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When a Developer or Owner first contemplates constructing
a project on a particular site, it is necessary to obtain basic information
about the site before any design work can commence. Some of this work may
take place before the Developer even acquires an interest in the land on
which the project is to be sited. The Developer needs to explore local zoning
and land use restrictions, the General Plan for the locality as well as other
regulatory requirements to determine if the project he is contemplating is
permissible on that site or whether it will be necessary to obtain changes
or variances from local officials.
Assuming these obstacles are not insurmountable, the Developer next must
investigate the existing condition of the earth and any structures on the
site to determine how those conditions will impact the feasibility and cost
of its proposed project. The two concerns most likely to impact the project
are the presence of environmental contamination on the site and the geological
and geotechnical conditions of the ground on which the project is to be founded. The
presence of either environmental contamination or atypical soils conditions,
if not discovered in advance of project design and commencement of construction,
have the potential to adversely impact project costs greater than virtually
any other factor affecting a project.
A few examples will illustrate this circumstance. An owner decided to construct
a hotel with a four story underground basement near the beach in an urban
area. During the geotechnical investigation prior to design, the soils engineers
unexpectedly encountered concrete obstructions in two of the soil borings. Speaking
to a long time local resident, the engineers were told that there was previously
a commercial swimming pool in that location. The engineers reported that
finding and proposed additional investigation to verify that finding. The
owner decided not to incur that cost. When construction commenced, the excavation
contractor found an intact two story basement structure. The cost of the
excavation tripled as did the length of time to complete the excavation phase. In
this case, because the contract contained a clause whereby the contractor
waived claims for differing site conditions, the contractor saw his entire
profit for the project disappear into the ground. The contractor cut corners
on the remainder of the project and was eventually terminated. The delays
in construction, cost increases incurred through changing contractors and
other project cost overruns forced the Owner into bankruptcy before the project
was completed. All of this started with unanticipated subsurface conditions.
A Developer identifies a rural site for development as single family homes.
It retains a consultant to prepare a Phase I ESA. The consultant does so
and follows the ASTM procedures including a review of applicable public records
and aerial photographs. The consultant does a walk around but the current
owner is absentee and knows little about the site. Based on available information,
the consultant opines that there is no evidence of hazardous materials on
site. In reliance on that report, the Developer acquires the site. After
property acquisition and during construction, the contractor discovers a
substantial quantity of lead shot from an old shooting range. Construction
is suspended while environmental sampling is conducted and regulatory officials
review the collected data. The result is that a substantial portion of the
site cannot be developed for residential use unless a large quantity of contaminated
soil is hauled off to a Class 1 landfill at considerable expense rendering
the project no longer commercially viable.
In another example, in connection with the acquisition of a former shipbuilding
property, an environmental consulting firm conducted a Phase II investigation
and issued a report outlining the known contamination. During construction,
the grading contractor unknowingly began distributing “reddish dirt” around
the site. The “reddish dirt” turned out to be contaminated with lead based
paint. In a subsequent cost recovery action under CERCLA, the grading contractor
was held to be an operator and a transporter under CERCLA.1 The
grading contractor in turn cross-complained for indemnity against the environmental
consultant claiming that the consultant was negligent in failing to identify
the paint contaminated soil. While the Court held the consultant did not
owe a duty of care to the grading contractor with whom it was not in privity,
the consultant could have been successfully joined by its client in that
action.
Because of the substantial risks associated with unanticipated environmental
contamination or soil conditions, the contractual arrangements under which
geotechnical engineers and environmental consultants perform the appropriate
site investigations are critical. They are not typically included in the
package of standard form agreements put out by AIA, AGC or DBIA because they
are usually direct contracts between Owners and the responsible engineer
or consultant. The AIA does provide a form for owners to use2, but in the 20 years I have been representing
geotechnical engineers I have never seen that form used.
ASFE: Professional Firms Practicing in the GeoSciences, a trade organization
of engineering firms providing geotechnical and environmental services have
developed contract guides for their member firms but do not provide sample
contract forms. Companies that provide insurance to geotechnical and environmental
firms such as XL DP and Terra Insurance provide contract reference guides
but not complete contract templates.
The purpose of this article is to provide some proposed form agreements
and to discuss the most important clauses in those agreements. First however
I will provide a context concerning the purpose and scope of a typical geotechnical
investigation and preliminary environmental site assessment so put the contract
terms in perspective.
The Purpose and Scope of a Typical Geotechnical Investigation
Whenever a structure is constructed it imposes certain loads
on the earth. If the structure is built on bare bedrock, presumably the
bedrock will provide sufficient support that the structure will not undergo
any movement or shifting during its useful life. However the vast majority
of structures of course are not directly on bare bedrock but rather on top
of the soil overburden. Depending upon the geological characteristics of
the soil and its thickness, the soil will provide varying degrees of support
for a structure. Frequently the soil is not uniform and therefore the differing
geological composition of the soil and the thickness of the different layers
or lenses of soil will provide different amounts of support for the structure
built on those soils. The depth to groundwater may also play a role in the
manner in which the earth supports a structure. Further, while to a layman
the difference between rock and soil may seem clear, there is in fact a continuum
between what we understand as solid rock and sand or silt. Certain types
of soils, particularly clays, are highly expansive. This means that they
swell when they get wet and shrink as they dry out. Structures built on
highly expansive soils can experience heave. Structures that are not properly
supported on compressive soils such as mud can experience differential settlement
where portions of the structure may settle as much as 1-2 feet relative to
other portions of the structure. In the worst cases, the structure may even
collapse.
