A. Is a Contract Important?

The author has defended enough architects, engineers, and land surveyors to know that many of you do not understand the importance of memorializing your agreements in a contract signed by your client. If you believe a carefully drafted contract is merely a nicety, now is the time to change your thinking.

Contracts are important. Good ones clearly identify your scope of services, define the terms and mechanisms for payment, and carefully assign risks to each party. In 2004, the Colorado Supreme Court reinforced the importance of contracts between design professionals and their clients. In BRW, Inc. v. Dufficy & Sons, Inc., 99 P.3d 66 (Colo. 2004), the Court applied the economic loss rule to prohibit common law tort (negligence) claims against an engineer because the engineering firm had entered into a detailed contract for its services at the beginning of the project. As a consequence, the Court ruled that the remedies available against the engineer would be limited to those outlined in the contract, and that only the party with whom the engineer had contracted could pursue those remedies.

The economic loss rule, in essence, is a rule fashioned by the courts to prohibit a party who suffers purely economic loss (money) from suing a potentially responsible party on a negligence theory. An engineer’s successful invocation of this rule depends greatly upon the terms of its contract. The Dufficy Court explained that the economic loss rule is founded on sound principles:

(1) to maintain a distinction between contract and tort law; (2) to enforce expectancy interests of the parties so that they can reliably allocate risks and costs during their bargaining; and (3) to encourage the parties to build the cost considerations into the contract because they will not be able to recover economic damages in tort.

Generally speaking, if a design professional has a contract with a client, (1) the client’s recovery will be limited to the remedies that are outlined in the contract; and (2) in some cases, other parties (those with whom the design professional did not contract) will be barred from asserting negligence claims against the design professional.

There are important exceptions to the economic loss rule. The largest exception concerns claims by homeowners. The Colorado Supreme Court has consistently given homeowners more rights than the owners of other types of construction projects. The courts have declared that public policy mandates protecting homeowners to the maximum extent possible. Because homeowners are treated as a special class of claimants, the courts have held that all participants in a residential construction project owe an independent duty of care to the homeowners (separate and apart from any contract that may exist) to design and construct the home in a non-negligent manner. Because of this independent duty, a homeowner (or even an HOA or subsequent purchaser) can sue a design professional for negligence, even if the design professional had a carefully crafted contract.

Another important exception focuses on the type of loss being claimed. If someone is physically injured, or property is damaged as a result of your design services, the aggrieved party can sue you in negligence, even if that party has no contract with you. This is because the courts have stated that all design professionals owe an independent duty to the general public to protect against harm.

The remainder of this basic overview is intended to provide information on some of the more important clauses of a construction contract.

B. Parties to the Contract

i) Identify the Contracting Parties

 It should be self-evident that the parties to a contract must be plainly identified in the contract itself, and that all of the parties identified must sign the contract. Most of your clients are corporate entities for which an authorized representative will sign. Be sure to print the name of the individual who is signing the contract beneath the signature line and indicate that the individual is signing on behalf of the corporate entity, ensuring that the complete, correct name of the corporate entity is included on the signature block. You must do the same for your own company.

ii)  Get Your Contract Signed

 Design professionals often have difficulty obtaining signatures from their clients, but a signature should not be considered a mere formality. Whether a valid contract has been formed and can be enforced without the signature of all parties is typically a question of fact to be determined by a jury after a trial. Avoid the tremendous cost and inconvenience of litigating for several years only to have a jury decide that your contract is not enforceable because your client did not sign it. Without fail, every agreement you send to your client should be signed by you and your client before you provide services for the project.

iii)  Eliminate Potential Third-Party Beneficiaries

Whether a person who is not a party to the contract can sue to enforce the terms of the contract depends on whether the contracting parties intended to confer a benefit on that person. Under Colorado law, when the parties to a contract intend to confer a direct benefit upon some third party at the time of forming the contract, the third party can sue you pursuant to the agreement. The intent of the parties to confer such a benefit can be determined from the language of the contract itself, the surrounding circumstances, or both. Unless the parties clearly write down their intent, it will be left for a jury to determine. To eliminate this uncertainty, be sure your contract clarifies that nothing contained in the contract shall be deemed to create a contractual relationship with or a cause of action in favor of any third party. The contract should also state that the obligations created by the contract are solely for the benefit of the parties, and are not intended by either party to benefit any other person or entity. Obviously, this is not of universal application, even if the contract suggests as much. For example, a contract between an architect and engineer almost always will be for the benefit of the owner of the project, even though the owner is not a party to the contract.

