This article is not about social media. We are not going to discuss the latest in emojis, posting on Facebook, pictures on Instagram, or the duration of posts on Snapchat. We are also not going to discuss the array of acronyms populating chat rooms, such as ROTFL (rolling on the floor laughing), SMH (shaking my head) or BRB (be right back). While engineers may be a gleeful bunch, we are also not going to talk about the LOL (laugh out loud) that often shows up in text messages. Instead, we are going to discuss the LOL that commonly appears in professional engineering contracts – the “Limitation of Liability” clause.
LOL clauses are designed to shift the risk in a construction project. More specifically, if drafted properly, these clauses shift the risk away from the professional engineer and onto another party. Drafting these clauses properly, however, is where the challenge lies, because interpretation and enforceability of LOL clauses vary from jurisdiction to jurisdiction. Courts and statutes differ widely on their treatment of LOL clauses. One should never assume that just because an LOL clause appears in a particular contract it is enforceable as written. A number of factors need to be considered – factors with which a construction attorney admitted in the local jurisdiction should be familiar. Thus, the oft-repeated admonition of this column rears its ugly head once again: Have your contracts reviewed by a construction attorney familiar with the laws and requirements of the specific jurisdiction. To assist the engineer with their conversation with counsel, this article covers some key concepts regarding the enforceability of LOL clauses. We take a closer look at how two jurisdictions, Pennsylvania and New Jersey, treat LOL clauses.
We begin our foray into the LOL clause landscape with a seminal case from the United States Court of Appeals for the Third Circuit: Valhal Corp. v. Sullivan Assocs., Inc., 44 F.3d 195 (3d Cir. 1995). In Valhal, a developer (Valhal) sued an architectural firm (Sullivan) for breach of contract and professional malpractice, arguing that the architect failed to inform the developer of a height restriction on a Philadelphia property in a pre-purchase, feasibility study. Valhal wished to build a high-rise residential tower on a portion of the property. Relying on Sullivan’s report, Valhal entered into a contract of sale for the purchase of the property. After the sale contingencies expired, Valhal learned that the property was subject to a height restriction that would be violated by its prospective building. Valhal nevertheless closed on the sale and bought the property for $10.1 million. It subsequently sued Sullivan in federal court, seeking damages in excess of $2 million.
Valhal and Sullivan cross-moved for summary judgment. Valhal sought to strike the LOL clause in the parties’ contract and argued that it was unenforceable. This clause provided as follows:
The OWNER agrees to limit the Design Professional’s liability to the OWNER and to all construction Contractors and Subcontractors on the project, due to the Design Professional’s professional negligent acts, errors or omissions, such that the total aggregate liability of each Design Professional shall not exceed $50,000 or the Design Professional’s total fee for services rendered on this project.
The district court granted Valhal’s motion, finding that while the LOL clause was part of the parties’ contract, it was void as against public policy pursuant to Pennsylvania’s anti-indemnity statute, Pa. Stat. Ann., tit. 68, § 491 (1994). The case subsequently went to a jury, which returned a $1 million verdict in favor of Valhal. Both parties appealed to the Third Circuit.
First, the Third Circuit pointed out that the LOL clause was not barred by Pennsylvania’s anti-indemnity statute, noting the key difference between an LOL clause and an indemnity clause. An indemnity clause “holds the indemnitee harmless from liability by requiring the indemnitor to bear the cost of any damages for which the indemnitee is held liable. The [LOL clause here] has no such consequence. [It] does not bar any cause of action, nor does it require someone other than Sullivan to ultimately pay for any loss causes by Sullivan’s negligence. Sullivan remains liable for its own negligence and continues to be exposes to liability up to a $50,000 ceiling. Thus, the amount of liability is capped, but Sullivan still bears substantial responsibility for its actions.” Valhal, 44 F.3d at 202 (citations omitted).
The Third Circuit rejected that LOL clauses violate public policy and found that they are “are not disfavored under Pennsylvania law; especially when contained in contracts between informed business entities dealing at arm’s length, and there has been no injury to person or property. Furthermore, such clauses are not subjected to the same stringent standards applied to exculpatory and indemnity clauses . . . . So long as the limitation which is established is reasonable and not so drastic as to remove the incentive to perform with due care, Pennsylvania courts uphold the limitation.” Valhal, 44 F.3d at 203-04 (citations omitted). In this case, the LOL clause in the parties’ agreement was upheld and Sullivan’s exposure was limited to $50,000.
To summarize, when evaluating the enforceability of an LOL clause in Pennsylvania, one needs to look at:
New Jersey courts “have traditionally upheld contractual limitations of liability.” Marbro, Inc. v. Borough of Tinton Falls, 297 N.J. Super. 411, 417 (Law Div. 1996). Yet, they “have not hesitated to strike limited liability clauses that are unconscionable or in violation of public policy.” Lucier v. Williams, 366 N.J. Super. 485, 491 (App. Div. 2004) (emphasis added). Courts determine unconscionability based on (1) relative bargaining power; and (2) the cap on party liability as compared to expected compensation. See Lucier, 366 N.J. Super. at 492-93; see also Marbro, 297 N.J. Super. at 418-19.
In Lucier, the court found a limitation of liability clause in a home inspection contract between a homeowner and a licensed engineer unconscionable because (1) it was between a consumer and a professional, the latter of which possessed far greater bargaining power, and (2) its liability cap was 50 percent of the compensation amount. 366 N.J. Super. at 492-93.
Conversely, in Marbro, the court found a limitation of liability clause in an engineering consulting contract between a borough and an engineering firm enforceable because (1) the borough and the firm bargained at arms-length; and (2) the liability cap equaled the compensation amount. 297 N.J. Super. at 418-19.
Furthermore, exculpatory clauses (those that limit all liability) in professional contracts violate public policy. See Lucier, 366 N.J. Super. at 496. To this end, if a limitation of liability clause has a cap that is nominal as compared to the expected compensation, courts will treat it as an exculpatory clause, subject to this public policy scrutiny. Id.; see also 66 VMD Assocs., LLC v. Melick-Tully & Assocs., No. A-4008-09T3, 2011 WL 3503160, at *5 (App. Div. Aug. 11, 2011) (Engineering contract with $25,000 cap and $19,826 compensation did not violate public policy).
Thus, New Jersey courts, in practice, enforce limitation of liability clauses in professional service contracts when they are (1) between a professional and a non-consumer; and (2) cap liability at an amount at least equal to the professional’s expected compensation.
As the Third Circuit commented in Valhal, “Limitation of liability clauses are a way of allocating ‘unknown or undeterminable’ risks and are a fact of everyday business and commercial life.” Valhal, 44 F.3d at 204 (citation omitted). The majority of states enforce LOL clauses to some extent. Some states prohibit them on public policy grounds. Others apply anti-indemnity statutes to bar LOL clauses as well. Some states limit claims that are subject to LOL clauses (e.g., contract claims), while others require clear, unequivocal language in bold, visible type. These “factors” – only a few of which are illustrated in the Pennsylvania and New Jersey cases described above – vary greatly and could be a veritable minefield for the uninitiated engineer. As a result, engineers should not draft LOL provisions (among other contractual clauses) – attorneys should. Engineers do, however, need to be cognizant of the importance of LOL clauses as a contractual risk-shifting mechanism so that they may work with their counsel to develop an appropriate clause for the circumstances of a particular project.