It is the province of the geotechnical engineer to assess the
ability of the site soils to support the proposed structure. They do this
by drilling a number of soil borings to sample the subsurface conditions. They
remove core samples from the borings and subject the samples to tests to
determine the strength, plasticity, moisture content and composition of
the soils. The analysis of these test results and the assessment of the
bearing capacity of the tested soils is called soil mechanics. The geotechnical
engineer than extrapolates between the data points(borings) to provide a
professional opinion concerning the soil conditions beneath the proposed
structure and recommendations as to the appropriate foundation system to
support the loads anticipated by the project structural engineer. Foundation
types range from slab on grade to spread footings to pile supported structures.
While geotechnical engineers are now able to provide reliable
scientific judgments as to how the particular soils sampled from a site and
tested will perform when subjected to building loads and stresses, the ability
to predict with a high degree of accuracy the soil characteristics on a site
with any degree of variability is more problematic. It is noteworthy that
even for the most experienced geotechnical engineers, characterizing subsurface
conditions and interpolating between boring locations remains a matter of
engineering judgment. “Although soils mechanics has become a science, subsurface
soils investigation by soil boring techniques is still an art.”3 Indeed the practice of geotechnical engineering
is somewhat akin to drilling holes in a book and trying to read the book’s
text by peering down those holes.
For that reason it is important that all of the participants in a construction
project understand the uncertainty and risks of unanticipated subsurface
conditions and contract with each other in a way to properly allocate those
risks among those not only best able to manage the risk but also with an
eye toward the financial rewards of a successful project.
The Purpose and Scope of a Typical Phase I Environmental Site Assessment
A Phase I Environmental Site Assessment (ESA), is a somewhat
analogous exercise attempting to understand whether or not a site is contaminated
based on a limited amount of data. The standard of care for an ESA has been
largely standardized by ASTM. The purpose of an ESA is to identify without
undertaking any subsurface investigation whatsoever, whether it is
likely that a site is contaminated. The scope of a typical ESA involves
four tasks: (1) A review of historical aerial photographs, Sanborn maps and
other public records to attempt to determine past uses of the site no longer
apparent through a visit to the site; (2) Interviews of current owners, tenants
and in some cases neighbors in order to develop an understanding of past
and present uses of the site and uses of hazardous materials on and in the
immediate vicinity of the site; (3) A visit and walk through inspection of
the property looking for visible signs of the use of hazardous materials,
the existence of underground storage tanks, or evidence of discoloration
of soils reflecting past releases of contaminants; and (4) A data base search
of the records of regulatory agencies to determine whether the site or other
sites in the vicinity have had reported releases of contaminants to the soil
or groundwater. An ESA may or not contain conclusions and/or recommendations
for further investigation depending upon the contracted for scope of work. Where
evidence of present or past contamination is known or suspected the consultant
will typically recommend a Phase II Investigation which will consist of a
program of soil, soil vapor or groundwater samples to determine the presence
and concentration of contaminants. Again, it is a limited investigation
from which the consultant can develop professional opinions about the nature
and extent of contamination at the site.
ASFE, a trade organization of consulting firms, as well as the
major insurers issuing policies to environmental consulting firms have identified
Phase I ESA’s as the professional service that gives rise to the greatest
frequency of claims against their member firms. ESA’s are typically low
cost, low profit-margin jobs often with a very short turn around time. Frequently
clients incorrectly view this service as a commodity and look simply for
the lowest cost provider. Some clients and lenders look at the consulting
firms as an insurance policy against unanticipated remediation costs.
With that background lets turn to the key clauses in a contract
for geotechnical engineering services from the perspective of the engineer.
Scope of Work
The services to be performed by the geotechnical or environmental
consultant are among the most important provisions of the contract as they
set forth the consultants and clients agreement as to extent of the investigation
that will be undertaken to best meet the clients need to reduce the uncertainty
as to subsurface conditions at a manageable cost. The number of borings
necessary to adequately characterize a site is a matter of professional judgment
depending upon what is known about the site from previous nearby investigations,
published geologic maps, the details of the proposed project and the owner’s
budget. It is important for the engineer to explain and the Owner to understand
that geotechnical engineering is more an art than a science when it comes
to predicting subsurface conditions in areas where there is significant geologic
variability. An analogy I have used is that investigating a site is something
like drilling holes through a closed book and trying to understand the theme
of the book based on the words or letters you can see peering down those
the holes. The more holes you drill the better understanding you have of
the book but that understanding remains imperfect and subject to error.
