Limiting Liability: Three Clauses to Consider in your Next Construction Contract

In your next contract, consider including some (or all!) of the following clauses to limit your liability and maximize your profits.

Waiver of Consequential Damages

While a proven breach of contract will leave a design professional or contractor exposed to direct or compensatory damages, a waiver of consequential damages will help “stop the bleeding” and protect the design professional or contractor from paying every damage that might flow from the breach. Consequential damages include those damages which indirectly flow from the breach of contract, for example, lost rents, lost profits, lost use, lost opportunity, loss of employee productivity, and damages to reputation.

The American Institute of Architects (AIA) has included a mutual waiver of consequential damages in its sample A201 for over 20 years. The AIA provision includes a definition of consequential damages which are waived, including many of the examples cited above. However, the AIA waiver of consequential damages clause carves out an exception for liquidated damages to the owner. Prudent design professionals and contractors will strike this exception so as not to render the clause meaningless. A well-drafted waiver clause will be mutual, will define which damages are consequential versus direct, and will not contain exceptions.

Limitations of Liability

Imagine a scenario where a design professional holds $1,000,000 in insurance coverage per occurrence and the owner alleges over $2,000,000 in damages. The design professional is concerned about personal liability beyond the limits of the available insurance, particularly because they netted less than $200,000 on the project at issue.

This common scenario is easily avoided with a clause limiting liability. The parties can agree to any limit of liability, but common limits include:

  • The design professional or contractor’s anticipated profits on the project (most often stated as a dollar figure);
  • A percentage of the insurance required under the contract; or
  • The total insurance required by the contract.

When liability limits are based on insurance, it’s important to identify if the policy limits are per occurrence or aggregate for the policy period (usually one year). For example, you would never limit liability to the total available insurance on an aggregate policy, as you would risk exhausting your available insurance for the entire policy period on a single claim.

Percentage Clause

This practical clause acknowledges the realities of construction: errors will occur but errors are not always the result of a deviation from the standard of care. This clause allows a design professional or contractor to increase construction costs through change orders without facing potential liability from the owner. For example, the parties may agree that the owner releases the design professional from liability so long as the design professional’s “errors” do not increase construction costs by change order by more than three percent (3%). In a $5,000,000 project, the owner will have released the design professional for the first $125,000 in errors, as defined by the contract. The owner, in turn, can anticipate these costs by including a reasonable percent contingency in its budget for errors.

Illinois Supreme Court Limits Reach of Implied Warranty Claims Against Contractors

In a recent decision, the Illinois Supreme Court held that a purchaser of a newly constructed home could not assert a claim for breach of the implied warranty of habitability against a subcontractor where the subcontractor had no contractual relationship with the purchaser. Sienna Court Condo. Ass’n v. Champion Aluminum Corp., 2018 IL 122022, ¶ 1. The decision overruled Minton v. The Richards Group of Chicago, which held that a purchaser who “has no recourse to the builder-vendor and has sustained loss due to the faulty and latent defect in their new home caused by the subcontractor” could assert a claim of a breach of the warranty of habitability against the subcontractor. 116 Ill. App. 3d 852, 855 (1983).

In Sienna Court Condo. Ass’n, the plaintiff alleged that the condo building had several latent defects which made individual units and common areas unfit for habitation. 2008 IL 122022 at ¶ 3. The Court rejected the plaintiff’s argument that privity should not be a factor in determining whether a claim for a breach of the warranty of habitability can be asserted. Id. at ¶ 19. The Court also rejected the plaintiff’s argument that claims for a breach warranty of habitability should not be governed by contract law but should instead be governed by tort law analogous to application of strict liability. Id.

The Court reasoned that the economic loss rule, as articulated in Moorman Manufacturing Co. v. National Tank Co., 91 Ill. 2d 69, 91 (1982), refuted the plaintiff’s argument that the implied warranty of habitability should be covered by tort law. 2008 IL 122022 at ¶ 20. Under the economic loss rule, a plaintiff “cannot recover for solely economic loss under the tort theories of strict liability, negligence, and innocent misrepresentation.” National Tank Co., 91 Ill. 2d at 91. The Court explained that the rule prevented plaintiffs from turning a contractual claim into a tort claim. 2008 IL 122022 at ¶ 21. The Court further noted that contractual privity is required for a claim of economic loss, and an economic loss claim is not limited to strict liability claims. Id. Because the plaintiff’s claim was solely for an economic loss, it was a contractual claim in nature; therefore, the Court concluded that “the implied warranty of habitability cannot be characterized as a tort.” Id. at ¶ 22.

