The Inter-Relationship Of Risk Management - Provisions In Construction Contracts: Part 2

In a previous article we highlighted the need for contract drafters to give consideration to the inter-relationship of common risk management provisions in construction contracts and specifically reviewed the relationship between a maximum liability clause and the requirement to obtain a performance bond in a stipulated amount. The within article explores the potential concerns that arise when parties tie a maximum liability clause to the insurance provisions in the contract.

The inter-connection between maximum liability clauses and insurance provisions is most often found in contracts involving design professionals and engineering firms, although they are also seen in standard terms and conditions relating to the sale of goods. Most commonly, one encounters a contract that states any liability is limited to the extent that such liability is covered by the insurance in effect or, alternatively, that liability will be limited to the amount of insurance required by the contract.

The first concern that arises from such provisions is of primary import to the owner or purchaser. Making an ability to recover damages contingent on the presence of insurance is a risky proposition that may preclude or severely limit recovery. For example, what if the policy was never purchased, was cancelled, or simply lapsed? What if the insurer denies coverage? What about per claim, aggregate and multiple or successive contract issues? What if legal fees and expenses reduce the limits of the policy?

The second concern that arises is of significance to both contracting parties. The problem with connecting maximum liability provisions to insurance coverage and policy limits is that ambiguity frequently results as to what the actual liability limit is. As is well known to those in the industry, the problem with ambiguity is that it is the life blood of litigation.

The potential ambiguity is illustrated by the following example from a case the author litigated. In an EPCM contract the engineer represented it would perform the services with the standard of professional skill, diligence and care customarily applied by others performing similar services for similar projects. The engineer then stated its maximum liability for a breach of this provision would be limited to:

The obvious ambiguity or uncertainty created by the clause is the nature of the claim and whether the claim is pursuant to the standard of care provision and therefore caught by the maximum liability provision, or otherwise, in which case there is no liability cap whatever. The next question, assuming the claim falls within the standard of care provision, is whether it is covered by insurance. These problems can be magnified in the EPC or EPCM context where the engineer provides multiple services with the result the claim can be characterized in different ways. A further ambiguity, particularly as it relates to the errors and omissions insurance, is whether there are single or multiple claims. Finally, when there are various limits for different claims, there is often uncertainty as to the aggregate liability.

A recent reported example of uncertainty over the actual maximum liability where the liability limit was tied to insurance is SaskPower International Inc. v. UMA/Black & Veatch Ltd., 2007 SKCA 40. The contract in question was for engineering services for the construction of a cogeneration facility at a potash mine. The contract provided for a $10 million fee to the engineers and required the engineers to obtain a $10 million errors and omissions policy with a deductible not to exceed $500,000.00. The contract limited the engineers' liability as follows:

A lawsuit ensued and the owners claimed $18 million against the engineers. The engineers argued that if the owners' insurance applied, their liability was limited to $500,000.00 and in all other cases, their liability was limited to the amount the owners paid the engineers. As the parties agreed the owners' insurance applied, the engineers argued clause (a) limited their liability to $500,000.00 and clause (b) was not engaged.

Conversely, the owners argued clause (a) limited liability to the amount of insurance (where it applies) plus the deductible, and that clause (b), if and to the extent coverage did not apply, limited liability to the amount paid to the engineers. As the parties agreed the insurance applied, the owners argued the engineers were liable to the extent of the coverage ($10 million), plus the deductible, and then liable for the excess amount, but not exceeding the amount paid to the engineers.

The Saskatchewan Court of Appeal agreed with the argument advanced by the owners, such that the entire $18 million claim could be pursued.

In summary, connecting limitation of liability clauses to the insurance provisions can lead to ambiguity and uncertainty as to the actual limits of liability and therefore to unexpected results. The SaskPower case starkly illustrates the dangers, as one party argued its maximum liability was $500,000.00 while the other party argued its entire $18 million claim could be advanced. Generally speaking, the practice of linking the two clauses ought to be avoided. If a party wishes to limit its liability, it should do so expressly and independently of other contractual provisions. Proceeding in this manner should bring clarity to a party's potential liability regardless of the nature and characterization of the claim being advanced and irrespective of whether it is covered by insurance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.