Depending upon the project, some clients may be content to contract
for a limited investigation understanding that this will increase the risk
of unanticipated subsurface conditions the risk of which will be managed
by contingencies in the construction contracts or a project design that is
less likely to be impacted by variable soil conditions across the site. Other
owners may want to conduct extensive subsurface investigations either because
that is necessary for purposes of building design or in order to provide
contractors with sufficiently detailed information so that contingencies
are reduced or eliminated.
In order to properly document the clients involvement in the
decision as to the appropriate scope of work, it is preferable to detail
the scope of work in a proposal letter to the client which includes a discussion
of the trade-offs that have been discussed with the client and the decision
on scoping. The letter should reference not only the tasks that the engineer/consultant
is going to perform but also those tasks that are frequently performed on
similar projects that pursuant to discussions with the client are not going
to be performed. This proposal letter is then referenced as an Exhibit to
the contract with the client and incorporated by reference.
Standard of Care
Professional Engineers and Consultants
may be held liable if they fail to comply with the applicable professional
standard of care and someone is damaged or injured as a result. The failure
to meet the standard of care creates liability under common tort law. That
liability is described as professional negligence. Although the phrasing
may differ slightly from one jurisdiction to another, the following approved
California Jury Instruction is illustrative of how the term “standard of
care” is applied by courts throughout the country.
An engineer performing professional services for a client,
owes that client the following duties of care:
1. The duty to have that
learning and skill ordinarily possessed by reputable engineers, practicing
in the same or a similar locality under similar circumstances;
2. The duty to use the
care and skill ordinarily exercised in like cases by reputable members of
the profession practicing in the same or a similar locality under similar
circumstances; and
3. The duty to use reasonable
diligence and his or her best judgment in the exercise of skill and the application
of learning.
A failure to perform any one of
these duties is negligence4
This standard of care does not
require an engineer or consultant to guaranty or insure the results of his
or her professional efforts. Unless the professional by contract guarantees
or warranties a particular result, the failure to achieve a desired result
in the design is not necessarily negligence. California juries are instructed
on this point as follows:
An engineer is not necessarily negligent because he or she
errors in judgment or because his or her efforts prove unsuccessful. However,
an engineer is negligent if the error in judgment or lack of success is due
to a failure to perform any of the duties as defined in these instructions.5
The same standard of care applies
whether the project is for a private client or for a public entity. In a
case involving an architect, the Board of Contract Appeals for the Corps
of Engineers described the obligations of a design professional in the following
manner:
It has been said that an architect will be held liable for
damages sustained by his employer where, by reason of the architect’s breach
of his duty to exercise care and skill, his plans and specifications are
faulty and defective. However, in the absence of any special agreement in
that regard, an architect’s undertaking does not imply or guaranty a perfect
plan or satisfactory result and there is no assurance that miscalculations
will not occur. Liability rests only on unskillfulness or negligence and
not upon their errors of judgment.6
Design Professional Insurance Company
(D.P.I.C.) states the concept slightly differently.
As a design professional, you are subject to the doctrine
of professional negligence. Established in common law, it requires
you to maintain a professional standard of practice, i.e. that level of
professional skill and competence ordinarily and contemporaneously demonstrated
by members of your profession in the area where you practice. Simply
committing an error or omission is not necessarily a negligent act. You
are human; humans make errors; errors are allowed. If the error resulted
because you failed to exercise ordinary skill or care, however, and if
someone is damaged or injured as a result, then negligence exists.”
The Minnesota Supreme Court in City of Mounds
View v Warlijarv discussed the rationale behind the standard
of care. 7
Architects, doctors, engineers, attorneys
and others deal in somewhat inexact sciences and are continually called
upon to exercise their skilled judgment in order to anticipate and provide
for random factors which are incapable of precise measurement. The indeterminate
nature of these factors makes it impossible for professional service
people to gauge them with complete accuracy in every instance. Thus doctors
cannot promise that every operation will be successful; a lawyer can
never be certain that a contract he drafts is without latent ambiguities;
and an architect cannot be certain that a structural design will interact
with natural forces as anticipated. Because of the inescapable possibility
of error which inheres in these services, the law has traditionally required,
not perfect results, but rather the exercise of that skill and judgment
which can be reasonably expected from similarly situated professionals.
The professional standard of care
to which an engineer or consultant’s performance is compared, is that standard
of care which existed at the time that the work was performed. An engineer
or consultant need not anticipate advances in technology or in the “state
of the art”. This is particularly important in fields such as environmental
assessment and remediation, where the professional standard of care is constantly
evolving.
In an excellent discussion of the judgments and trade offs that
apply to geotechnical engineers, Steven Stein and Carl Popovky in an article
titled Design Professional Liability for Differing Site Conditions and
the Risk Sharing Philosophy that appeared in the April 2000 issue of
The Construction Lawyer point out the degree of judgment involved in geotechnical
engineering. They note, ‘[a] fundamental problem is that the present state
of the art simply has not advanced sufficiently to allow designers to reasonably
predict some of the most basic conditions under which the contractor will
perform its work.” These limitations on the ability of geotechnical engineers
to predict with accuracy subsurface conditions will lead to overly conservative
design recommendations unless the contract provides a fair risk allocation.
