a client may recover from the design professional as a result of the design professional’s wrongdoing. The rationale for capping damages is that the relatively small fee paid to the design professional does not justify the firm’s assumption of the risk that the project goes awry. In the interest of fairness, the design professional’s exposure should be relative to its potential reward.
The monetary cap included in limitation of liability clauses varies depending on the goals of the design professional. While there is no set amount, the cap oftentimes represents the design professional’s fee or available professional liability coverage. Other times, the cap is a “reasonable” fixed amount dependent on the size of the underlying project. Most of the “B” series standard agreements published by the American Institute of Architects contain clauses whereby the owner and design professional waive all claims for consequential damages, as well as damages covered by property insurance (except such rights as they may have to the insurance proceeds).
While limitation of liability clauses are one of the most effective risk allocation tools available to design firms, many firms do not even attempt to negotiate such clauses into their agreements. Many of these firms express concern about the legality of limitation of liability clauses and whether such clauses will hold up in court. Some firms are likewise concerned that limitation of liability clauses are unprofessional and could jeopardize the relationship between the firm and its potential client.
Limitation of liability clauses are generally valid and enforceable in most states. Courts in both New York and New Jersey routinely uphold limitation of liability clauses which: (1) are clear and unambiguous; (2) are not unconscionable as a result of inequities in the bargaining power of the contracting parties; and (3) are not against public policy to the extent that the monetary cap is unreasonably low relative to the value of the underlying services. However, design professionals in New York and New Jersey are barred from limiting their liability resulting from their own gross negligence (voluntary disregard of the need to use reasonable care), recklessness and/or intentional torts.
The benefits gained from requesting limitation of liability clauses often outweigh the inherent risks associated with requesting a limitation. As discussed above, valid and enforceable limitation of liability clauses serve to cap, if not negate, design professionals’ personal exposure and reduce their insurance premiums (through incentives provided by insurance carriers as a result of their limited exposure). Further, design professionals oftentimes derive benefits from the negotiating process even when their clients ultimately reject the proposed clause. Notably, candid discussions regarding risk allocation and reduction serve to improve communications and understanding. For example, the potential client may offer the design professional an increased scope of services and/or increased fees in exchange for removing the limitation of liability clause from the project agreement.
The benefits derived from limitation of liability clauses are perhaps best illustrated by a lawsuit I personally handled. My architect client was sued for over $3 million in damages when a fire destroyed a new home designed and inspected by the architect. The home owner claimed that the direct vents for the hot water heater and boiler system were negligently designed and installed too close to grade level. The home owner substantiated nearly $3 million in claimed damages with backup documentation. However, we settled the lawsuit for under $20,000 because the agreement between the home owner and architect contained a limitation of liability clause capping the architect’s exposure at an amount equal to his fees for services rendered.
While design professionals cannot eliminate the risk of potential exposure, limitation of liability clauses go a long way in reducing such exposure and consequently decreasing the premium amounts paid for professional liability insurance coverage. In negotiating limitation of liability clauses into their agreements, design professionals protect their bank accounts and gain the peace of mind needed to focus on their practice.