Seventh Circuit Upholds Limitation of Liability Clause in Construction Contract

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In Sams Hotel Group, LLC v. Environs, Inc., 2013 WL 2402824, the Seventh Circuit upheld an Indiana district court’s validation of a contractual limitation of liability clause against a hotel developer.  In its ruling, the Court examined some recurring commercial litigation issues including the economic loss rule, and the standards that govern contractual indemnification and limitation of liability clauses. 

Facts: The owner and defendant architect entered into a $70,000 contract for the design of a six-story hotel in Indiana.  A little over a year later, when the hotel was nearly complete, numerous defects surfaced and the property ultimately had to be demolished.  The hotel never opened and the owner brought negligence and breach of contract claims against the architect.  The owner claimed it sustained over $4 million in damages due to the architect’s negligent hotel design. 

Trial Result: The Indiana district court granted summary judgment to the architect on the negligence claim based on the economic loss rule.  This rule (known as the Moorman doctrine in IL) posits that a plaintiff cannot recover for purely economic loss in tort where a contract governs the parties’ relationship – absent any personal injury or damage to other property. 

Once the owner’s negligence count was out, the parties went to trial on the owner’s  breach of contract claim.  The court ruled in the owner’s favor on that count but pared down its damages to the $70,000 architectural services contract price.  This was a harsh result considering the owner was claiming damages sixty times this amount!  The owner appealed its Pyrrhic victory to the Seventh Circuit.

The Court (applying Indiana law – this was a diversity suit) affirmed.  It first held that parties are free to enter into contracts and bargain as they see fit. * 2.  Contracts will be enforced as written absent the involvement of a consumer or a contract of adhesion (a “take it or leave it” scenario).  Since the property owner and architectural firm were sophisticated commercial entities with equal bargaining power, the Court enforced the contract’s $70,000 maximum liability amount.

The Court rejected the owner’s argument that the limitation of liability clause was an impermissible indemnification against negligence clause because it allowed the architect to avoid significant liability for its negligent design services.  *2-3. 

The Court distinguished limitation of liability provisions from contractual indemnification terms.  Limitation of liability clauses “serve to establish a contractual ceiling” on awardable damages while indemnification terms completely shield or insure a party against his own negligence. *3. 

In the latter indemnity situation, if a party wants to be indemnified for its own negligence, the contract must “clearly and unequivocally” provide that a party will pay for another’s negligence.  *2. But limitation of liability clauses can be less specific  – especially where the contracting parties are on an equal bargaining footing.  *3.

Take-aways.  In Indiana, limitation of liability provisions (which cap damages at a specific amount) are subject to less scrutiny than contractual exculpatory clauses (which completely insure a party against his own negligence).

This relaxed standard for damage limitations is even more prominent in contracts between two sophisticated commercial entities. Parties to high-dollar construction contracts should be leery of contractual terms which cap damages.

 

 

Illinois Home Repair and Remodeling Act (HRRA) – Are Oral Home Improvement Contracts (Over $1,000) Enforceable?

can-stock-photo_csp15933599The Illinois Home Repair and Remodeling Act, 815 ILCS 513/1 et seq. (“HRRA” or the “Act”) was enacted in January 2000 to protect consumers from unscrupulous home repair contractors.    The HRRA sections that seem to spawn the most litigation are Sections 10, 15, 15.1, 20 and 30.  These sections provide:

Section 10 (815 ILCS 513/10) – “home repair and remodeling” means any improvement to residential real property including accessories like swimming pools, chimneys, garages, fences, HVAC equipment and driveways;

Section 15 (815 ILCS 513/15) – requires a contractor (“person engaging in business of home repair and remodeling”) for all contracts exceeding $1,000 to furnish the homeowner a written contract or work order with job specifics (costs, materials used, contact info for contractor, etc)

Section 15.1 (815 ILCS 513/15.1) – consumer/homeowner must be notified of contractual jury waiver or  binding arbitration clause and must be given opportunity to accept or reject the terms in writing.

 Section 20 (815 ILCS 513/20) – contractor must provide a “Home Repair: Know Your Consumer Rights” pamphlet before starting the job.  If the contract price exceeds $1,000, the homeowner and contractor must sign an acknowledgement (stating that the homeowner received the pamphlet from the contractor).  If under $1,000 – no written acknowledgement required.

Section 30 (815 ILCS 513/30) – provides that any person who suffers actual damage for a HRRA violation can sue under Section 10a of the Illinois Consumer Fraud Act (815 ILCS 505/10a) [Note – this Section was added in July 2010]

Another key HRRA section concerns insurance.  Section 25 requires contractors to have $100K/$300K bodily injury and $50K property damage insurance.  The Section also requires contractors to maintain $10K in coverage for home repair work that doesn’t conform with local building codes.  815 ILCS 513/25.

K Miller Construction Case Summary

K Miller Construction Company, Inc. v. McGinnis (38 Ill.2d 284 (2010) is the Illinois Supreme Court’s most recent discussion of the HRRA.  It involves a home improvement contract that exceeded $500,000.  The plaintiff contractor spent more than two years on the project and was owed more than $300,000 for his work.  When defendants failed to pay, plaintiff sued to foreclose a mechanics’ lien, for breach of contract and alternatively, for quantum meruit. The defendants moved to dismiss all counts on the basis that plaintiff violated the HRRA’s requirement of a written work order for projects over $1,000.  The trial court agreed and dismissed all three counts of the complaint with prejudice.  On appeal, the First District affirmed dismissal of the lien and breach of contract counts but reversed on the quantum meruit count (holding that the contractor should be able to pursue quantum meruit recovery).  The homeowner defendants appealed to the the Illinois Supreme Court.