The Court also rejected the plaintiff’s argument that warranty of habitability should be governed by tort law because it involves a duty imposed by the courts. Id. at ¶ 23. It reasoned that “an implied term in a contract is no less contractual in nature simply because it is implied by the courts . . . .” Id. The Court noted that the warranty of habitability can be waived under Illinois law, but individuals are not able to waive duties imposed upon them by the courts. Id. If the warranty of habitability was a tort claim, it would “raise[] significant practical problems, particularly for subcontractors” given that they “depend upon contract law and contracts with the general contractor to protect and define their risks and economic expectations.” Id. at ¶ 24. Because a subcontractor’s fees, costs, and liability are controlled by his contracts, turning an implied warranty of habitability claim into a tort would make those contracts pointless. Id.

The Court’s decision to overrule Minton rested on three primary reasons: (1) Minton failed to discuss why the economic loss rule did not apply; (2) Minton did not address what effect its holding would have on the contractual relationships of subcontractors and general contractors; and (3) there is “no authority for the idea that a tort duty comes into and out of existence depending on whether another entity is bankrupt.” Id. at ¶ 25. In light of the opinion, a home purchaser’s remedy where there is economic loss is now limited to those parties with whom it has a direct contractual relationship.

Don’t Just Go With the Flow (Down)

There are some contract provisions that we see so often that we occasionally stop actually reading them, stop actually thinking about them, and just mentally check the provision off our list of things we expect to see in the contract. They fall into the catchall description “boilerplate,” and indeed often populate a section of the contract referred to merely as “Miscellaneous.” While this is obviously not a best practice, it’s also fair to say that some terms (like integration clauses) are virtually never negotiated, and therefore not worth as much time and attention as others. To paraphrase George Orwell, all contract clauses are equal, but some are more equal than others.

One clause that is often treated this way is the flow-down provision, which usually reads something like “We shall have all rights, remedies, powers, and privileges as, to, or against You which the Owner has against us. To the extent that the Subcontract Documents relate in any respect, whether directly or indirectly, to your scope of work under the Subcontract, You agree to be bound to us in the same manner and to the same extent as we are bound to the Owner.” While such clauses are, indeed, common-place, the reality is that they would frequently benefit from far more fine-tuning than they actually receive. One size does not fit all.

Consider dispute resolution proceedings. On public contracts, dispute resolution between the prime contractor and the owner is virtually always litigation in a local court. A smart prime contractor wants a far more nuanced approach to dispute resolution with its subcontractors. Indeed, very often, a smart prime contractor wants an array of options made available to it, to be chosen as appropriate given the nature of the dispute. Disputes solely between the prime and a sub can be resolved via arbitration, whereas any dispute that the prime believes involves the owner must be resolved via the process outlined in the prime contract, and the sub agrees to be joined to any litigation with the owner in the event that the sub’s work is implicated in that litigation. Such provisions are reasonably common, but often run directly afoul of the flow-down provision, which would mandate litigation in all disputes between the prime and the sub, because litigation is mandated in all disputes between the prime and the owner.

Conflicts like these are often addressed (or intended to be addressed) via an order of precedence clause, which exists to explain which document (the prime contract or the subcontract) governs in the event the two are in conflict. But this solution only masks the real problem: the best order of precedence is not necessarily the same in all situations. With respect to some kinds of clauses (like dispute resolution), the prime contractor usually wants the subcontract terms to supersede the prime contract terms. With respect to other kinds of clauses (like the sort of documentation that must be submitted to obtain a progress payment), the prime contract frequently wants the prime contract terms to supersede the subcontract terms. Therefore, a typical blanket order of precedence clause (“in the event of any express conflict between the terms of this Subcontract and the terms of the Prime Contract, the terms of this Subcontract shall prevail[,]”) will not work. Even worse is the attempt to use “higher, stricter, or better” order of precedence language—which form of dispute resolution requires the higher, stricter, or better performance?