Some clients seek to commit consultants contractually to perform to “the highest standard of the profession” or
the equivalent. This can present substantial problems for the engineer or
consultant in the event of claim. First, while there is a general understanding
of the concept of a reasonable standard of care and the kind of expert testimony
required to prove a breach of the standard of care and thus negligence, there
is no such body of case law or general understanding as to what is necessary
to prove that an engineer or consultant either met or failed to meet “the
highest standard of the profession”. Is that the equivalent of the state
of the art? Does it impose a nationwide standard as opposed to the more
localized focus in a traditional standard of care analysis in most jurisdictions? Has
a plaintiff met its burden if it produces expert testimony that somewhere
in the country another engineering firm drilled more exploratory borings
on a similarly sized site, or conducted additional soil mechanical tests? Is
the highest standard the most conservative design, the most cost effective
design, the most innovative design? All of these are uncertainties facing
the parties contracting under such terms.
Of potentially greater significance to both parties is the effect
of such a clause on insurance coverage. One policy covering professional
errors and omissions contains a coverage grant agreeing to pay “…DAMAGES
and EXPENSES caused by YOUR PROFESSIONAL ACTS, ERRORS OR OMISSIONS. It defines
YOUR PROFESSIONAL ACTS, ERRORS OR OMISSIONS as follows:
N. “PROFESSIONAL
ACTS ERRORS OR OMISSIONS” means YOUR negligent acts, errors
or omissions in YOUR performance of YOUR usual and customary professional
services or a series of such related professional services in YOUR professional
capacity, rendered subsequent to the Retroactive Dates(s) as set forth
in the GENERAL DECLARATIONS. Items 8 and/or 9, as applicable, which
result in a CLAIM.
If the engineer or consultant performs their work in a manner
that is non-negligent, i.e. consistent with the common law standard of reasonable
care, but is adjudged to have failed to meet the “highest standard of the
profession”, there is a risk that the policy will be held not to provide
coverage for the claim. This is obviously not in the interest of either
the engineer/consultant or the client.
Pricing and Payment
Geotechnical engineers and environmental consultants generally
provide services under one of two compensation schemes: lump sum, or time
and materials. Where the payment method is lump sum the contractual issues
are generally the same as those found in traditional Owner/Architect agreements
or Owner/Contractor agreements; pay if paid/pay when paid clauses, payment
application processes, retainage, and the right to offset actual or potential
claims against payments owed.
Where the services are to be performed on a time and materials basis, the
contract almost always includes a dollar amount beyond which the engineer
or consultant will not be compensated without further client authorization. The
most common ambiguity in these provisions is a lack of clarity as to the
relationship between the specified dollar amount and the engineer or consultants
obligation to complete the scope of services described in the contract.
For example, contracts frequently contain the following or substantially
similar language:
“Consultant shall perform the services described in the attached proposal
on a time and materials basis, not to exceed $__________ without Clients
express written approval.”
From the viewpoint of the consultant, the “not to exceed” dollar amount
in the above clause is a target budget. The consultant understands that
they will not be paid if they bill in excess of that budget amount without
first obtaining client approval to increase the budget. On the other hand,
the consultant does not feel contractually obligated to complete all services
identified in their proposal for this “guaranteed maximum price”.
In contrast, the client may view the above clause as establishing a guaranteed
maximum price contract. If the cost to complete the identified scope of
services is less than the “not to exceed” dollar amount stated, than the
client gets the benefit of the cost savings. If on the other hand the cost
to complete the contracted for scope of work is greater than the “not to
exceed” amount, the risk of that additional cost is to be borne by the engineer
or consultant.
While either approach may be satisfactory to the parties, what is critical
is that the contract language clearly expresses the intent of the parties. If
the “not to exceed” dollar amount is intended to place the risk of cost overruns
on the engineer or consultant, the payment provision should be clearly labeled
as a “Guaranteed Maximum Price”. Alternatively, if the “not to exceed” number
is a target budget, the contract should use the term budget and should contain
a parenthetical phrase stating that because of potential uncertainties in
the work, the consultant is not guaranteeing that it will complete the scope
of services described within the budget amount but will not invoice in excess
of the budget without the written authorization of the client.
Indemnity/Liability Assumed by Contract
Geotechnical engineers and environmental consultants face the
same issues relating to indemnity as do most design professionals. Indemnity
clauses that seek to hold the engineer or consultant liable for damages beyond
those caused by the engineer or consultant’s negligence are frequently not
insurable. This is different from the typical insurance coverage afforded
under a Comprehensive General Liability policy. This difference is highlighted
by the prevailing practice of professional liability insurers to refuse to
issue additional insured endorsements.
It is beyond the scope of this paper to undertake a coverage
analysis of professional liability policies. However in general terms, professional
E&O policies do not cover liability assumed by contract that is greater
than the liability the insured would have under the law in the absence of
the contractual indemnity provision. These policies do not cover the cost
of defending a client against claims beyond the comparative negligence of
the insured. Thus most carriers refuse to pay for the cost of retaining
separate counsel to defend a client. If there is a judgment against an insured
and its client the clients defense costs may be covered as compensable damages
flowing from the negligent conduct of the insured, but such defense costs
will not be paid by the carrier during the course of the litigation.
