Design services contracts, like all contracts, represent a mutual understanding of the parties respective obligations and duties for the project at issue. Risk allocation understandings do not necessarily relate to the scope or the fee, but they are a catalyst for resolving issues and disputes that arise during or after a project. It is of paramount importance that these understandings weigh in favor of a fire protection engineering firm-at least to the greatest extent practicable.
Every fire protection engineering firm (the firm) should seek to minimize risk in its agreements with prime consultants and owners. (For simplicity these parties are collectively referred to as the owners.) The reasons for minimizing risk are obvious when the firm is the party undertaking the risk.
However, measures to minimize risk are equally as important in circumstances in which a firm is or would be covered by its professional liability policy. First, firms are often required to pay substantial deductibles when defending against an errors and omissions claim, which could adversely affect the profitability of the firm. Second, the absence of, or the minimization of claim payments and attorney fees result in lower annual premiums. Third, minimizing what a firm may perceive as insurance risk will also minimize exposure for claims in excess of the available insurance coverage limits.
This article reviews a number of issues to consider in contract formation and negotiation. It is imperative that a firm draft and use a set of STCs to begin the negotiation of each project. A well-crafted proposal could lead to substantial savings in terms of time and expense.
Favorable Proposal Provisions for a Design Firm
A contract is not always a negotiated, written and signed agreement. In fact, a contract neither has to be signed nor written. Blacks Law Dictionary1 defines contract as an agreement between two or more parties creating obligations that are enforceable or otherwise recognizable at law. A contract can be as simple as a handshake agreement or in certain circumstances a unilateral proposal sent by an engineer to an owner.
Most projects begin with a proposal sent from a firm to an owner. Upon the owners receipt of the proposal, the owner can do one of a number of things. First, the owner could do nothing (or it can expressly accept the proposal) and ask the firm to commence work. Second, the owner could negotiate the terms of the proposal. Third, the owner could send the firm a contract that incorporates the proposal for purposes of scope and fee only. Fourth, the owner could send to the firm its own contract and scope.
The first scenario is the best for a firm if the firm has taken steps to protect itself in its STCs. In this scenario, a proposal is first sent to an owner. Then the firm is directed to commence services. Throughout the project, the owner accepts the services and pays the firm in accordance with the proposal. There is a good chance that, in this situation, the owner has accepted the proposal as a binding agreement and is bound by its terms. (The likelihood of the owner being bound by the proposal and STCs is drastically improved if the proposal is signed.)This is the best opportunity for a firm to minimize its risk by the terms of its proposal and STCs, which should be attached to and incorporated by the proposal. Some ideal clauses for STCs are discussed in the following paragraphs.
Statute of Limitations
A contractual statute of limitations clause prescribes the date by which all disputes must be litigated. Some states, like Virginia, have along limitations period (five years) for a written contract. Others, like Maryland, have what is called the discovery rule, which specifies that the accrual period does not commence until an owner discovers a defect for which a firm may be liable. The limitations period could exceed a decade in states that have adopted the discovery rule. A carefully crafted statute of limitations clause can reduce statutory limitations periods and provide a firm with a defense against an owners claim.
Limitation of Liability
Limitation of liability clauses specify the absolute maximum that an owner could recover from a firm. If the limitation is sufficiently low (or if the claim is sufficiently high), these clauses could be a deterrent to a lawsuit. If they are not a deterrent, they will minimize a firms risk. The firms preference should generally be to limit liability to the fee for the project. If a firm encounters resistance, the fall-back position should be to limit liability to the proceeds of a professional liability policy available at the time of settlement or judgment. It is unlikely that an owner will want to bankrupt a firm but reasonable that an owner should be able to avail itself of the firms professional liability insurance coverage (after all, thats what its for). Limiting liability to available proceeds guards against the rare instance where the firm has two significant claims against it in the same policy period. This clause has saved firms from bankruptcy.
Certificate of Merit
A Certificate of Merit clause requires a claimant, as a condition precedent to litigation, to obtain a signed and sworn statement of a professional specifying that in that professionals opinion, the firm has breached its duty to act in accordance with the applicable standard of care. This clause has the effect of weeding out frivolous lawsuits and preventing potential suits that the owner has not effectively evaluated from the standpoint of the appropriate standard of care.
STCs are an excellent place for a one-way attorney fees provision. Such a provision provides that if the firm is required to institute legal proceedings to collect fees owed, the firm shall be awarded all reasonable attorney fees associated with a collection effort.
Often a firm will rely on information provided to it from a governmental entity, a prime consultant, the owner or others. If a firms reliance is reasonable, it should not be liable to the owner or to other parties for reliance on what may turn out to be inaccurate information. To combat this, a firm can draft a clause that compels an owner to indemnify and defend a firm from any claims or allegations of professional negligence or breach of contract arising out of the firms reliance on third-party information.