C. Clearly Identify the Scope of Services You Will Provide

You must carefully delineate what services will be included as part of the fee you are charging your client, what services are available for an additional fee, and what services you will not agree to provide. Admittedly, this can be a time-consuming task. Take the time on the front end of the project to discuss your client’s needs and expectations and then prepare a proposal that reflects them. By doing so, you will more accurately (and favorably) arrive at a reasonable fee, and can then better defend yourself against scope creep.

Agreeing to “design a 50-story office building for $50,000” is nothing more than an invitation to unlimited liability. Very frequently, litigation claiming design errors focuses on what the design professional “should have done, but failed to do.” If you are careful to identify and fully describe those tasks you will perform, and equally careful to identify those tasks you will not perform, it will be much easier to defend you when your client complains that you did not perform a service that wasn’t included in your contract.

Defining what you won’t do is difficult, as each client has different preconceptions about your role in the project. Your experience with clients of different levels of sophistication will serve you well in this regard. It may be helpful to keep a running list of the types of services that you do not typically provide but that certain clients have expected from you as part of the basic fee. You should then incorporate these items into a list of excluded services.

In addition, consider these guidelines:

• Be clear that construction administration services are not intended to constitute a thorough “inspection” of every aspect of the work;
• Specifically state that you are not responsible for supervising, overseeing or inspecting contractor means and methods or for ensuring the accuracy/quality of the contractor’s work, or for job site safety;
• Specifically identify the disciplines of those subconsultants you will utilize for the project and those excluded from the scope of your services;
• Do not voluntarily assume additional responsibilities or duties that are not contained in your contract, unless both parties agree to modify the contract in writing, and you are paid for the additional services; and
• Include a provision that entitles you to rely upon the accuracy and completeness of the plans, specifications, recommendations and reports prepared by other consultants retained by the client and that you will have no liability for damages resulting from errors and omissions resulting from such reliance.

D. Incorporate the Standard of Care

The key to the Court’s decision in BRW v. Dufficy was the existence of a clause in the design professional’s contract which outlined the standard of care to which the design professional agreed to adhere. Every contract you sign should contain a clause indicating that the services you provide will be performed utilizing the same knowledge, skill and care that other reasonably careful design professionals who provide similar services in your locale would exercise. Your failure to include this simple statement makes you much more susceptible to negligence claims.

However, do not take this clause too far. Never agree to perform to a “heightened” standard of care, or to abide by the “highest professional standards.” This is because agreeing to a heightened standard of care constitutes “liability assumed by contract” that the law does not otherwise impose upon you. By doing so, you are jeopardizing your insurance coverage. Equally important, you are making it easier for your client to prove that your services fall below the contractual standard.

E. Refuse to Agree to Unreasonable Indemnity Clauses

Very frequently, clients will ask you to sign contracts which contain very onerous and one-sided indemnity provisions. An indemnity agreement obligates you to pay the client for a loss incurred by some third party who then claims against the client. Legislation in Colorado has made most broad forms of indemnity in construction contracts unenforceable as violating public policy.

Colorado Revised Statute § 13-21-111.5(6) renders void any indemnity clause which requires you to indemnify your client for anything other than your own negligence (or that of your consultants). In doing so, the Colorado legislature has signaled its clear intent that each party to a construction project should now be responsible for its own negligence, and that responsibility cannot be passed off to another party in a contract (rather, it is non-delegable). The statute applies to all contracts formed on or after July 1, 2007.

The legislation has not yet been interpreted by the courts, but it may have far-reaching consequences for your contracts. In general, the statute gives design professionals much more leverage to fight off harsh indemnity clauses, because they are only limitedly enforceable. In many ways, this is a positive development for design professionals. However, as outlined in the section on limitations of liability below, the statute may void other provisions in your contract that have traditionally favored design professionals.