Similarly, where a design professional agrees to indemnify a
client under a Type 1 indemnity agreement and thus is responsible contractually
for the clients proportionate fault unless the client is solely negligent,
the E&O policy does not cover the clients proportionate fault.
The result of these limitations on insurance coverage is to
create a significant uninsured potential liability when engineers and consultants
agree contractually to broad indemnification language. Where a claim is
complex and the litigation contentious, this uninsured exposure could exceed
the firms available resources. As the current insurance market has driven
up deductibles, it is conceivable that a modest sized engineering or consulting
firm with a deductible of $100,000-$150,000 might find that the cost of funding
the client’s uninsured contractual defense makes it impossible to pay the
deductible. Under that scenario, the client’s insistence on having its defense
paid for might prevent the design professional’s E&O coverage from being
triggered.
Even where the insurer does provide coverage for the defense obligation
(often under a reservation of rights) such clauses are particularly problematic
for design professionals in a way different from the impact of such clauses
on contractors. That is because most professional liability polices provide
that the policy limits are eroded by defense costs. Without an additional
insured endorsement, the professional liability insurers will almost always
refuse to pay for the defense of the client no matter what claim is asserted.
Waiver of Consequential Damages
A waiver of consequential damages provision is even more important
for geotechnical and environmental consultants than architects or contractors. In
the first instance, like other design professionals, geotechnical and environmental
consultants rarely sustain substantial consequential damages even if a project
is significantly impacted by owner caused delays. The time in the field
necessary to conduct a geotechnical investigation is a few days or weeks
at most. There is little if any equipment that remains on site as the investigation
is customarily conducted with a mobile drilling rig that is not a particularly
expensive piece of equipment that can be easily removed from the site and
returned without substantial mobilization or demobilization costs. Personnel
can be shifted to other projects with relatively little delay or impact.
In contrast, the potential impact to contractors or owners from
project delays resulting from inaccurate subsurface investigations can be
quite substantial and out of all proportion to the consultants fee or even
the costs directly related to account for the unanticipated conditions. One
need only think of the lost revenue or profits from a substantial delay in
the scheduled opening of a casino or “Big Box” retail store to understand
how consequential damages can quickly dwarf the direct project costs of unanticipated
subsurface conditions.
Limitations of Liability
From the perspective of a geotechnical engineer or environmental
consulting firm, Limitation of liability clauses are often one of the most
critical terms of a contract. The reason for this should be readily apparent. The
typical soil investigation and resulting report for a project costs in the
range of $__________. The profit margin for engineering firms ranges typically
from 5% to 10%. Assuming conservatively total billings for a soil investigation
of $100,000 and a profit margin of $10%, that leaves the firm $10,000 in
profits for a project. Phase I Environmental Site Assessments frequently
cost no more than $5000 and have a similar profit margin. There simply is
no way that a firm can survive if it places the company’s entire assets at
risk on each and every project when the rewards of a successful project are
so relatively modest when compared to the other project participants.
For that reason, many engineering and consulting firms require
some limitation of liability provision in their contracts or have in place
stringent internal procedures that must be followed before they will sign
contracts without a limitation of liability provision. Alternatively, such
firms may insist upon significantly greater mark ups or a much more extensive
scope of work for the investigation or a more conservative foundation design
where clients are unwilling to agree to limitation of liability clauses.
A limitation of liability clause is neither exculpatory, nor does it indemnify
the design professional. It merely serves to cap the potential financial
exposure of the design professional in the event that the design professional
is liable for either negligence or breach of contract. Limitation of liability
clauses in engineering contracts have been upheld as enforceable in a number
of jurisdictions including California, New Jersey, Washington, Texas, Pennsylvania,
Florida, Georgia, and New York.
A. California law
Generally, provisions limiting liability in construction contracts
are enforceable under California law so long as the parties negotiated and
expressly agreed to the limitations, and the provision is not against public
policy.8
There is only one published case in California addressing the
issue of limitation of liability clauses in a designer’s contract. That
case is Markborough California, Inc. v. Superior Court.9
In Markborough, a developer brought an action for breach of contract
against an engineering firm arising from the failure of a lake liner designed
by the defendant. The trial court granted defendant’s motion for summary
adjudication, determining that a limitation of liability clause in the contract
between the parties was valid, and that defendant’s liability was limited
to $67,640 as stated in said clause. Plaintiff petitioned for writ relief. In
its petition, plaintiff contended that the limitation of liability clause
was invalid because it had not been negotiated and expressly agreed upon
by the parties, as required by Civil Code § 2782.5.
