The Increasing Trend of Caps in Construction Contracts and Negotiating Them
Jarred Trauth, Partner, Jones Walker LLP
Posted: October 11, 2023 | Legal
By: Jarred Trauth, Partner, Jones Walker LLP
Risks are inherent in every construction project and all parties involved face them: owners, designers, general contractors/builders, subcontractors, suppliers…. Equitably allocating such risks is one of the most important and most negotiated areas of any construction related contract. Limitations of liability provisions are key to risk allocation. These provisions include no damage for delay provisions and caps on delay damages, warranty limitations and exclusions, indemnity limitations, and consequential damage waivers. Another, and the focus of this article, is a liability cap fixing the total amount of damages for which a party may be liable under the contract (the “Liability Cap”). Liability Caps have become more and more common in construction and construction related contracts, including major component supply agreements and design agreements.
This article will discuss Liability Caps generally and considerations of an owner or contractor negotiating them, including carve-outs (i.e. exceptions) to them.
LIABILITY CAP PROVISIONS
The purpose of a Liability Cap is to establish a fixed, monetary cap on a party’s overall liability under a contract. The fixed cap can be expressed as an actual specified dollar amount or in a manner to describe how to calculate the cap, such as a multiple of the contract price (i.e. 100% of the contract price or 2 times the contract price). Here is an example of a Liability Cap without any carve-outs:
UNDER NO CIRCUMSTANCES SHALL [SELLER]’S TOTAL LIABILITY FOR LOSSES, DAMAGES OR CLAIMS TO [BUYER] ARISING FROM ANY EQUIPMENT OR SERVICES PROVIDED UNDER THIS AGREEMENT OR THE PERFORMANCE OF THIS AGREEMENT EXCEED [100% OF][or][TWO TIMES] THE TOTAL AGGREGATE CONTRACT PRICE PAID BY [BUYER] FOR THE EQUIPMENT OR SERVICES PURCHASED UNDER THIS AGREEMENT.
CONSIDERATIONS IN NEGOTIATING A LIABILITY CAP
If owner/contractor is considering accepting a Liability Cap requested by its downstream contracting party (the “Lower Tier Party”), it should consider the following in negotiating the Liability Cap:
1. Cap Amount. The Liability Cap amount is heavily negotiated. A Lower Tier Party frequently proposes a Liability Cap amount equal to 100% of the contract price. Depending on the value of the contract price, this may or may not be acceptable to the owner/contractor. If the contract price is high, 100% of the contract price may be a sufficient level of risk allocation to the Lower Tier Party. However, the lower the contract price, the more concern there is whether 100% of the contract price is sufficient. When considering what is sufficient, owner/contractor should also consider the relative risks associated with the types of equipment or services being provided.
2. Reciprocal Cap. When a Lower Tier Party proposes a Liability Cap provision, it will frequently only apply to, and cap the damages of, the Lower Tier Party. The owner/contractor should typically require the Liability Cap be reciprocal and cap both parties’ damages.
3. Cap Carve-Outs. Owner/contractor should consider requiring certain carve-outs to the applicability of the Liability Cap. Said differently, the Liability Cap applies in all instances except in certain situations depicted in the specified carve-outs. Below is a list of some of the carve-outs that could be considered and a brief discussion of them.
a) Gross Negligence, Willful Misconduct and Fraud. This carve-out would mean the Liability Cap would not apply to cap the Lower-Tier Party’s liability in the event owner/contractor’s damages or losses resulted from the Lower-Tier Party’s gross negligence, willful misconduct or fraud. The idea is if the Lower-Tier Party’s actions rise to the level of an intentional action or an action taken with a wonton disregard for its duty, then the Lower-Tier Party should not have the benefit of the Liability Cap. This is a very common carve-out.
b) Indemnity Obligations for 3rd Party Claims. This carve-out would apply in the event the Lower-Tier Party owes the owner/contractor an indemnity obligation for third-party claims against owner/contractor. Most contracts will require the Lower-Tier Party to indemnify owner/contractor for its damages and losses resulting from third-party claims (for example, the Lower-Tier Party’s manufactured equipment or design services cause an explosion that causes millions of dollars in damages to a third-party’s adjacent property). In most instances, the third-party’s damage or loss will not be capped, so why should the Lower-Tier Party’s indemnity obligation to owner/contractor be capped? Many believe Liability Caps should only apply to cap first party losses between the parties to the contract. This carve-out for third-party claims is a common carve-out.
c) Breach of Confidentiality/Non-Disclosure Obligations. This carve-out would apply in the event damages or losses are caused by the Lower-Tier Party’s breach of its confidentiality obligations because the damages or losses owner/contractor could suffer could be immense and potentially fatal to its business. This carve-out would be important to consider if there is valuable proprietary information being disclosed and there is a confidentially provision in the contract. This is a common carve-out.
d) Violation or Infringement of IP Rights. This carve-out would protect owner/contractor in the event the Lower-Tier Party’s product or design infringes on another party’s intellectual property rights depriving owner/contractor of the use of such product or design. This is a fairly common carve-out when the Lower-Tier Party is providing design services or manufacturing equipment with important intellectual property.
e) Violation of Applicable Laws. This carve-out would apply in the event damages are caused by the Lower-Tier Party’s violation of applicable laws. The Lower-Tier Party may counter by requiring the carve-out to apply only in the event owner’s damages or losses result from a claim by a government agency and possibly even a claim for fees or penalties assessed. This is a fairly common carve-out.
f) Insurance Proceeds. This carve-out, depending on how it is worded, would apply in the event damages or losses are or should have been covered by the Lower Tier Party’s insurance coverage. This is a fairly common carve-out but it is heavily negotiated. The Lower Tier Party will want to limit this carve-out to only insurance proceeds it actually receives under the policies and coverage amounts required by the contract.
g) Cost of Carrying Out Work. This carve-out would make it clear that any amounts expended by the Lower-Tier Party in completing the work or curing any defects under its warranty would not reduce or apply to the Liability Cap.
Overall, Liability Caps offer a key mechanism to control and allocate risks on projects. As a result, it is important to understand the nature and impact of these clauses in construction contracts.
“The Construction Industry Team at Jones Walker LLP is one of the most highly regarded and award-winning construction law practices in the nation. Our experienced construction attorneys understand the complex dynamics between — and the unique priorities of — project participants and can craft effective solutions that minimize disputes, manage risks, and help keep projects moving from conception to completion.”
The views expressed in this article are not necessarily those of ConsensusDocs. Readers should not take or refrain from taking any action based on any information without first seeking legal advice.
Repinted with permission from ConsensusDocs.
Image by 3D Animation Production Company from Pixabay