Source: http://www.constructionrisk.com, October 2013
An architect’s contract containing a limitation of liability clause (LoL) was enforced to grant a partial summary judgment limiting the architect’s liability to $70,000 in the face of a $4.2 million claim for damages due to structural problems that required a nearly completed hotel to have to be demolished. The U.S. Court of Appeals for the Seventh Circuit, in the case of Sams Hotel Group, LLC v. Environs, Inc., 716 F.3d 432 (7th Cir. 2013), held the limitation of liability clause in question applied to claims arising out of the indemnitor’s own negligence, and that it was not relevant that the clause had not specifically referenced the indemnitor’s “own” negligence, in contrast to negligence in general. In this case, the court explained the distinction between an exculpatory clause that removes all liability from a party, in contrast to an LoL clause that allows damage – even if only nominal in comparison to the total damages claimed. Applying Indiana law, the court stated that parties have freedom of contract and that “includes the freedom to make a bad bargain.” To allow the plaintiff to get out from under the bargained for LoL clause here, said the court, “would permit an end-run around Indiana’s economic loss rule and [plaintiff’s] own contract with [the design professional].”

The Limitation of Liability Clause

The design professional here was to be paid a flat fee of $70,000 for its services.  The limitation of liability clause of the contract provided:
“The Owner agrees that to the fullest extent permitted by law, Environs Architects/Planners, Inc. total liability to the Owner shall not exceed the amount of the total lump sum fee due to the negligence, errors, omissions, strict liability, breach of contract or breach of warranty.”
When the hotel was merely complete, structural problems were discovered which resulted in condemnation of the building by the county building department and ultimately the demolition of the building.  At the trial based on allegations that the designer was negligent and breached its contractual obligations, the court found the designer was liable for breach in several ways – none of which were detailed in the appellate court decision.  The trial court granted partial summary judgment limiting the amount of damages that could be recovered by the plaintiff to the $70,000 amount specified in the limitation of liability clause.
The developer argued that the limitation of liability clause could not be enforced despite the fact that it had knowingly and willingly agreed to its terms with the architect.  It argued that “the provision did not refer specifically to a limit on damages for Environ’s own negligence,” but instead must be understood to cover only Environ’s liability for negligence of third parties.

Court Decision

The question to be decided on appeal was whether an LoL clause in a professional services contract that generally refers to liability for “negligence” and breach of contract was enforceable in favor of the breaching party even though the clause did not specifically refer to that party’s own negligence.  Because the Federal Circuit predicted that the Indiana Supreme Court would say yes, it affirmed the U.S. District Court’s summary judgment in favor of the architect.
As a first point, the court stated that the contract was not a consumer contract or a contract of adhesion, but rather was between two sophisticated business entities of equal bargaining power who were aware of the risks involved in designing and building a hotel.  No one disputed that the parties signed the contract with knowledge and understanding of its terms.   The developer didn’t argue that the limitation of liability clause contravened law or public policy or was ambiguous.  Its only argument was that it should be excused from the terms of its bargain because the language didn’t refer explicitly to the architect’s own negligence.
This argument by the developer relied primarily on cases that would completely indemnify or exculpate a defendant for its own negligence.  For those types of clauses to be enforceable, the court explained that under Indiana law they must clearly and unequivocally” manifest a commitment by the one party to pay for damages caused by the other party’s own negligence.   But an indemnification clause is not the same as a limitation of liability clause, and the court stated that because they serve different purposes they must not be analyzed alike.
As explained by the court,
“Limitation of liability clauses … do not operate as insurance the way that indemnification clauses do.  They also do not entirely prevent one party to the contract from bringing a claim against the other, as exculpatory clauses do.  Limitation of liability clauses serve to establish a contractual ceiling on the amount of damages to be awarded if a plaintiff prevails in later litigation between the contracting parties.  We agree with SAMS that when a clause limits a party’s liability to only nominal damages, a limitation of liability clause can be as harsh as a full exculpatory clause would be.  This would be particularly true if the plaintiff were an unsophisticated individual or if the plaintiff had been bound to the provision through a contract of adhesion.  But SAMS and Environs were sophisticated commercial entitles that know the risks and freely bargained for the terms of the contract, including the limitation of liability clause.  SAMS did not unwillingly agree to the limitation of liability clause or assume these risks.  To the extent it suffered a harsh result, it cannot blame the general nature of limitation of liability clauses.”
Once the negligence claim had been dismissed by the trial court based on the applicability of the economic loss rule, the developer’s only claim was for breach of contract.  The court found it unjustifiable under the law for the developer to prevail on the breach of contract theory but avoid the contractually agreed upon LoL.  As concluded by the court,
“If SAMS could prevail on its argument that the limitation of liability clause in the parties’ contract should be jettisoned because it does not meet the specificity standard required to limit negligence claims by contractual terms, that result would permit an end-run around Indiana’s economic loss rule and SAMS’s own contract with Environs.”
For these reasons, the court affirmed the partial summary judgment in favor of the architect.

Comment

The limitation of liability clause in this contract specifically named the various causes of action to which it would be applied, including negligence, breach of contract, and breach of warranty.  It is prudent to list out the causes of action rather than to draft the clause more generically to just say it applies to any and all causes of action.  If the clause in this contract had been written generically like the one discussed in the next article, it is quite likely that the court would have found merit to the developer’s argument that the clause was unenforceable since it did not specifically address damages arising out of the architect’s own negligence.
This decision provides a useful analysis contrasting an LoL clause and an indemnification or exculpatory clause, and explains why an LoL clause may be enforceable in circumstances where a full exculpatory clause would not be.
About the author: Article written by J. Kent Holland, Jr.,  a construction lawyer located in Tysons Corner, Virginia,  with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners.  He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk.com Report, Vol. 15, No. 9 (Sept 2013).