Held: Appeals court affirmed in part and reversed in part; trial court reversed.  Plaintiff contractor can sue for both quantum meruit and breach of oral contract even where he violates the HRRA. 

Reasons: The Illinois Supreme Court held that just because a contract technically violates a statute, doesn’t mean the contract must be unenforceable – especially if the breach is not “seriously injurious to the public order”.  The Court also stated that the legislature could have (but did not) specified in the HRRA that an Act violation automatically invalidates the underlying contract.  Id. at 297.

Normally, where a statute is silent as to whether a statutory violation voids a contract, the court balances the private interest in enforcing the contract against any opposing public policies.  However, in K Miller, no balancing test was necessary because in July 2010, the Illinois legislature rewrote Section 30 of the HRRA to specifically delete the prior version’s reference to “unlawful” and to instead provide a Consumer Fraud remedy to anyone who suffers actual damage because of a contractor’s HRRA violation.

The K Miller Court found that the “new” Section 30 and its private consumer fraud cause of action was the proper remedy for an aggrieved consumer/homeowner; not a complete nullification of the contract. The Court bolstered its holding with prior caselaw that allowed contractors (who violated the HRRA) to still recover where there was substantial compliance with the HRRA.  The Court also noted that the HRRA’s legislative history revealed lawmakers were leery of consumers using HRRA violations as a pretext for not paying contractors.

Take-aways and Conclusion: This seems like a fair result.  Going forward, if a homeowner files a consumer fraud claim based on an HRRA violation, he must be able to show calculable monetary damage stemming from the HRRA violation.  Contractors and homeowners alike should also take note of the Act’s requirements – specifically the written work order, the “Know Your Rights” pamphlet and the Act’s provisions governing mandatory arbitration and contractual jury waivers.

Third-Party Beneficiary Claims in Public Construction Contracts – Illinois Law

Lake County Grading Company, LLC v. The Village of Antioch, 2013 IL App (2d) 120474, 985 N.E.2d 638 (2nd Dist. 2013), illustrates the importance of joining an alternative common law claim with a statutory one when the statutory claim  is time-barred.

The plaintiff subcontractor sued a public entity under a third-party beneficiary theory for improvements plaintiff made to two residential subdivisions.  After the general contractor who hired plaintiff defaulted and filed for bankruptcy, the plaintiff sued the public entity under the Public Construction Bond Act, 30 ILCS 550/1 and the Mechanics’ Lien Act, 770 ILCS 60/23 and also brought claims for third-party beneficiary breach of contract. 

The lien and Bond Act claims were dismissed and the trial court granted summary judgment for the plaintiff on its third-party beneficiary claims.

Affirming the trial court, the First District rejected the Village defendant’s argument that plaintiff’s sole remedy was under the Bond Act.  The Bond Act requires a subcontractor like plaintiff to serve a verified notice within 180 days of the completion of its work and to file suit within one year after the public entity accepts the project.  30 ILCS 550/1, 2; Lake County, ¶¶ 17-19. 

Siding with the plaintiff, the Court noted that Bond Act states that the Act’s statutory remedy is “in addition to and independent of any other rights and remedies provided at law or in equity”.  Id., ¶ 20.  The Court then stated some key third-party beneficiary rules:

a person’s status as a third-party beneficiary turns on whether the contract language shows that the parties’ intent was to directly benefit the supposed third-party plaintiff;

– the contract language must show that the contract was made for the direct, not merely incidental benefit of the third party;

– the intent to directly benefit a third party must be shown by express provision in the contract identifying the third-party beneficiary by name or description of a class to which the third party belongs;

– if a contract makes no mention of the plaintiff or a class to which he belongs, he is not a third-party beneficiary of the contract;

– the plaintiff bears the burden of showing that the contracting parties intended to confer a benefit on him.

( ¶ 24)

Applying these rules, the Second District found that the plaintiff was a direct third-party beneficiary under both the Bond Act – which is “read into” the prime contract and the prime contract itself. Read together, the two documents clearly conferred third-party beneficiary status on plaintiff. (¶¶ 26-27).

Once the Court found that plaintiff was a third-party beneficiary of the prime contract, the Court applied Illinois’ four-year limitations period for construction-related claims (see 735 ILCS 5/13-214) instead of the Bond Act’s shortened 180 day/one-year limitations period. (¶ 31). 

The Court also declined to apply the Bond Act’s 180-day notice period was because the Village failed to require the general contractor to tender a payment bond as required by the Bond Act.  (¶ 25)  Since the Village failed to require a payment bond of the general contractor, there was no bond for the plaintiff to sue on.  This rendered the 180-day rule inapplicable.

Take-aways

The case illustrates that where a subcontractor blows the 180-day Bond Act notice rule, he can still sue as a third-party beneficiary of the prime contract.  

This case also makes clear that the party suing as a third-party beneficiary must demonstrate that the contract language clearly shows that the plaintiff is an intended, direct contract beneficiary.  Finally, the case provides an interesting contrast to the Mechanics’ Lien Act cases that hold that a subcontractor’s exclusive remedy against an owner is a statutory mechanics’ lien foreclosure suit.