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.

 

 

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PaulP

Litigation attorney at Fisher Kanaris, P.C. representing businesses and individuals in all types of commercial disputes.

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