In negotiating indemnity clauses, consider these tips:

• Do not agree to indemnify your client for anything other than your own negligence or for the negligence of your subconsultants or other parties for whom you would be legally liable anyway (ex. an employee);
• Agree to indemnify only to “the extent permitted by Colorado law”; if possible, negotiate a provision that limits your indemnity obligation (even in the event of your own negligence) to the available proceeds under your professional liability policy or other insurance policies;
• Do not agree to reimburse your client for your client’s attorney fees as part of an indemnity obligation. Quite often, clients insist on this provision, but the courts in the United States generally do not make the loser pay the winner’s attorney fees. This is known as the “American Rule,” and is directly opposite to the “English Rule,” which does require the loser to pay the winner’s attorney fees. By agreeing to pay your client’s attorney fees, you are assuming a liability in your contract which is not otherwise imposed on you by law, and this is not covered by your insurance policy;
• If you are agreeing to indemnify your client for your own negligence and for that of your subconsultants, be absolutely sure that your contracts with your subconsultants contain identical indemnity language in your favor – in other words, do not get caught holding the bag for your subconsultants’ mistakes;
• Limit the types of damages subject to the indemnity obligation. Certain “consequential damages,” such as lost profits, tax credits, increased loan interest, etc., can significantly increase the amount of a claim against you, and you should attempt to exclude these types of damages from your indemnity obligation; and
• Be sure that every indemnity provision you sign is bilateral; that is, be sure your client is agreeing to indemnify you to the same extent you are agreeing to indemnify your client. Do not give more than you get.

F. Insert a Clause that Places a Monetary Limitation on Your Liability

A limitation of liability clause caps the maximum amount of money your client can recover from you in the event of a claim. Typically, limitation of liability clauses limit a design professional’s liability to its fee or a set dollar amount, whichever is greater. Most insurance companies strongly encourage design professionals to negotiate limitation of liability clauses into their contracts, and some even provide a premium credit for the inclusion of a limitation of liability clause in a standard proposal issued by a design professional. While this is generally a wise practice, Colorado’s recent anti-indemnity legislation may impact the enforceability of limitation of liability provisions. Because a limitation of liability could be construed as a form of shifting responsibility for your own negligence to your client, such clauses may now run afoul of this legislation. Be mindful of the questionable enforceability of these clauses going forward.

If you do include limitation of liability clauses in your contracts, be sure they are clearly drafted to eliminate ambiguities. Such clauses cut against the general rule that everyone should be responsible for their own negligence. Consequently, these clauses are strictly construed against the drafting party.

Nonetheless, if including a limitation of liability clause in your contract, consider these issues:

• Be sure to harmonize the limitation of liability clause with all other “remedies” clauses in your contract. A perfect example is an indemnity clause. If you agree to indemnify your client “to the fullest extent permitted by law” for damages caused by your own negligence, then you need to ensure that the indemnity obligation is qualified by the limitation of liability clause so that there is no conflicting language as to the amount of damages recoverable;
• Make the limitation reasonable. If you will earn a $500,000 fee on the project, a $10,000 cap on liability is probably unreasonable;
• Ensure that the limitation applies to your company, its employees, and to your subconsultants;
• If intended to apply as a single limitation for an entire project, clearly define what the project is and whether the project is broader than the scope of services for the particular contract being negotiated;
• State that the limitation applies to all causes of action, including, but not limited to, breach of contract and negligence;
• State that the limit of liability is in the aggregate, meaning that even if there are multiple claims by your client under the same contract, your liability can never be more than the one single limit outlined in the contract itself; and
• Consider including the categories of damages subject to the limitation, some examples being damages, costs, expenses, attorney fees, interest, and consequential damages.

Limitation of liability clauses are not enforceable if a design professional engages in willful and wanton conduct or gross negligence. While a very high quantum of proof is required to establish willfulness and wantonness, you should not contractually attempt to limit your potential liability for such conduct, as it may jeopardize your ability to enforce a limitation of liability for garden-variety negligence claims.

G. Identify the State Whose Law Will Govern the Contract

Because most of you are based in Colorado, and you design projects that will be built in Colorado, it is likely that any claim against you will be brought in a Colorado court. Given this likelihood, you should insert a clause in your contract providing that the law of the State of Colorado will govern the validity, interpretation, enforcement, and performance of the contract.

H. Utilize a “Corporate Protection” Clause

Generally speaking, individuals who provide design services for a construction project can be held individually liable for the negligent performance of those services. The Colorado courts have made it very clear that individuals, even when acting through companies, are liable for their own negligence. In contrast, an officer of a company cannot be held individually liable for the company’s actions or the actions of one of the company’s employees, unless that officer actually participated in the conduct at issue. Unfortunately, for design professionals engaged in residential construction, there is no effective way to limit individual exposure to a lawsuit.

