Schinnerer's RM Blog - professional liability tag

The Dangers of Proceeding Without a Signed Contract

Thu, 26 May 2011 13:19:00 GMT

A recently reviewed agreement between an architect and a subconsultant illustrates the importance of having a signed agreement in place prior to performing services for a client or receiving services from a subconsultant. The architect’s subconsultant agreement had been revised by the subconsultant to include the following language:

Subconsultant’s maximum aggregate liability under this Agreement shall not exceed $250,000.

Having been warned of the dangers of limiting the liability of a subconsultant without having a corresponding limitation in the prime agreement, the architect attempted to further negotiate with the subconsultant. The subconsultant agreed to increase their liability to $500,000 but said “I am told by our legal council that based on the work we are doing and the amount of our fee, $500,000 is our limit.” The architect asked for our further advice because, as he stated: “Work on the project had begun prior to the contracts being completed. Now the subconsultant is withholding their design documents until they receive a contract on the project. What can we do?”

The subconsultant is withholding the documents because they are still negotiating a contract. If the architect had a signed agreement prior to the start of services, they would not be in such a precarious position. At this point the architect’s options are severely limited. The options include:

Continue to negotiate with the subconsultant.
Attempt to negotiate a corresponding limitation of liability in the prime agreement (noting that it’s probably too late to do so).
Conduct a risk management analysis based on the project type, location, client, and extent of the subconsultant’s services to evaluate the probability and cost of a potential claim to determine whether or not the architect is willing to assume the risk of a claim that exceeds $500,000.
Discuss with local legal counsel the legal status of limitation of liability provisions in the local jurisdiction.
Analyze, with advice from legal counsel, the risks of walking away from the agreement with the subconsultant and starting over with another firm. Might this action result in delay claims from the owner? Could this result in a fee claim by the subconsultant?
Consider, with input from local legal counsel, the option of not signing the agreement but continuing to pay the subconsultant. This might force the subconsultant to turn over its deliverables without the protection of a contractual limitation of liability.

It is important to have a signed agreement prior to the start of services, even when the agreement is with subconsultants.

The Difference Between Design Professionals and Contractors

Wed, 16 Feb 2011 13:56:00 GMT

Many clients of design professionals do not understand the difference between design professionals and contractors. This is particularly true when a design professional is being retained as a subconsultant to a design-builder, but it can occur with all types of clients on a myriad of projects.

When I review a contract in which a design professional is referred to as “Contractor” or “Subcontractor,” a red flag goes up. While there is nothing inherently wrong with a design professional being referred to as a "Contractor” or “Subcontractor,” the use of these terms may be an indication that the contract being offered is one that is more appropriate for hiring someone to build a portion of the project, rather than for retaining a design professional.

Contractors have very different duties and responsibilities from design professionals. A design professional’s duty is to "exercise the degree of learning and skill ordinarily possessed by a reputable design professional in the same or similar locality and under similar circumstances." The legal system recognizes that a design professional cannot guarantee a perfect result, and professional liability insurance only provides coverage for damage caused by the design professional’s breach of a standard of reasonable care. Professional liability insurance policies exclude coverage for claims arising out of express warranties or guarantees. Coverage is for professional services provided, and not for assumed contractual obligations. Coverage does not "stretch" to cover a warranty of services or a contractual promise beyond meeting the standard of care.

Contracts that are traditionally used when hiring a contractor contain many terms that are inappropriate when securing services from a design professional. Examples include such words as work, warrant, guarantee, and supervise. Such contracts may include the phrase “responsibility for construction means and methods and job site safety,” or “requirements regarding liquidated damages and bonding.” Indemnity provisions in these types of contracts are typically not limited to negligence.

Here are some examples of problems found in a recently reviewed “contractor agreement” offered to a civil engineer to update a Master Utilities Record Plan:

The engineer was asked to secure a performance bond.
The Agreement contained a “time is of the essence” provision as well as a “liquidated damages” provision.
The indemnification was not limited to the extent damages were caused by the “Contractor’s” negligent acts, errors and omissions, and it contained an uninsurable duty to defend the client.
The engineer was required to provide an uninsurable one-year warranty that the “workmanship and materials be proper and sufficient for the purpose contemplated,” “be free from defects,” and that the “work shall conform to, perform as set forth in, and meet all requirements of this Agreement.”
No professional standard of care language was included and there was no requirement to carry professional liability insurance.

If you are presented with a similar type of contract you should try to persuade your client that it is the best interest of both you and the client to use a professional services agreement that is better suited to procuring design services.

Be Wary of Client-Created Solutions for "Errors or Omissions"

Thu, 10 Feb 2011 19:01:00 GMT

A professional service firm, like any business, is responsible for harm to its client caused by the firm’s breach of its contract. But breach of contract is not what professional liability insurance covers. All professionals must meet an applicable standard of care for the services provided, and must rectify any harm caused if they are negligent in their performance. It is this professional obligation that is within the scope of professional liability insurance coverage.

Many clients, however, want to conflate the two responsibilities. At times this is accomplished through a liquidated damages provision—a stated amount due from a party based on a specific contractual occurrence or nonoccurrence. Clients may also set up elaborate payment withholding or contractually obligated payment schemes based on their decision that professional services were deficient. Sometimes these are applied beyond a “threshold of harm” amount.

