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By John Fedun
Howrey LLP
Indemnity is the duty of one person to make good any loss, damage or liability incurred by another. This duty is common in construction industry contracts. One example is a clause requiring a contractor to indemnify an owner for damages resulting from personal injuries on the job.
Limitations of liability operate to limit the liability of one party to a contract to the other party for a breach of contract or negligence. For example, such limitations often cap an engineer’s total potential liability to the project owner at the fee to be earned by the engineer on the project.
Many states have enacted statutes limiting the reach of indemnity clauses in construction contracts. As courts recognize, the statutes are intended to prevent parties from eliminating their incentive to exercise due care. Three recent cases shed light on the distinction between liability limitations and indemnity clauses and the interaction between anti-indemnity statutes and liability limitations.
North Carolina
A surveyor mistakenly set benchmarks for a project 1.7 feet higher than specified, which required the contractor to import fill. Blaylock Grading Co., LLP v. Smith, 658 S.E.2d 680 (N.C. App. 2008). The contractor sued, and a jury returned a verdict awarding the contractor $574,714 in damages. The contract between the surveyor and contractor provided:
[Surveyor’s liability to Contractor] for any and all injuries, claims, losses, expenses, damages or claim expenses arising out of this agreement, from any cause or causes, shall not exceed the total amount of $50,000, the amount of [Surveyor’s] fee (whichever is greater) or other amount agreed upon when added under Special Conditions. Such causes include, but are not limited to, [Surveyor’s] negligence, errors, omissions, strict liability, breach of contract or breach of warranty.
The surveyor asserted the provision as a defense, but the trial court held that the provision was void as against public policy and entered judgment on the jury verdict. The surveyor appealed, and the Court of Appeals reversed, limiting liability to $50,000.
The appeals court noted that the North Carolina Supreme Court, in a case involving telephone directory advertising, had held that liability limitations were not contrary to public policy. The Supreme Court held that people “should be entitled to contract on their terms without the indulgence of paternalism by courts,” even if the contracts lead to bad bargains, hardship or unreasonable agreements. Courts could intervene only if the contract was so unconscionable as to evoke a “profound sense of injustice.”
In the case before the Court of Appeals, the plaintiff contractor did not claim unconscionability or inequality in bargaining position. As the appeals court noted, both parties were “sophisticated, professional parties who conducted business at arms’ length.”
Rather, the contractor asserted that land surveying fell within a public service exception to the Supreme Court’s rule because land surveying is an “extensively regulated” industry.
The appeals court rejected the argument. It held that while surveying is regulated by statute and surveyors must be licensed, this does not automatically convert a profession into a public service. Rather, the appeals court concluded, when the breach of contract involves only economic loss, as in the case before it, the health and safety of the public is not implicated. Also, the contract did not preclude third parties that might be affected by the negligence of the surveyor from bringing negligence actions against the surveyor.
The contractor also argued that the clause violated North Carolina’s anti-indemnity statute (NCGS §22B-1). It provides:
Any promise or agreement in, or in connection with, a contract or agreement relative to the design, planning, construction, alteration, repair or maintenance of a building, structure, highway, road, appurtenance or appliance, including moving, demolition and excavating connected therewith, purporting to indemnify or hold harmless the promisee, the promisee’s independent contractors, agents, employees, or indemnitees against liability for damages arising out of bodily injury to persons or damage to property proximately caused by or resulting from the negligence, in whole or in part, of the promisee, its independent contractors, agents, employees, or indemnitees, is against public policy and is void and unenforceable.
The appeals court held that the statute was inapplicable because the contract only limited a party’s liability and was not an indemnity agreement under which one party agreed to be liable for the negligence of the other party. In addition, the court held that the statute applied only to damages paid to a third party for personal injury or property damage. The statute does not apply, it held, to liability limitations affecting only parties to a contract. Because the clause was enforceable, the surveyor was entitled to the contract’s liability limitation, the appeals court held.
Georgia
Another clause recently at issue covered third parties and thus was broader than the North Carolina clause. But, the attempt to achieve more protection ultimately left the negligent party with no protection. Lanier at McEver, L.P. v Planners and Engineers Collaborative, Inc., 284 Ga. 204, 663 S.E.2d 240 (2008).
There, a residential developer contracted with a civil engineer to design a storm water drainage system for an apartment complex. After completion of construction, the developer discovered erosion and other damage that it believed was caused by negligent design. By the time of the court decision, the developer had spent $250,000 on repairs and expected to spend a total of $500,000.
The developer sued the designer. The designer moved for partial summary judgment, seeking to limit its liability to $80,514, the amount of its fee. The engineering contract provided:
In recognition of the relative risks and benefits of the project both to [Developer] and [Engineer], the risks have been allocated such that [Developer] agrees, to the fullest extent permitted by law, to limit the liability of [Engineer] and its subconsultants to [Developer] and to all construction contractors and subcontractors on the project or any third parties for any and all claims, losses, costs, damages of any nature whatsoever, or claims expenses from any cause or causes, including attorney’s fees and costs and expert witness fees and costs, so that the total aggregate liability of [Engineer] and its subconsultants to all those named shall not exceed [Engineer’s] total fee for services rendered on this project. It is intended that this limitation apply to any and all liability or cause of action however alleged or arising, unless otherwise prohibited by law. [emphasis added]
The trial granted partial summary judgment, and the Court of Appeals affirmed. The Georgia Supreme Court granted review and reversed on the basis of Georgia’s anti-indemnity statute (OCGA §13-8-2 (b)). It provides:
A covenant, promise, agreement, or understanding in or in connection with or collateral to a contract or agreement relative to the construction, alteration, repair, or maintenance of a building structure, appurtenances, and appliances, including moving, demolition, and excavating connected therewith, purporting to indemnify or hold harmless the promisee against liability for damages arising out of bodily injury to persons or damage to property caused by or resulting from the sole negligence of the promisee, his agents or employees, or indemnitee is against public policy and is void and unenforceable.