Sadly, the only solution to this problem, like so many problems in life, is thoughtfulness and hard work. Post-contract award, and prior to entering into subcontracts on a project, the prime contractor’s project management and risk management staff need to sit down and have a thoughtful discussion about which prime contract terms ought to flow down, and which should be superseded by the subcontract terms. A simple work product that can be produced in such a meeting is a “flow down chart” that identifies each of the prime contract terms and indicates (via the use of a check-a-box graphic, if so desired) which terms flow down versus which are superseded by the subcontract terms. That chart can then be made part of the subcontract documents.

So, the next time a contract comes across your desk, take a moment to really think about those few, forgotten, but proud terms in the back of the contract. Some of them represent opportunities to add real value, so long as you pause for a moment, and don’t just go with the flow.

Governor Scott Paves the Way for Greater Clarification as to when a Contract for the Design, Planning, or Construction of Real Property is “Completed” Under Florida’s Statute of Limitations for Construction Defect Litigation

On June 14, 2017, Governor Rick Scott signed off on House Bill 377, which modifies § 95.11(3)(c) and brings clarification to condominium associations, developers, contractors, and design professionals by specifying the date of “completion” of a contract for the designing, planning, or construction of an improvement to real property.

Section 95.11(3)(c), Florida Statutes, requires that the following actions be brought within four years:

An action founded on the design, planning, or construction of an improvement to real property, with the time running from the date of actual possession by the owner, the date of the issuance of a certificate of occupancy, the date of abandonment of construction if not completed, or the date of completion or termination of the contract between the professional engineer, registered architect, or licensed contractor and his or her employer, whichever date is latest; except that, when the action involves a latent defect, the time runs from the time the defect is discovered or should have been discovered with the exercise of due diligence. In any event, the action must be commenced within 10 years after the date of actual possession by the owner, the date of the issuance of a certificate of occupancy, the date of abandonment of construction if not completed, or the date of completion or termination of the contract between the professional engineer, registered architect, or licensed contractor and his or her employer, whichever date is latest.

95.11(3)(c), Fla. Stat. (2016). In Cypress Fairway Condo. v. Bergeron Constr. Co., 164 So.3d 706 (Fla. 5th DCA 2015), the Florida Fifth District Court of Appeal was presented with the issue of whether, for purposes of § 95.11(3)(c), the date of “completion . . . of the contract” for the the design, planning, or construction of an improvement to real property is the date upon which construction is completed, or, if it is when the contract is completed, which, in Cypress, was the date on which final payment was made. The Court held that a contract governed by the § 95.11(3)(c) ten-year statute of repose is completed when “final payment is made under the terms of the contract.”

In so ruling the Court explained: “Completion of the contract means completion of performance by both sides of the contract, not merely performance by the contractor. Had the legislature intended the statute to run from the time the contractor completed performance, it could have simply so stated.”

The Court’s interpretation that term “completion” in § 95.11(3)(c) means the date upon which final payment is made under the contract is that, even if construction has long been completed, so long as the required final payment has not been made, the statute of repose continues to be tolled. The practical consequence of such an interpretation may stretch so as to toll § 95.11(3)(c) long after construction is completed and enlarges the window of potential liability for a contract.

Of course, parties to a contract for the design, planning, or construction of an improvement to real property are free to expressly declare in the governing documents a completion date that will utilized to determine the time period within which a plaintiff bring an action for a construction defect. Notwithstanding that clear option, the Legislature obliged the Cypress court and has taken affirmative action to correct that problem by introduction of House Bill 377, which introduces the following tag-along clause to § 95.11(3)(c): “Completion of the contract means the later of the date of final performance of all the contracted services or the date that final payment for such services becomes due without regard to the date final payment is made.” Chapter 2017-101, House Bill No. 377.

Accordingly, contrary to the conclusion reached in Cyrpess, under § 95.11(3)(c), and unless contractually stated otherwise, the date of “completion” is the date upon which construction is completed. Although House Bill 377 provides greater clarity to contractors, it remains advisable to expressly indicate in the governing documents the final date of completion so as to avoid the possibility that a dispute will arise over when that precise date is. Indeed, in Cypress, the competing dates—one of which two dates would have foreclosed the plaintiff’s claim—for “completion” were a mere three days apart, demonstrating the importance of definitively establishing such parameters.

GRSM counsels clients in the areas of construction, design, and planning for public and private projects in various capacities in Florida and across the entire Country. Please contact us with any questions you might have concerning the manner in which this legislative change could impact your business.