Enforcing limitation of liability provisions in owner architect engineer contracts.

• Author: Fox, Reeder R.

SHOULD AN architect or engineer be permitted to limit his liability to an owner for economic damages that may result from the design professional's negligence?

A number of recent cases have dealt with the issue of whether limitation of liability provisions in contracts between design professionals and owners or developers are a proper exercise of the parties' common law contracting rights, or are void and unenforceable as against public policy as reflected in various state anti-indemnity statutes. Decisions have been far from uniform.

In a recent case, Valhal Corp. v. Sullivan Associates Inc.,(1) the Third Circuit held that a provision in a contract between an architect and a developer that capped the architect's liability at $50,000 was enforceable under Pennsylvania law, where the parties to the contract were sophisticated business entities dealing at arm's length, the limitation was reasonable in relation to the professional's fee, and the developer's damages were purely economic. The court rejected the developer's arguments that the limitation provision was contrary to the Pennsylvania anti-indemnity statute and that the limitation should be applied only to negligence claims, not contract claims.

Decisions from other jurisdictions reflect a wide range of views on the enforceability of such provisions based on that particular state's contract law, public policy and anti-indemnity statutes, if any. For instance, some courts hold that these provisions should be construed liberally so as to foster the rights of private parties to contract freely,(2) while others view any provision that limits liability as an exculpatory clause that requires strict construction against the design professional.(3) In addition, the jurisdiction's view on the economic loss rule can prove determinative.

As a result, it is often difficult to harmonize the decisions, especially since they depend, in large part, on the particular language used in the limitation of liability provisions as well as the variation among state anti-indemnity statutes.

VALHAL CORP. V. SULLIVAN

A. Facts

Valhal, a real estate development company, was considering the purchase of a parcel of real estate for the construction of a residential high-rise. It entered into discussions with Sullivan, an architectural firm, for Sullivan to provide a feasibility study in connection with the project. The contract between Sullivan and Valhal included the following limitation of liability provision:

The Owner agrees to limit the Design Professional's liability to the Owner and to all construction Contractors and Subcontractors on the project, due to the Professional's professional negligent acts, errors and omissions, such that the total aggregate liability of each Design Professional shall not exceed $50,000 or the Design Professional's total fee for services rendered on this project.

Should the Owner find the above terms unacceptable, an equitable surcharge to absorb the Architect's increase in insurance premiums will be negotiated.

Under the contract, Sullivan's total fee was $7,000. Although Sullivan had signed each proposal, Valhal failed to sign any of them, but by written correspondence it authorized Sullivan to perform the work. Sullivan completed the feasibility report, and then an issue arose as to the applicable height restrictions.

Valhal filed an action against Sullivan for negligence and breach of contract, claiming economic damages in excess of $2 million.

B. District Court's Decision

Sullivan filed a motion for summary judgment wherein it argued that its liability to Valhal was limited to $50,000 based on the contractual limitation of liability provision. Valhal claimed that the provision was unenforceable because it was against public policy and contravened Pennsylvania's anti-indemnity statute, which provides, in pertinent part:

Every covenant, agreement or understanding in or in connection with any contract or agreement made and entered into by owners, contractors, subcontractors or suppliers whereby an architect, engineer, surveyor or his agents, servants or employees shall be indemnified or held harmless for damages, claims, losses or expenses including attorneys' fees arising out of: (1) the preparation or approval by an architect, engineer, surveyor or his agents, servants, employees or invitees of maps, drawings, opinions, reports, surveys, change orders, designs or specifications, or (2) the giving or the failure to give directions or instructions by the architect, engineer, surveyor or his agents, servants or employees provided such giving or failure to give is the primary cause of the damage, claim, loss or expense shall be void as against public policy and wholly unenforceable.(4)

The district court held that the limitation of liability provision constituted an exculpatory clause and therefore was disfavored under Pennsylvania law and subject to strict construction. The court went on to find that the provision was contrary to a public policy against architects exculpating themselves from liability, as evidenced by that statute.

The case proceeded to trial, and the jury found against Sullivan on both the negligence and contract claims but awarded damages to Valhal in the amount of $1 million on the breach of contract claim only.

C. Decision of Court of Appeals

The Third Circuit's starting point for analysis as to whether the limitation of liability provision was unenforceable on public policy grounds was whether the provision was an exculpatory clause, as the district court had found. It recognized that the distinctions between indemnity provisions and limitation of liability provisions are highly significant. The court observed that a limitation of liability provision, unlike an exculpatory clause, does not completely insulate a party from liability; it merely caps the party's liability at a predetermined level. It does not bar a cause of action, but simply limits the amount of damages recoverable. Unlike an indemnity provision, a limitation of liability provision does not impose liability for a party's negligent conduct on an innocent third party.

Reviewing Pennsylvania case law, the court observed that for these reasons exculpatory clauses and indemnity provisions, with their severe consequences, are disfavored in Pennsylvania and are construed against the party seeking their protection.

On the other hand, the court noted that limitation of liability provisions are not disfavored and are routinely utilized in many types of commercial contracts as a reasonable method to allocate commercial risk between the contracting parties. The court observed that a seller's typical contractual exclusion of consequential damages is an example of a limitation of liability, for although the seller is thereby relieved from liability for all consequential damages, it is still liable for other damages.(5)

As a result, the court ruled that the provision at issue in Sullivan's contract was a limitation of liability and not an exculpatory clause. The effect of the provision was to limit Sullivan's liability for Valhal's economic losses to $50,000. The provision did not release Sullivan from all liability, did not impose liability on a third party for...