The purpose of the statute, the Supreme Court wrote, is to prevent an owner, contractor or subcontractor from contracting away liability for accidents caused by its sole negligence.
The court rejected the argument that the clause at issue was purely a liability limitation that simply capped damages. While recognizing that the clause did not exculpate the engineer from all monetary liability, the court held that the clause was an indemnity provision within the meaning of the statute, particularly regarding claims by third parties for which the engineer might be solely liable. “This is because the clause applies to ‘any and all claims’ by third parties and shifts all liability above the fee for services to [the developer] no matter the origin of the claim or who is at fault.”
Thus, the court noted, once the $80,514 threshold, based on the engineer’s fee, was reached, the engineer could recover from the developer for all judgments, even those of third parties for which the engineer was solely negligent. This complete avoidance of liability to third parties for sole negligence “is exactly” what the anti-indemnity statute prohibits, the court held.
In response to the engineer’s argument that other jurisdictions allowed liability limitations, the court noted that the clauses in those cases did not apply to third party claims.
The court did note that parties could avoid the statute by shifting the risk of loss to an insurer no matter who is at fault.
Arizona
The Arizona Supreme Court considered a contractual liability limitation in light of Arizona public policy and Arizona’s anti-indemnity statute. 1800 Ocotillo, LLC v. The WLB Group, Inc., 196 P.3d 222 (Ariz. 2008). There, a townhouse developer hired a surveyor to identify project boundaries. After the survey was completed, the owner of a nearby canal claimed an interest in a right-of-way that was not accurately reflected on the survey. As a result, the City of Phoenix denied building permits. The developer sued for negligence to recover the cost of delays and additional engineering services.
The contract between the developer and the surveyor provided:
[Developer] agrees that the liability of [Surveyor], its agents and employees, in connection with services hereunder to the [Developer] and to all persons having contractual relationships with them, resulting from any negligent acts, errors and/or omissions of [Surveyor], its agents and/or employees is limited to the total fees actually paid by [Developer] for services rendered by [Surveyor] hereunder.
The clause was similar to the North Carolina clause because it applied only to the liability of the surveyor to the developer and persons under contract to the developer. Unlike the Georgia clause, the Arizona clause did not seek to make the developer liable for claims asserted against the surveyor by third parties.
Even so, the developer argued that the clause violated public policy as reflected in Arizona's anti-indemnity statute. The trial court disagreed and granted partial summary judgment, limiting the developer’s liability to the $14,242 in fees it had paid the surveyor. The Court of Appeals agreed. It did, however, hold that the liability limitation amounted to an assumption of risk defense and, therefore, could be decided only by a jury, as provided in the Arizona Constitution.
The Supreme Court affirmed, holding that the liability limitation did not violate public policy. It held that a jury trial of the limitation was not required.
The Supreme Court reviewed when public policy may defeat contractual provisions and then considered Arizona’s anti-indemnity statute (ARS §32-1159). It provides:
A covenant, clause or understanding in, collateral to or affecting a construction contract or architect-engineer professional service contract that purports to indemnify, to hold harmless or to defend the promisee from or against liability for loss or damage resulting from the sole negligence of the promisee or the promisee’s agents, employees or indemnitee is against the public policy of this state and void.
The court found that the clause did not violate the anti-indemnity statute because it merely was a limitation of liability, not an indemnity. The court held:
The policy underlying the anti-indemnification statute clarifies why the distinction between indemnity and liability limitation is important. Anti-indemnification statutes are primarily intended to prevent parties from eliminating their incentive to exercise due care…. Because an indemnity provision eliminates all liability for damages, it also eliminates much of the incentive to exercise due care.
The provision in the [agreement in this case] does not completely insulate [surveyor] from liability, as would an indemnity or hold harmless provision, nor does it require [developer] to defend [surveyor]. The provision merely limits liability.
However, the did court caution that “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, [but] this is not the case here.”
Here, though, the court found that the loss of professional fees – “undoubtedly [the surveyor’s] main reason for undertaking the work” – gave it “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.”
The developer also argued that the liability limitation violated public policy expressed in laws regulating professional corporations, limited liability companies performing professional services and partnerships because those laws held professionals personally liable even when practicing in such business organizations. The court rejected the argument, noting that the statutes do not address liability limitations and that the defendant surveyor was organized as a traditional corporation.
The court also rejected the developer’s contention that the clause was contrary to judicially identified public policy. The court recognized that liability limitation clauses serve the useful purpose of allowing parties to consider and properly allocate liability to those most able to mitigate the potential damages. Thus, it wrote, liability limitations generally are not considered a violation of public policy.
The court also held that the liability limitation was not an assumption of risk within the meaning of Arizona’s Constitution because it did not relieve a person of a duty to exercise due by barring any recovery by the injured party. The court also noted that the benefits of liability limitations would be largely lost if their enforceability were subject to jury determination.
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For more information about the issues covered in this report, please contact John Fedun in our New York office at 212-896-6579 or at fedunj@howrey.com or contact your Howrey attorney. For more information about Howrey’s Construction Practice Group, click here.
©2009 Howrey LLP
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