On the risk-reward scale, it easily can be said that design professionals take on tremendous risk for little reward.
In order to ameliorate this disparity, design professionals rely on various contractual clauses and legal doctrines in an effort to shift the risk of loss from themselves to their consultants, clients or their clients’ contractors. Following are four risk transfer concepts, along with a discussion of recent trends in related laws that could further increase the current risk-reward disparity:
- Additional Insured Requirement
- Economic Loss Doctrine
- Limitations of Liability
- Limiting Liability for Compliance with FHAA and ADA Regulations
1. Anti-Indemnity Statutes and the Additional Insured Requirement
Although many states allow contracting parties to shift the risk of loss arising from one party’s own negligence to the other party through an indemnification provision, 45 states have enacted some form of “anti-indemnity” statute limiting a party’s ability to do so in the design and construction context. However, a party may attempt to circumvent this statutory prohibition by including an additional insured obligation in the contract. Such an obligation is independent of, and may provide broader protection than, the indemnity obligation, i.e., it may ultimately cover the additional insured’s negligence.
Oftentimes, design agreements contain provisions requiring both the design professional and the client to maintain insurance identifying each other along with a host of other entities as additional insureds. For example, the design agreement may obligate the client to require that the general contractor identify the design professional as an additional insured. Similarly, the agreement may require the design professional to identify the client, its lender, its partners, etc., as additional insureds. Further, the design professional’s agreement with its consultants may require the consultant to identify the design professional, the client and the general contractor as additional insureds. By naming these entities as additional insureds, the parties are afforded the benefits of the other party’s insurance policy.
While most anti-indemnity statutes apply only to the indemnification provision itself, others (either expressly or implicitly) apply to the additional insured contractual requirement as well. There are currently 14 states with some form of statutory prohibition against parties requiring additional insured protection from downstream parties, and this number is slowly increasing. It is likely that this trend will continue, thus rendering unenforceable the requirement that one party name the other as an additional insured.
2. The Economic Loss Doctrine
The Economic Loss Doctrine (ELD) is a court-developed doctrine that has been adopted by a majority of U.S. states. In general, the ELD provides that purely economic losses are not recoverable in tort unless the plaintiff has sustained personal injury or property damage. Purely economic losses are defined as “damages for inadequate value, costs of repair and replacement of the defective product, or consequent loss of profits-without any claim of personal injury or damage to other property…” as well as “the diminution in the value of the product because it is inferior in quality and does not work for the general purpose for which it was manufactured and sold.” These definitions are consistent with the policy behind contract law, which is to protect a party’s expectations. Thus, under the ELD, a plaintiff is expected to protect itself through a breach of contract claim rather than a negligence claim.
While the ELD originally developed in the area of products liability, it has been consistently applied by a majority of states in the area of design and construction defect claims. Specifically, the ELD has been applied by a majority of courts to bar negligence claims by third parties, such as claims by contractors against design professionals based on errors and/or omissions in their designs. However, over the last several years decisions by courts throughout the United States have begun to erode the ELD protection that design professionals have enjoyed.
The California Supreme Court, in Beacon Residential Community Association v. Skidmore, Owings & Merrill, LLP, recently held that “an architect owes a duty of care to future homeowners [with whom the architect did not have a contract] where the architect is the principal architect on the project — that is, the architect in providing professional design services, is not subordinate to any other design professional — even if the architect does not actually build the project or exercise ultimate control over construction decisions.” This decision eliminated ELD protection for design professionals in the residential construction context. The question, however, remains whether the holding will be extended to subject design professionals to claims by third parties other than homeowners, and to other contexts.
Most recently, the Pennsylvania Superior Court held, in Gongloff Contracting, L.L.C. v. L. Robert Kimball & Assoc., that an engineer could be liable for economic loss a subcontractor suffered based on a theory of negligent misrepresentation where the misrepresentation occurred in a design that the engineer knew would be used or relied upon by third parties, such as the subcontractor. According to the court, the architect had “impliedly represented that normal construction measures could be employed to erect the structural steel” and, therefore, the engineer was subject to liability for the subcontractor’s economic losses.
Most recently, the U.S. District Court for the Northern District of California, in Apex Directional Drilling, LLC v. SHN Consulting Eng’rs & Geologists, Inc., held that an engineer who prepares documents that contractors will rely on when preparing their bids owes a duty of care to the contractors, and thus can be held liable to these contractors for both breach of professional duty and negligent misrepresentation.
These decisions are among a growing line of cases where courts have begun limiting the application of the ELD and have held that design professionals and contractors can be held liable in tort for defective work. It is likely that this trend will continue over the next several years.
