We have identified five commonly seen terms in contracts that might have unexpected impacts on the cost of a project and who is qualified to perform the needed services. Let’s talk about what can be done to align the intent of contracts with the work being contracted, and dig in on some of the pitfalls those terms can create.
We have identified five commonly seen terms in contracts that might have unexpected impacts on the cost of a project and who is qualified to perform the needed services. Let’s talk about what can be done to align the intent of contracts with the work being contracted, and dig in on some of the pitfalls those terms can create.
Establishing an appropriate standard of care is a cornerstone of a good contract, because negligent conduct is defined as any performance below the identified standard. When contract language says that consultants are expected to perform at the highest standard of the profession, this creates unrealistic expectations of perfection. If every NBA contract used the word “best,” then every NBA player that wasn’t Michael Jordan would be in breach of contract. There can only be one best. Words like highest, best, guarantee, assure and certify, to name just a few, significantly elevate the standard of care. This creates what is called an “express warranty,” which the majority of professional liability insurance policies exclude.
While it is understandable that clients expect top-notch performance, promises in a contract to be “the best” or to perform at “the highest” level invite the insurance carrier to deny coverage. Such promises don’t actually improve performance; instead they undermine the security the client is seeking from the professional insurance policy.
Every contract has a limitation of liability; some are expressed and some are inherent in the contracting parties. An expressed limit is written into the contract and allows the parties to properly assign risk and reward. Inherent limits are a function of the ability of a service provider to pay for any liabilities it may cause and are generally limited to available assets and insurance proceeds. In other words, the value of the company.
Sophisticated companies are not willing to take risks in a contract that outweigh the associated rewards. Consequently, clients may be limiting their access to important service providers, who are unwilling to take such risks. By contrast, firms that are willing to take such risks may be telegraphing they have little to lose because they don’t have enough assets or insurance to pay for liabilities. Expressed limits from financially sound, sophisticated companies provide confidence that appropriate resources will be available if liabilities arise.
Operators understandably want contractors to indemnify them, picking up the cost of defending their work against claims. But when contracts seek broadly to indemnify “against all claims” or “alleged damages,” the contractor can be left on the hook for frivolous claims or issues outside of its control.
Overbroad indemnity clauses in professional service contracts create risks that increase service provider costs and can discourage them from providing the work. For example, professional liability insurance does not pay for the defense cost prior to a determination of fault and associated liability, but it will reimburse for such cost after liability is determined. Requiring the service provider to pay for defense costs when they haven’t been found at fault creates unrecoverable costs for the design professional.
Consequential damages, like direct damages, result from mistakes and accidents. Unlike direct damages, they aren’t the type of damages parties normally anticipate when contracting for design and construction services. Damages that come from lost sales, business interruption, additional financing costs or lost profits are generally considered consequential damages. Since these damages arise from matters in the control of others, they are impractical for design professionals and contractors to account for when pricing their services.
Furthermore, such damages are often large relative to the value of the work being performed. A mistake that specifies or orders an incorrect part or material could cause a few days of delay in getting the use of a passenger holding area, resulting in loss of use. The loss of use would cost many times the value of the part or material. Asking companies to assume such an indeterminate risk transfers a disproportionate amount of exposure to professional who generally are not willingly to take on such risk; consequently limiting the owner’s access to sophisticated professionals, who are unwilling to accept such risks.
Subrogation allows a third party like an insurance carrier to stand in the shoes of others to recoup costs. Assuming both parties have insurance, if an incident or damage occurs, the insurance company will settle and pay out. Without a waiver of subrogation, the insurance carrier could turn around and file a claim to recoup its costs, even though premiums already have been paid for that insurance. A mutual or reciprocal waiver for the client and the contractor prevents potential disruptions to a project and the expense of unnecessary litigation.
None of this is intended as legal advice, but the reality is that contract language has the potential to control the vast majority of claims. It is the highest evidence of a mutual understanding between the contracting parties. Courts will not care what’s fair to any given party; their concern is what the contract actually says. Attempting to remove contradictions and ambiguities — and recognizing the potential cost impacts due to unbalanced expectations — offers a sensible path to clarity and confidence.