In denying the petition, the Court of Appeal rejected plaintiff’s “contention
that the phrase ‘negotiating and expressly agreeing’ imposes upon parties
such as [defendant] the affirmative duty to specifically advise the other
party of the inclusion of a liability limitation clause in the contract and
to inform the other party of the risks involved in the project.”10 Rather, the Court held “that ‘negotiating’ as
used in § 2782.5 and applied to a particular contract containing a limitation
of liability clause simply means that the agreement was reached between parties
wherein each party had an opportunity to accept, reject or modify such a
provision. If the parties had such an opportunity with respect to the provision,
the provision is valid even if there is no actual discussion regarding the
provision but rather it is simply proposed and accepted.”11 In conclusion, the Court noted that plaintiff “agreed,
whether knowingly or simply because it failed to read the contract, to assume
the risk of most of the economic loss which might result from [defendant’s]
negligence in exchange for a consulting fee acceptable to it. There is no
justification for allowing [plaintiff] to shift this loss to [defendant]
which neither agreed to assume it nor was compensated for such assumption.”12
Essentially, the court held that two prongs must be met before a limitation
of liability provision in a construction contract will be enforced. The
first is that the contract limiting the liability must have been negotiated. The
court specifically rejected the argument that “negotiation” meant that the
party had to specifically advise the other party of the potential risks involved
by agreeing to the limitation. The court held that had that been a requirement,
the Code would have so stated. The court then defined “negotiate” as meaning
a “fair opportunity for both parties to accept, reject or modify the other’s
offers or demands.”13
In Markborough, the court held that the fact that the
proposed contract was accompanied with a letter that stated “[i]f the contract
documents are acceptable to you, we can begin work as soon as we receive
a copy of the signed contract. We would, of course, have to approve any
requested changes before proceeding,” was sufficient evidence to demonstrate
a negotiation took place.14
Moreover, after examining the legislative history of § 2782.5,
the court affirmed the generally accepted rule that a limitation of liability
provision will be enforced unless the provision is unconscionable or otherwise
against public policy.15 Therefore, the second requirement set forth
in Markborough is that the contract must not be against public policy
or unconscionable. In Markborough, the court stated that one factor
in determining unconscionability is whether the contract was a result of
an arm’s length transaction between the parties. An exculpatory clause can
be deemed to be unconscionable based upon the unequal bargaining power of
the parties. The parties are bound by the terms of the contract even if
they do not read it.16 Where the parties are both sophisticated entities
they presumably negotiated the contract at arm’s length with equal bargaining
power on both sides. The limitation of liability provision is simply one
of the bargained for provisions contract and should be enforceable.
B. Out of State Authority
The U.S. Court of Appeals for the Third Circuit provides a thoughtful analysis
of whether limitation of liability provisions contravene public policy under
the law of Pennsylvania in Valhal Corp. v. Sullivan Associates, Inc. 17Limitation of liability clauses are not disfavored,
especially when contained in contracts between informed business entities
dealing at arm’s length, and there has been no injury to person or property. Limitation
of liability clauses are a way of allocating “unknown or undeterminable risks,” and
are a fact of every-day business and commercial life. So long as the limitation
which is established is reasonable and not so drastic as to remove the incentive
to perform with due care.
Though it is possible that an agreement setting damages at a nominal level
may have the practical effect of avoiding almost all culpability for wrongful
action, the difference between the two concepts is nevertheless a real one. The
distinction becomes more apparent in a situation which the damage level is
substantial rather than minimal.
Any agreement must spell out the intention of the parties with particularity. In Valhal,
Sullivan Associates, Inc. (“Sullivan”) was exposed to liability which was
seven times the amount of the remuneration under its contract with Valhal. Sullivan’s
total fee was $7,000. Sullivan’s limitation of liability was $50,000. Accordingly,
the cap did not immunize Sullivan from the consequences for its own actions. It
was a reasonable allocation of risk between two sophisticated parties and
did not run afoul of the policy disfavoring clauses which effectively immunize
parties from liability.
According to the court in Valhal, the inquiry must be whether the
cap is so minimal compared to the expected compensation as to negate or drastically
minimize concern for the consequences of a breach of its contractual obligations.
Likewise, in Marbro, Inc. v. Borough of Tinton Falls,18 the court decided on summary judgment that a
limitation of liability clause in a contract between a municipality and an
engineer was enforceable. There, the clause limited the engineer’s damages
for “professional negligent acts, errors or omissions” to $32,500. Id. at
418. This figure represented the engineer’s total fee for services rendered
under the contract.
Relying heavily on the Valhal analysis, the New Jersey Court held:
“The limitation of liability clause (paragraph 13) in question does not
shield [the engineer] from all professional liability for professional negligence. If
it is determined that [the engineer] acted in a negligent manner, the firm
may be held liable for up to $32,500. This figure represents [the engineer’s]
total fee for services rendered under the construction contract. As expressed
by the court in Valhal Corp., the appropriate inquiry is whether the
cap is so minimal compared with the expected compensation, that the concern
for the consequences of a breach is drastically minimized. In the instant
matter, [the engineer] stands to lose its total fee for services rendered
if negligence is found. This is not a liability cap so minimal compared
with the expected compensation as to minimize [the engineer’s] concern for
the consequences of a breach of its contractual obligations. The agreed-upon
cap provided adequate incentive to perform.”19
The court further held that the clause was clear and unambiguous
and enforceable as a matter of law. Id. at 164. Summary judgment
was granted in favor of the engineer enforcing the limitation of liability
clause.