3. Contractual Limitations of Liability Provisions
For years, design professionals have been attempting to limit or avoid liability for damages caused by their errors and omissions by inserting limitations of liability (LoL) provisions into their contracts. By definition, an LoL provision is a contractual clause that limits the liability of one party to the other as set forth in the clause. This clause typically limits liability in one of the following ways:
- The compensation paid under the contract
- An agreed-upon sum
- Available insurance proceeds
- A combination of two or more of the above
In general, the courts in almost every state allow parties to include an LoL clause in their contract. However, courts have refused to enforce such provisions when:
- The provision is ambiguous or unconscionable
- The parties’ intentions were not clearly expressed
- One party had unequal bargaining powers or a higher level of sophistication
- The provision violates public policy
- The provision violates a statute
With regard to design professionals, there are two arguments for voiding an LoL provision that have been gaining ground in recent years. The first is that the provision violates public policy. According to this argument, public policy holds professional service providers to certain industry standards and “the very nature of a professional service is one in which the person receiving the service relies upon the expertise, training, knowledge and stature of the professional. Exculpation provisions are antithetical to such a relationship.”
For example, a New Jersey court held, in Lucier v. Williams, that an LoL provision in a home inspection contract was against public policy because it allowed the home inspector to avoid the state’s public policy of holding professional service providers to certain industry standards. According to the court, the provision conflicted with the purpose of a home inspection contract, which is to render a reliable evaluation of a home’s fitness for purchase.
The second argument for barring the use of LoL provisions centers around a state’s anti-indemnity statute. As previously discussed, an anti-indemnity statute does not allow a party to obtain indemnity from another for a loss caused by that party’s negligence. The argument is that an LoL provision, effectively, indemnifies a party for its own negligence. Even though the culpable party is required to pay some amount, the other party bears the risk of the remaining loss. The seminal case on this point is City of Dillingham v. CH2M Hill Northwest, Inc., an Alaska Supreme Court case, in which that court found that an LoL provision was a de facto indemnification provision that violated Alaska’s anti-indemnity statute.
A New Mexico court, in Fort Knox Self Storage, Inc. v. Western Technologies, Inc., also voided an LoL provision by looking at whether the LoL amount was “so minimal compared to one’s expected compensation as to negate or drastically minimize concern for liability for one’s actions.” According to the court, if the LoL amount was too low, it violated the state’s anti-indemnity statute.
Despite a handful of courts refusing to enforce LoL provisions, it appears that these cases are outliers and that courts will continue to enforce these provisions. While these decisions may provide guidance in drafting LoL provisions, they do not spell the end to a design professional’s ability to contractually limit its liability.
4. Indemnification for Non-Compliance with ADA and FHAA Design Guidelines
Oftentimes, a design professional on a multi-family housing project will retain the services of an accessibility consultant to assist in developing a design that meets FHAA and ADA design guidelines. Typically, the consultant agreement will contain an indemnification provision providing that if the consultant errs, it will indemnify the design professional for any resulting losses it may suffer.
However, that indemnity is not worth the paper it is printed on. The current rule is that no indemnification claim can be brought to transfer liability for FHAA and ADA violations. This was the holding in the seminal case, Equal Rights Center v. Archstone-Smith Trust, which was decided by the U.S. Court of Appeals for the Fourth Circuit in 2010. In that case, a developer, architect, and contractor of a multi-family project were sued for violating the FHAA and ADA. The developer entered into a consent decree with the plaintiffs that required retrofitting the buildings and payment of damages and fees. The architect entered into a separate consent decree with the plaintiffs. The developer then sued the architect for indemnification for the cost of retrofitting the complex.
The architect moved for summary judgment arguing that all of the owner’s claims were preempted by the FHAA and ADA. The trial court agreed and the appellate court affirmed. The court concluded that compliance with the FHAA and the ADA is a “non-delegable” duty. If an entity was allowed to transfer liability under the FHAA and the ADA to third parties, it would interfere with and stand as an obstacle to the purpose of these acts by disincentivizing designers from ensuring compliance.
While Archstone dealt with a developer’s claim against its architect, the basis for the decision is equally applicable to a claim by the design professional against its accessibility consultant. The decision makes clear is that in such a case, the design professional cannot rely upon contractual indemnification provisions in the consulting agreement to avoid liability where a project fails to comply with the FHAA and/or ADA. The rationale underlying this decision can also be used to find that the design professional cannot escape liability for a violation of the FHAA and/or ADA by pointing at the contractor as the cause for the noncompliance (through, for example, an indemnity provision in the construction contract indemnifying the architect for losses caused by the contractor’s defective work).
To date, there is no reported federal or state court decision contradicting the Archstone-Smith Trust holding. Thus, it seems unlikely that, without an act of Congress, a design professional who is sued for an error caused by its accessibility consultant will be left holding the proverbial bag.
Given the skewed risk-reward, it is critical that design professionals contractually minimize their risk to the greatest extent possible. However, the law is continually evolving and contractual limitations that the design professional is using today may not be enforceable tomorrow. It is, therefore, critical for the design professional to consult with experienced counsel when negotiating its contracts.
Scott Fradin is Co-chair of the Construction Law practice group at Chicago-based law firm Much Shelist. In his practice, Scott draws on his significant experience as both an attorney and a licensed architect (having practiced for several years) to draft and negotiate complex design and construction agreements on behalf of owners, architects, engineers, contractors and specialty subcontractors.