• The Limits on Limiting Liability: Enforcing Limitation of Liability Clauses
  • August 7, 2009 | Author: Buck S. Beltzer
  • Law Firm: Holland & Hart LLP - Denver Office
  • As the Arizona Supreme Court recently noted, “Our law generally presumes, especially in commercial contexts, that private parties are best able to determine if particular contractual terms serve their interests.” Yet, recent activity across the country shows that courts are divided on the extent to which they will agree to follow this rule to enforce limitation of liability provisions negotiated between sophisticated parties.

    Parties to construction and design contracts routinely rely on limitation of liability clauses to limit their potential financial exposure in the event that the project does not go as expected. Such clauses make it commercially practicable for designers to undertake certain types of services for limited compensation, without worrying about liability for potentially catastrophic damages later.

    Some courts have recently upheld limitation clauses, while other courts have struck them down. While the difference in approach can frequently be explained by differences in state law and fact scenarios, recent court activity does place an increased burden to either draft limitation of liability clauses more carefully or to price the risk of large potential liability into their contracts, or both.

    Limitation of Liability Clauses
    Most often, limitation of liability clauses impose a monetary financial limitation on the party’s ability to recover money damages against the other such as limiting liability to one of the following:

    • The amount of the professional’s fee or some percentage of the fee;
    • The amount of insurance proceeds; or
    • A negotiated number appropriate in light of the party’s contribution to the project, its fee, and the possibility for large damages arising from services.

    Historical Trends
    Over the last fifteen years, courts that have struck limitation of liability clauses were a limited minority or had extreme cases. Courts in Alaska and Nebraska used state-specific anti-indemnity statutes as the sword to pierce the limitation of liability shield. Specifically, the courts determined that it was against the public policy of the state or a specific state anti-indemnity statute to allow a party to contract away responsibility for its own negligent or intentional actions. Naturally, as more states have passed anti-indemnity legislation, more courts have used those anti-indemnity statutes to strike limitation of liability clauses.

    Now: Invalidating Clauses
    Last year, the Georgia Supreme Court determined that state’s anti-indemnity statute barred a contract clause limiting the liability of an engineer to the amount of the engineer’s total fee for the project. The court determined that Georgia law prohibited a party from contracting away liability for its own sole negligence. The court determined that the limitation of liability clause violated Georgia law because it shifted all liability for damages above the engineer’s total fee to the developer, “no matter the origin of the claim or who is at fault.”

    Similarly, last month, a Florida court of appeals ruled that a liability limiting clause did not preclude tort-based negligence claims asserted by a third-party. Accordingly, the court held that while a limitation of liability clause may limit a professional services company’s exposure, public policy dictates that such a clause cannot limit the remedies available to an aggrieved party against an individual.

    Now: Upholding Clauses
    Arizona went the opposite direction and upheld a limitation of liability clause despite Arizona’s anti-indemnity statute. The court was persuaded by the business realities of the construction world. Specifically, it stated, “it is possible that a limitation of liability provision could cap the potential recovery at a dollar amount so low as to effectively eliminate the incentive to take precautions.” However, in this case, because the liability was limited to the amount of the consultant’s fees, the firm had a “substantial interest in exercising due care because it stands to lose the very thing that induced it to enter into the contract in the first place.”

    North Carolina acted similarly and upheld a limitation of liability clause in a contract between a surveyor and contractor. Specifically, the court found that because the limitation of liability clause was different and distinct from an indemnity provision that North Carolina’s anti-indemnity statute did not apply.

    Parties in some states need not worry about the enforceability of limitation of liability clauses because anti-indemnity statutes expressly allow negotiated limitations. In California, for example, the anti-indemnity statute expressly allows parties to agree “to the allocation, release, liquidation, exclusion, or limitation as between the parties of any liability (a) for design defects, or (b) of the promisee to the promisor arising out of or relating to the construction contract.”

    Lessons Learned
    While it is certainly difficult to predict how courts will view limitation of liability clauses in the future or to identify all of the potential caveats that courts will analyze, lessons learned from these recent cases can help parties draft enforceable clauses. Parties should consider the following:

    1. Limitations of liability are more likely to withstand scrutiny than waivers of liability.
    2. Limitations based on intentional acts are less likely to be upheld.
    3. A clause that expressly excludes indemnity liability is more likely to be enforced (but offers the party less protection).
    4. Make the level of limitation proportionate in some meaningful way to the party’s role in the project.
    5. Recognize that a limitation may not be enforceable. Price the work or service to reflect the risk of a large potential liability, and consider additional insurance to cover the worst case scenario.