One shortcoming of limitation of liability clauses is that they
are generally only enforceable against the party with whom the engineer or
consultant contracted. Thus they provide no protection or limitation on
claims by third parties such as the owners of residential units sold by a
developer or contractors in those states where the economic loss rule does
not bar contractors direct claims against the designer. There is also some
question as to whether limitation of liability clauses provide any protection
against claims for indemnity by other parties sued by the client. Certainly
such third parties have not contracted to limit their right to recover from
the designer. Yet it does not seem equitable for a party to negotiate a
contract with a limitation of liability provision that presumably resulted
in a cost savings to be able to avoid that provision by suing another party
that is jointly and severally liable for the injury.
There is some case law that supports
limiting indemnity claims by third parties where there is a contractual limitation
of liability. The theory is that the party seeking indemnity is in essence
seeking to recover for damages claimed by the Client who contracted for the
limitation. Faced with an indemnity claim, the designer has the right to
raise any substantive defense against the party seeking indemnity as it would
against its client.20.
In the Western Steamship case,
plaintiff sustained injury while on board a ship and her injuries were allegedly
compounded when she was later taken to a hospital on shore. At trial, plaintiff
recovered damages from the ship owner; the ship owner then sought indemnity
from the hospital. The hospital asserted the liability limitation on damages
for emotional distress contained in the California Medical Injury Compensation
Reform Act (“MICRA”)21. The California Supreme Court held that MICRA
limits applied to indemnity, as well as direct claims. In reaching this
holding, the Court first noted that “as against the indemnitee, the indemnitor
can invoke any substantive defense to liability that would be available against
the injured party. Id. at 114. Second, the Court explained that
the right to indemnity is “wholly derivative and subject to whatever immunities
or other limitations on liability would otherwise be available.” Ibid. The
Court also recognized that “whenever one concurrent tortfeasor is insolvent or
immunized, either partially or completely, from liability, the remaining
tortfeasors must pay more than an amount measured by their proportional responsibility
for the injury. Id. at 117. See also, Trammell v. Western Union
Tel. Co. (1976) 57 Cal.App.3d 538 (agreed limitation liability applies
to third party); Colich & Sons v. Pacific Bell (1988) 198 Cal.App.3d
1225 (liability limitation applies to party seeking indemnity).
Third Party Reliance
One of the most common claims against environmental consulting
firms over the past fifteen years are claims for professional negligence
or negligent misrepresentation by third parties who have obtained copies
of Environmental Site Assessments (ESA) from Clients or other sources and
assert that they have purchased property in reliance upon what they contend
are negligent assertions in the ESA concerning the environmental condition
of the property. Similar claims are asserted against geotechnical engineers
by third parties purchasers of development opportunities who argue that a
geotechnical report improperly characterized subsurface conditions resulting
in increased development costs or lost development opportunities.
Other claims may come from lenders who contend that they loaned
money to acquire the property based on representations in the environmental
or geotechnical reports and that as a result of subsurface conditions not
disclosed in the reports the property is not worth the amount loaned.
There is a substantial amount of case law discussing the obligations
of providers of professional information to third parties with whom they
are not in contract22.
In order for the engineer or consultant to properly protect
itself from third party claims it is critical that the contract clearly identify
for whom the report is being prepared, those entities who are entitled to
rely upon the report, and protections for the engineer or consultant in the
event the report is provided to third parties without the written consent
of the engineer or consultant. Requiring written consent of the engineer
or consultant is critical because it allows the engineer or consultant to
take steps to educate the client and third parties of any limitations on
the report as drafted due to the passage of time, cost or scope limitations
on the original report, or the inapplicability of the report for the project
or use intended for the property by the third party.
Certifications, Guarantees, Warranties and Representations
It is not unusual on projects where the geotechnical engineer
is providing construction phase observation services for the owner to present
the engineer with a proposed certification form drafted by a lender or requested
by the local building department. Execution of the form is often couched
as a condition to receipt of final payment for the engineer’s services. Frequently
the proposed form contains representations or certifications by the engineer
that the project has been built in strict conformance with the plans and
specifications or other language that can be construed as a guarantee or
statement of fact as opposed to professional opinion. In the environmental
context, the proposed form may contain representations or warranties that
the property is free of environmental contamination.
Certifications, representations warranties or guarantees of this kind may
be quite problematic for the engineer or consultant. In the first place,
they may be much more definitive statements than the engineer or consultant
can reasonably make based on their actual knowledge of site conditions. A
geotechnical engineer who has observed the compaction of building pads or
the placement of drainage lines on an “on-call” or periodic basis is not
in a position to state as a fact that the work was performed in strict accordance
with the plans and specifications. Thus the engineer may find themselves
liable either under a theory of express warranty or negligent misrepresentation. Where
the theory is express warranty there may be no insurance coverage as the
engineer may have performed their services in a manner consistent with the
standard of care but then made a positive statement of fact giving rise
to liability if it turns out not to be accurate.
