Critical Risk Mitigation Provisions for Design Contracts — Part 2: Limitation of Liability Clauses

As discussed in Part 1 of this series, design professionals face significant exposure for claims arising out of alleged errors and omissions in the performance of their services. While waivers of consequential damages help limit exposure to indirect losses, limitation of liability (“LOFL”) provisions serve as another critical contractual tool for allocating and managing risk in design contracts.

LOFL provisions must be specifically negotiated into design professional contracts and are sometimes the most contentious element of contract negotiation. Although enforceability of the details of LOFL clauses still varies from state to state, these clauses are generally enforceable unless found to be unconscionable, void for public policy reasons, or if the clause limits liability for gross negligence or willful misconduct. In this regard, it is important not to go too far in absolving the design professional from liability for their actions. For example, a clause limiting an architect’s liability for gross negligence, fraud, intentional misconduct, or reckless acts would likely be determined to be unenforceable, while a clause limiting its scope to negligent acts will almost always be determined to be reasonable and enforceable.

Good LOFL clauses will include: (1) the types of liability the limitation applies to, and the exclusions therefrom; (2) whether the limitation applies to the total aggregate liability of all covered claims or if it represents a limitation of individual claims; and (3) a clear description of the limitation amount or how it is determined. A popular exclusion from the protection of an LOFL clause is claims based on indemnity.

As to the breadth of the provision and its exclusions, LOFL clauses typically apply to claims based on breach of contract and negligence but often exclude indemnity claims. This exclusion is often insisted upon by the owner/developer. Without such an exclusion, if the owner is sued by a third party for damages that arise from design defects, the owner/developer may be liable to the third party for amounts in excess of the limit the owner can recover from the design professional under the LOFL provision. In addition to excluding things like fraud and intentional misconduct from the coverage of the LOFL provision, owners and developers should likewise exclude claims based on indemnity.

Particularly in design agreements that cover more than one project, it is imperative to be clear whether the limitation amount is a total aggregate limit of liability for all claims for all projects, or is a limit on the liability for each individual project or unit. Examples of such contracts would be a contract to design all units in a subdivision or a master agreement meant to cover all future projects between the parties.

As to the limitation amount and how it is determined, LOFL clauses commonly cap the design professional’s financial exposure in several distinct ways. These include a stated total dollar amount, the total amount of fees set forth in the contract (or the total amount collected by the design professional), or the total amount of required insurance (or available insurance proceeds).

To help ensure enforceability, the goal should be reasonableness under the circumstances. There is some risk, for example, in setting the liability cap below the amount of insurance the design professional is required to carry, as this frustrates the owner/developer’s ability to realize the proceeds of the insurance the design professional has contractually agreed to carry to cover such claims. However, in a commercial setting, courts generally respect such limitations as a reasonable means of risk allocation, even if the allocation seems onerous in particular cases.

While the focus here has been on contracts between design professionals and their clients, design professionals must also pay close attention to waiver and limitation clauses contained in the contracts they have with their subconsultants. Design professionals must be careful that any waivers or limitations they agree to in subconsultant contracts are no broader than the waivers and limitations they agree to in their contracts with their clients. Otherwise, the design professional might be in the unenviable position of having greater liability to the project owner for its subconsultants’ acts than those subconsultants have to the design professional.

Together with waiver of consequential damages provisions discussed in Part 1, limitation of liability clauses are among the most important contractual mechanisms available to design professionals for allocating project risk. Because these provisions are not typically included in design contracts as a matter of course, they must be specifically negotiated and carefully drafted to maximize enforceability and align with the parties’ intended allocation of risk.