By: William E. Kelley, Jr., LEED AP BD+C
In a decision that should have both Owners and Design Professionals taking close notice, the U.S. Court of Appeals for the 7th Circuit recently upheld enforcement of a contractual limitation of liability clause, which resulted in the design professional’s liability being capped at $70,000, despite the Owner’s claim that its damages were over $4.2 Million.
In SAMS Hotel Group, LLC v. Environs, Inc., (7th Cir. 2013), the Owner contracted with the Design Professional, for architectural services related to construction of a six-story hotel development. The contract between the parties provided that Owner would pay Design Professional a flat fee of $70,000. In addition, the contract contained the following limitation of liability clause:
The Owner [SAMS] agrees that to the fullest extent permitted by law, Environs Architect/Planners, Inc. total liability to the Owner shall not exceed the amount of the total lump sum fee due to negligence, errors, omissions, strict liability, breach of contract or breach of warranty.
Soon after completion of the construction, there were serious structural defects discovered, and the county building department eventually condemned the hotel structure. The hotel was demolished without ever opening, and the Owner estimated its loss at more than $4.2 Million.
In the ensuing lawsuit by Owner against Design Professional, Owner brought claims for both negligence and breach of contract. On cross-motions for summary judgment, the U.S. District Court ruled that the negligence claim was barred under the economic loss rule, since there was no personal injury or damage to “other property” outside of the project itself, citing to the Indiana Supreme Court’s ruling in Indianapolis Marion County Public Library v. Charlier Clark & Linard, P.C., 929 N.E.2d 722 (Ind. 2010). The District Court further ruled that the breach of contract claim was subject to the parties’ express limitation of liability clause, such that if the Design Professional was liable to Owner for breach of contract, that Design Professional’s maximum liability could not exceed $70,000 (i.e., the flat fee paid by Owner to Design Professional). The parties proceeded to trial, and the Design Professional was found to have breached the contract with Owner. Without deciding the total amount of damages incurred by Owner as a result of the breach of contract, the District Court held that Owner’s recovery was limited to the $70,000 fee.
On appeal, the Owner argued that the limitation of liability clause was not enforceable, arguing that the clause did not specifically state that it applied to the Design Professional’s own negligence. The 7th Circuit posed the question this way: “Is a limitation of liability clause in a professional services contract that generally refers to liability for ‘negligence’ and breach of contract, and that was freely bargained by two sophisticated commercial entities, enforceable in favor of a breaching party even though the clause does not specifically refer to that party’s own negligence?”
After examination of this issue under Indiana law, the 7th Circuit concluded that the limitation of liability clause was enforceable, thus limiting the Design Professional’s liability exposure to $70,000. In so holding, the 7th Circuit noted that the Indiana Supreme Court had drawn a line between negligence claims and breach of contract claims in the Indianapolis Marion County Public Library case, where the Supreme Court noted that “when it comes to claims for pure economic loss, the participants in a major construction project define for themselves their respective risks, duties, and remedies in the network or chain of contracts governing the project.” Once the Owner’s negligence claim was dismissed under the economic loss rule, the Owner was left with the express terms of its contract with Design Professional. The 7th Circuit noted that to ignore the contractual limitation of liability clause would be akin to providing an end-run around Indiana’s economic loss rule and the Owner’s own contract with the Design Professional.
The lesson for Owners and Design Professionals is clear: Clauses in a professional services contract that define or limit a Design Professional’s liability are enforceable. Consequently, both Owners and Design Professionals should take due care to review their contract agreements to identify these types of clauses, and also to confirm that the clauses accurately reflect the parties’ agreement. While an Owner’s initial reaction may be to strike all such limitation of liability clauses from its contracts, Owners should at least consider that unlimited liability and risk exposure to Design Professionals may increase the costs of the design fees charged on the projects, so that the Design Professional can attempt to adequately cover the potential risks through insurance and other protections. Design Professionals should consider, too, that limitation of liability clauses should probably not be arbitrary figures, but rather should be tied to some tangible basis, such as fees paid on the project, limits of available of insurance, or some figure or percent that represents a reasonable cap on a Design Professional’s liability in relation to the scope of the overall project.