The drafting solution to this problem is for the engineer or
consultant to first avoid any express representations or warranties in the
contract. Indeed, the engineer or consultant should disclaim all warranties
express or implied. Most courts have held that implied warranties of merchantability
or fitness for a particular purpose do not apply to design services including
engineering and environmental consulting. Secondly , the contract should
specify that the form of any certification or warranty must be provided to
the consultant in advance of contracting, thus giving the consultant a chance
to review and propose modifications to the proposed form of certification
or alternatively adjust their scope of work so that they are on site a sufficient
amount of the time during construction to permit broad statements about compliance
with the contract documents. Finally, all certification statements must
clearly state that the certification is a statement of professional opinion
and should set forth the bases for the opinion such as the frequency of site
visits, etc.
Dispute Resolution
The value of Alternate Dispute Resolution(ADR) is well known
to the members of the Forum. The pros and cons of the various forms of ADR
are beyond the scope of this paper and presentation. We recommend that all
contracts contain a provision specifying some form of ADR, with the precise
form dependant in part upon the particular client’s preferences and the nature
of the project involved. However in all contracts we provide that before
either party can initiate either arbitration proceedings or litigation the
parties must participate in a mediation. We further typically provide some
time limit on the mediation process to prevent one party from dragging out
the mediation process to avoid litigation or arbitration.
While “forcing” parties to mediate a dispute before filing suit
or an arbitration demand will not resolve a case where one party is not ready
to do so, such a provision does slow down the rush to the courthouse or AAA
office
A variation that has recently been getting a lot of attention
in California is the use of a procedure for the appointment of a judicial
referee under the code of civil procedure.23 Under this statute, the parties by written agreement,
either the project contract or a separate stipulation can agree to the appointment
by the court of a referee who will hear the dispute. The referee can be
a single individual or a panel of three. The referee or referee must be
agreed to by the parties and in practice this is typically a retired judge
or experienced private arbitrator. The individual may be named in the contract
or a process for their selection set forth.
Once appointed the referee is empowered to hold hearings and
make determinations of all issues of fact or law unless the parties have
specified differently in their agreement. The proceeding is conducted pursuant
to the California Code of Civil Procedure and Evidence Code which means the
same pretrial discovery rules and motion practice apply. Parties must comply
with the rules of evidence at the hearing. Once the referee has completed
the hearing he is required by statute to provide a written decision which “In
the case of a consensual general reference pursuant to Section 638, the decision
of the referee… upon the whole issue must stand as the decision of the court… judgment
may be entered thereon in the same manner as if the action had been tried
by the court.”24
Like binding arbitration a judicial reference provides for a
hearing by a mutually agreeable individual or panel that can be conducted
in a time frame unaffected by the congestion and constraints of the court
calendar and of course without a jury trial. A perceived advantage over
binding arbitration is that the decision is appealable and reviewable by
appellate courts for error and thus avoids the concern over a runaway award
or decision totally contrary to law. For those parties and practitioners
that are more comfortable with full discovery and the rules of evidence,
the referee is required to abide by those requirements.
One obvious disadvantage of the system is that unlike an arbitrator,
the referee is not empowered to closely regulate the proceeding by limiting
discovery. Absent stipulation, the parties are free to engage in all of
the discovery authorized by the applicable rules of civil procedure including
depositions, interrogatories, etc. Another possible disadvantage depending
upon your viewpoint is that since the referee’s decision is appealable once
final, the process does not provide finality as quickly as does binding arbitration. There
may be some difficulty in finding the appropriate referee with both the expertise
in construction desired by the parties and the legal background to make decisions
and write an opinion that will withstand legal scrutiny before the Court
of Appeals.
With those concerns noted, the referee process provides a third avenue for
those who want the advantage of selecting the trier of fact while preserving
their rights to conduct discovery, operate under the rules of evidence and
retain the right to appeal a decision they believe is wrong on the law.
Conclusion
Geotechnical and environmental consultants are required to provide professional
opinions about subsurface conditions based on a limited number of borings,
probes, wells or trenches. The variability of the subsurface is such that
encountering differing conditions during construction is not uncommon often
with significant cost ramifications. In today’s litigious climate, it is
easy to second guess the judgment of the engineer or consultant.
To protect themselves against claims, engineers and consultants should propose
overly conservative designs and recommendations unless adequately protected
against unfounded lawsuits or arbitration demands. Society is not served
by owners incurring the cost of over-designed foundations or costly soil
removal cleanups when less costly designs will work in the vast majority
of circumstances. It makes sense therefore for owners and their consultants
to agree on a risk allocation in their contracts that protects the owner
against professional negligence but does not require the consultant to “bet
their company” on every project or assume more risk than they can insure. Such
a fair allocation, when properly communicated to the client is ultimately
in the best interest of all the project participants.
(1991) 227 Cal.App.3d 705.
20Western Steamship
Lines, Inc. v. San Pedro Peninsula Hospital (1984) 8 Cal.4th 100
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