Are limitation of liability provisions a reasonable part of an overall risk management strategy?

The concept of limitation of liability is nothing new. It has been used for centuries in recognition of the fact that providers of a service obtain a small benefit (their profit) in the process of helping their clients receive a much greater benefit. The risk-reward relationship between the two parties needs to be balanced. One of the earliest examples of this dates from Babylon where merchants (clients) limited the risk/liability of their service providers (shippers) to obtain a more reasonable service fee (shipping). Cognizant of their taking on this additional risk, merchants limited their risk by selecting service providers with care and being certain that the service providers employed appropriate risk reduction measures. One can see numerous examples of limitations of liability in everyday life: Check the back of a parking garage time ticket or read the notice on an airline ticket or hotel room door. Think these are unfair? How much would it cost to own/operate a parking garage if the owner was fully liable for the actions of every person traveling through their garage? I would bet that your overnight delivery service limits their liability to their delivery fee if the package arrives late. The limitation of liability provision was first applied to design professionals in the early 1970s. ASFE, an international association of practicing geo-professionals that focuses on issues of professionalism, developed contractual provisions limiting the geotechnical engineer's liability on a given project to $50,000 or some other fixed amount. This was a reaction to the marketplace at a time when geotechnical engineers were seriously threatened because of an extraordinary number of claims filed against them. Liability insurance for geotechnical engineers was becoming basically unavailable. Think about the implications in 1970…then fast forward to the litigious nature of our society in 2007. Design professionals recognize the value of a good client and client-consultant relationship. The profit for any one project is inconsequential compared to the potential lifetime relationship that good quality professional service can engender. On the downside, we also know that the ill-will generated by one claim can spoil that client-consultant relationship as well as a community reputation built up over decades. An appropriate Limitation of Liability will still provide fiduciary motivation to the design professional. Interms of dollars, recognize that the profit from a design commission is on the order of 10% of the service fee: a $50,000 liability limit represents net profit to a firm from $500,000 worth of design fee. If the $50,000 value is still too low negotiate with your professional for a higher value. Most professionals would welcome such frank, open discussions concerning risks and risk management. For the professional to take on this higher risk some additional scope of work (more detailed design analysis, including additional construction phase oversight/inspection, etc.) and overhead fee to allow the professional to put together additional reserves against their higher risks should be expected (much like an insurance company). Before you bemoan these additional soft costs consider the benefit to your project of having such higher quality of professional services. Given that design costs are on the order of 10% of construction costs, a 10% increase in design fee is only a 1% increase in total costs. Optimizing one engineering system or preventing one construction phase headache through additional design effort can easily pay for itself. Any discussion of liability also needs to be cognizant of the fact that professional liability is different than general or product liability. The professional liability extends beyond the term of the professional-client contract and is a personal liability of the professional. Their personal assets are the ultimate back-up for a professional negligence claim. Most developers take advantage of Limited Liability Corporations (LLCs) to separate their individual projects from each other, let alone their personal assets. Consider how conservative a professional will be in their design if not only their job or career is on the line but also their house. While you would be hard pressed to find a case where a negligence lawsuit actually forced the design professional to liquidate all their personal assets this is what "Liability without Limitation" means to a design professional. The contract terms should reflect this fact. Given the ratio of design fee to construction fee there is virtually no way that the design professional can insure the developer against the potential of "total loss." While this may seem unfair recognize that the developer has so much more to gain than the design professional. What will be the profit over the 20 or more year life of a structure? Given this imbalance in "reward potential" it also makes sense to have a limitation on potential risk to one party. Trying to pit one side against the other on this issue does not serve the needs of either. We use a Limitation of Remedies clause in our contracts. It is written in straightforward language so our clients can understand what they are agreeing to. We are willing to negotiate the dollar amount of this limitation. In so doing we review risk factors such as level of detail to the scope of work, type of project, and the client. This concept…good communication and mutual respect...is the basis for our client-consultant relationship and has served our firm over its almost 30-year history. Credits: Practice Management for Design Professionals, by John Philip Bachner, 1991. James Baker, P.E., is president of Foundation Design, P.C., Rochester, N.Y.