For instance, a recent contract we reviewed stated that the design firm would be responsible for 25% of the cost of items or features omitted from bidding documents, 50% of the cost of errors in the bidding documents discovered “prior to installation,” 100% of the cost of any delay caused, and 100% of the cost of reconstruction, replacement, and delays if there has been “a partial or complete installation” of something because of an error in the bidding documents. It seems like a very clean and quick way to determine a remedy; the client will determine fault and either withhold payment or demand the contractual amount from the design firm.

However, any contractually assumed payment scheme falls outside of the coverage of professional liability insurance. Professional liability coverage only pays for actual damages (losses, costs, expenses) to the extent they are the result of the firm’s failure to meet the standard of care for the services provided. This finding of negligent performance cannot be made unilaterally by a client. And the withholding of a fee is not the same as a demand for money or services based on an allegation of negligent performance, which defines the claim trigger for professional liability insurance coverage.

When a client wants a simple contractual solution to its dissatisfaction with any aspect of professional services, be wary. Unless the contractual remedy tracks with your normal legal liability as a professional, do not expect professional liability insurance to respond. Both your firm and your client should recognize that the risk is uninsured. And that might mean that you should charge significantly more for your services to fund your uninsurable exposure.

Construction Defect Claims Addressed in Recent Court Cases

Wed, 02 Feb 2011 13:33:00 GMT

In construction defect cases it is often difficult to determine what damages were caused by negligent design and what damages were caused by faulty construction. Design professionals have coverage under a professional liability policy for damages caused by their negligent acts, errors, and omissions. Traditionally, damages caused by contractors have been covered by the contractor’s comprehensive general liability (CGL) policy. Although CGL policies excluded damage to the contractor’s “work product,” it covered damages to other property that resulted from the contractor’s faulty work. For example, a poorly constructed roof might result in water damage to the contents of a warehouse. The CGL policy would not pay to repair the roof but would pay for the damage to the contents. Several recent cases, however, may change an insurance company’s obligation to pay for these “other” damages. If the courts hold that these damages are not covered by the contractor’s CGL insurance, contractors may have to pay these claims out of their company’s personal assets. This could result in design professionals becoming bigger targets with “deeper pockets” due to the availability of their professional liability insurance policies.

These cases have caused the courts to address the issue of whether or not construction defect claims constitute an “occurrence” under a CGL policy. In Crossman Communities of North Carolina, Inc. vs. Harleysville Mutual Insurance Co. the Supreme Court of South Carolina found that an “occurrence” is an accident that occurs by chance with unintended and harmful results. The court ruled that there was no “occurrence” when a contractor’s faulty workmanship on a condominium project resulted in water intrusion because the water intrusion and ensuing damage were foreseeable consequences of the faulty workmanship and therefore not covered under the contractor’s CGL policy.

However, a similar case in Colorado was overturned by the state legislature.

A recent case in Hawaii (Group Builders, Inc and Tradewind Insurance Company, LTD vs. Admiral Insurance Company and National Interstate Insurance Company) also held that construction defect claims do not constitute an “occurrence” under a CGL policy. Interestingly, however, the majority of insurance carriers in Hawaii have not been denying coverage to contractors. There is speculation that the carriers are doing this so that the state legislature does not become as involved as it did in Colorado.

More than ever, design professionals should use sound risk management practices when selecting new projects—especially condo projects. Design professionals should insist upon providing full construction phase services and should urge developers to retain contractors using qualifications-based selection procedures.

It will be interesting to see if the courts in other states follow suit.

Contractual Liability Issues in PL policies

Wed, 19 Jan 2011 14:39:17 GMT

Occasionally, clients ask design professionals to have their professional liability policy endorsed to specifically insure contractual liability. This would provide coverage for the risks a design professional assumes in a professional services agreement.

Clients often ask for contractual liability coverage from design professionals because such coverage is found under a contractor’s CGL policy. Such a request is problematic, however, because a contractor’s CGL policy provides broad form coverage for contractual liability, due to the contractor’s broad risk exposure. Conversely, the professional liability policy provides a limited form of contractual liability coverage because a design professional’s risk exposure is limited to professional negligence.

The Schinnerer and CNA professional liability policy automatically includes a limited form contractual liability coverage that provides coverage to the extent that the liability is predicated on the insured’s negligence in providing professional services. If a request for contractual liability coverage is consistent with the coverage already provided by the policy, a special endorsement is unnecessary. On the other hand, if the contractual promises in the professional services agreement extend beyond what the policy already covers, the design firm may be assuming a business risk that is uninsurable. Examples of uninsurable contractual liabilities include express warranties and guarantees, representations that services will be free from fault and defect, and representations that the project, when finished, will be fit for its intended purpose.

Professional liability coverage is designed to pay on behalf of an insured firm that does not meet the standard of care in fulfilling professional obligations; it is not designed to stand behind all contractual obligations. By law, design professionals are liable for their own negligence as well as for the negligence of those for whom they have assumed vicarious liability (generally, professional consultants). If design professionals agree by contract to accept liability for more than this negligence, they are assuming a business risk that is not covered under the Schinnerer and CNA PL policy.