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.