Waiver of Consequential Damages
According to Blacks Law Dictionary,1 consequential damages are damages that do not flow directly and immediately from an injurious act, but that result indirectly from the act. Examples of consequential damages include an owners lost profits, lost rental income and additional interest on a construction loan. A waiver of these damages will limit an owners recovery to the direct damages suffered as a result of the firms negligence, which in many circumstances could amount to a substantial reduction in exposure to liability.
A firm should disclaim the existence of third party beneficiaries(where there are none). This clause is relevant when a firm contracts with a prime consultant or prime contractor. In such a scenario, a no-third-party-beneficiary clause will prevent an owner from suing the firm directly, which will significantly minimize the firms risk of liability.
Must-Have Clauses for a Negotiated Contract
Should the owner decide to negotiate the proposal, or counter with its own standard design services contract, a firms ability to minimize risk is not lost. A counter-offer of this sort should be viewed as an owners attempt to get more for less. A firm should not separate design scope and fee from contract terms. That is, as a firm incurs more risk, the design fee should increase. A firms proposal is based on the firms STCs. When the STCs are amended, so should the scope and fee.
For example, a firm proposes a scope and fee for a sprinkler system design and related construction phase services. The firms terms and conditions limit liability to the amount of the fee. The owner then wants to strike the limitation of liability clause in its entirety. At that point, a firm can relay the fact that the fee is based in part on the limitation of liability. Unlimited liability creates greater risk and, as such, a higher fee. At that point, an owner may be likely to soften its stance on the limitation of liability or compromise by offering a policy limits limitation of liability. The importance of linking scope, fee and contract terms in a negotiation should not be underestimated. A number of examples of must have clauses are discussed in the following paragraphs.
Limitation of Liability
A firm should insist on a limitation of liability. In most circumstances, it will be difficult for an owner to articulate a reason that it might want to seek uninsured assets of the firm. If the firm is large enough to handle a judgment or settlement in excess of its professional liability policy, an appropriate limitation of liability clause could state that the limitation of proceeds will be the available proceeds of the firms professional liability policy plus a dollar amount. In any event, a firm should always insist that its officers, directors, shareholders and employees will not have individual liability to the owner.
Indemnification for Negligence
Often an owner will insist on the inclusion of a provision in which the firm shall indemnify and defend the owner for claims and liabilities resulting from the work. A provision such as this may require a firm to pay for defense costs of an owner that may arise out of a third party claim against the owner that does not relate to the engineering services whatsoever. Such clauses are often written in a manner that requires the firm to defend the owner from allegations that result from the work. Such clauses (1) do not require a determination that the third-partys claim has any merit and (2) do not require a determination as to whether or not the firm is at fault.
As a consequence, a firm should never agree to defend an owner. Additionally, a firm should demand that the indemnification clause be triggered only by the firms actual negligence.
Lastly, indemnification clauses may void insurance coverage. When confronted with indemnification clauses, a firm should seek a coverage opinion from its professional liability insurance carrier or broker.
Standard of Care
A firm should always insist on a contract clause establishing a standard of care. The standard of care is the care ordinarily provided by an engineer practicing in the same or similar locality under the same or similar circumstances. Many firms market themselves as (and in fact are) highly qualified. However, there is no reason for a firm to be bound to a standard that exceeds the standard of care. Under the law, firms that represent themselves in contracts as highly qualified will be held to a standard that will be difficult to defend. More importantly, such an agreement could cause the firms professional liability insurance carrier to deny coverage because such a clause sets forth a standard of care that is above and beyond that of professional negligence, which is the standard for which firms are covered.
Firms should pay close attention to their marketing material and websites to ensure that they are not assuming any additional duties or obligations that could adversely affect the firms risk. Perfection is Our Promise is the kind of motto that firms should avoid.
Construction Phase Services
For construction phase services, a firm should specify the number or rate of site visits. Visits as may be required or as the project warrants are subjective, open to interpretation, and have great potential to involve the firm in a dispute over whether they should have seen the contractors defective work. The fee offered is based on a scope that considers a number of site visits. That number of visits should be provided with specificity; additional visits should constitute additional services.
Exclusions should always be part of a proposal. Exclusions demonstrate a clear understanding of what falls outside the scope of the project, but that could be inferred from the scope as the project progresses. A firm should disclaim any obligation to verify the documents presented to the firm by the owner; a firm should not be required to re-engineer such work.
A firm should make it clear that it is not a guarantor of construction means and methods or of the results of construction. The contractor should remain responsible for carrying out the work in accordance with the contract documents. Most importantly, a contract or proposal should contain a general exclusion, which states that all services not specifically described are excluded from the scope of the agreement.
By taking a series of small and inexpensive measures, firms can considerably minimize their exposure to liability. STCs should be reviewed and updated frequently to reflect developments in the law of the jurisdiction(s) in which firms are practicing.
James F. Lee, Jr. and Michael F. Germano are with Lee & McShane.
This article is an overview of contract terms and issues that confront design firms. This article is not and shall not constitute legal advice. For legal advice, please contact an attorney.
- Garner, B. (ed.), Blacks Law Dictionary, West Law School, Eagan, MN: 2009.