However, for commercial projects, the insertion of a clause limiting the parties against whom claims can be brought may provide some protection to individuals. Such a clause should reflect an agreement by both parties that in the event of any claim or dispute arising out of the contract, each party will bring the claim against the party to the contract only, and not against any individual officer, director, shareholder, engineer, employee or agent of the contracting entity. While no Colorado appellate court has directly decided whether such a clause is enforceable, the Colorado Supreme Court’s approval of the economic loss rule provides some leverage for enforcing such a clause.

I. Shorten the Period of Time for Filing a Lawsuit

In Colorado, the parties to a contract can agree to contractually alter the outside time limit by which a suit or claim must be brought. If the parties agree to such an alteration, that intent must be clearly stated in the contract. If utilized, the clause should, at a minimum, provide that any claim arising out of the contract or the services provided under it must be brought no later than X years after the date of substantial completion of the project, or within the time required by the laws of the state under which the contract will be construed, whichever is sooner. If you use this clause, be sure to clearly define what constitutes substantial completion of the project, by referring to either a certificate of substantial completion, a certificate of final payment, a certificate of temporary occupancy, or a certificate of final occupancy for the project.

J. Get All Modifications to a Contract Signed

Sometimes it becomes necessary to modify your contract. Just as with initial contract formation, any modification requires the mutual assent of the parties, rather than a unilateral declaration by one party. If both parties agree, a contract can be modified or waived, in whole or in part, by subsequent words and conduct.

The best practice to avoid disputes over oral modifications of a written contract is for the initial written contract to require that any modification be put in a writing (commonly referred to as an “amendment”) that is signed by both parties. Amendments should clearly identify the original terms that are being altered, the manner in which they are being altered, and should contain a statement that all unaltered terms remain in full force and effect. Another reason to “write it down” is to ensure the parties clearly agree on what has changed.

K. Control Ownership Rights of Your Work Product

From the owner’s perspective, there is a natural assumption that the instruments of service reflecting your design will become the property of the owner. After all, the owner is paying your fee to prepare documents that will be used to construct a building that it will be responsible for maintaining. Often, you will find your client asking why you will not readily agree to transfer ownership of your instruments of service.

From your perspective, there are a number of legitimate reasons to retain at least partial ownership of your instruments of service. Your plans and specifications are considered to be “intellectual property” under the law, and give you rights to use and reproduce those instruments. As a design professional, you obviously want to control the distribution of your designs and prevent your instruments of service from being utilized by strangers to your contract on other projects.

There is no easy way to resolve the tension between these competing expectations. Perhaps the wisest course is to ensure that you retain exclusive ownership over your instruments of services until you have been paid in full for your services. This will ensure that you are not left unpaid, and also makes it far less likely that the owner will terminate your contract for convenience. Upon final payment, it may be appropriate to grant the owner a permanent, non-exclusive license to “use” your instruments to maintain the facility, and to tie future alterations or additions into the existing project. Again, such a license should not ripen until you have been fully paid for your services.

If you find yourself in a relationship with a client who is adamant that you surrender all of your ownership rights to your instruments of service, at a minimum, you should require the owner to indemnify you against any future distribution or reuse of your instruments of service. Keep in mind, however, that if your design implemented a novel concept you wish to reuse, by surrendering your ownership rights, you are also giving away that novel concept. Not only does it belong to the owner, but you are infringing upon your client’s ownership rights if you attempt to employ that design concept in future projects.

Conclusion

The topics addressed in this primer are not meant to be an exhaustive list of all contract provisions you will encounter in your business. However, these clauses do present the opportunity to make your design service contracts more favorable and more reasonable. Rather than have a jury determine what is reasonable for you later, why not do it yourself now?

Bill Searfoorce
5445 DTC Parkway, Suite 800
Greenwood Village, CO 80111
(303) 779-2742
wsearfoorce@montgomerylittle.com

Bill is a shareholder with Montgomery Little & Soran, PC, where he has specialized in the legal representation of design professionals in the construction industry for 20 years.  His clients include designers of all specialties and a broad spectrum of projects.