Limitation of Liability, or Who's Left Holding the Bag

The Limitation of Liability Clause is an increasingly important aspect of contracts involving design professionals. The Clause provides a cap on damages in the event of a breach. On its face the Limitation of Liability Clause seems to be one-sided and out of place in an agreement between responsible professionals. However, it appears with significant regularity and understanding its effect is essential for the project owner.

To understand the Limitation of Liability Clause, it helps to first answer what it is not. The Limitation of Liability Clause is not an exculpatory or indemnification clause. It does not allow the contracting party to escape liability as would an exculpatory clause and it does not require the contracting party to hold a breaching party harmless as would an indemnification clause. Absent these functions, the Limitation of Liability Clause is not subjected to the strict language interpretation that courts apply to the previously mentioned clauses. Limitation of Liability Clauses are frequently challenged, but also regularly upheld.

For example, in SAMS Hotel Group, LLC, v. Environs, Inc., the Seventh Circuit Court of Appeals upheld a generous Limitation of Liability Clause. 716 F.3d 432 (7th Cir. 2013). In that case, the architecture firm (Environs) capped their liability at their lump sum payment of $70,000, which applied if the breach was for negligence, errors, breach, etc. When a mistake in the design resulted in a $4.2 million dollar loss for the hotel, the owner (SAMS) went after Environs for the loss. They alleged that Environs acted negligently in designing the hotel and the court agreed; however, the court found that SAMS could only recover $70,000 in damages in accordance with the Limitation of Liability Clause.

SAMS argued that the Limitation of Liability Clause should not be enforced because the phrase “negligence” did not specifically refer to Environs. Exculpatory and indemnification clauses are required to be as specific as possible because of the harshness of misinterpretation. The Court disagreed, finding that two sophisticated parties can contract to limit liability without the strict interpretation associated with avoiding liability. Unless the terms are grossly disproportional, limitation of liability will be upheld when neither party is at a clear disadvantage.

Comments: The result in this case may seem harsh, but the parties’ ability to negotiate a Limitation of Liability Clause tempers its strength. By assigning risk, design professionals are able to take on contracts where the potential damage may far exceed their assets. Without such protection, the risk associated with this work would be unreasonable. At the same time, by taking on more or less liability, a project owner is able to negotiate a lower price or lower security with contractors.

The Limitation of Liability Clause can be both a useful tool and an overlooked risk. Navigating a contract is no easy task, but careful consultation before signing may avoid catastrophic results. Knowing your risk when entering a contract could mean the difference of being protected and being out $4.2 million dollars.

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