Setting Limits

Restricting a consultant's financial liability promotes effective risk management

• By John P. Bachner
• Sep 01, 2006

The limitation of liability (LoL) provision made its appearance in engineering contracts almost four decades ago. The original provision -- introduced by ASFE/The Best People On Earth -- was simple: The client agreed to limit the engineer's negligence liability to a given amount or the fee, whichever was higher.

ASFE advanced the concept almost as an act of survival. Its member firms were being sued so frequently they were unable to obtain professional liability insurance (PLI) from any conventional source. As a consequence, they had to "go bare" or "go naked"; i.e., provide their services without insurance or, as some euphemistically put it, "practice on a self-insured basis." No matter what they termed the situation, however, one fact remained: Practitioners had to put their personal assets on the line -- their businesses, their homes, their savings -- every time they accepted an engagement.

The 10 firms that created ASFE did so, in part, to learn why they were being sued so much. This was a particular puzzlement to the founders, because, in truth, they were among the best "earth engineering" practitioners in the world. "We're good at what we do," they said. "Why do we have to defend so many claims?"

Research revealed the answer: the founders weren't good at what they did, principally because they didn't know what they were doing. They were laboring under the mistaken notion that they were engineers who provided their professional services on a consulting basis. But what they really did was operate small businesses that sold engineering services. They weren't being sued because of bad engineering. They were being sued because of business practices that were wholly inadequate for the business they were in.

ASFE was also chartered to develop programs, services, and materials to help its members lower their liability exposures and, toward that end, the organization focused on helping its members acquire the skills they needed to enhance their business performance. The development of effective written agreements was a particular concern. All too many engagements moved forward on a handshake basis, without a genuine contractual "meeting of the minds." What client representatives thought they had heard was not what firm representatives believed they had said, causing even the simplest projects to erupt into complex disputes, claims, and litigation.

ASFE's loss-prevention consultant at the time was an attorney named Ed Howell, a man known for his contrary viewpoints and, more important, brilliant innovation.

"If liability is such a big issue," Ed said, "why not limit it?"

He explained to his skeptical clients that LoL had been used in trade and transportation for centuries, principally to manage known risks in a manner that contributed to the greater good. While rumor has it that Phoenician traders developed the concept, it is a fact that, in 1601, England's Parliament enacted a law limiting the liability of ship owners to the value of a vessel's hull. The limitation of liability was necessary because England's vital maritime industry was in jeopardy. Merchants were suing ship owners for the value of the cargo lost to bad weather or piracy, forcing ship owners to charge sky-high rates in order to cover their risks, or to simply abandon the industry and leave England all the weaker for having done so. While certainly some level of liability should remain to discourage irresponsibility, relief was merited, especially given that merchants were hardly at the ship owners' mercy. In fact, merchants could employ a variety of means to help manage their risks; including reliance on the most seaworthy vessels, assignment of the most experienced officers and crews, and selection of the routes least affected by foul weather and people. They could also buy insurance.

"But will our clients accept limitation of liability?" ASFE members asked. "It's not a matter of 'if,'" Ed said. "They accept it every day. Whenever they ship something. Whenever they fly. When they check into a hotel. When they park a car. Risk affects everyone. The people who use a service need to be just as concerned about risk as the people who provide the service. The limitation of liability concept reflects that concept. The service user has no right to expect full recovery from a service provider because of mistakes the service user makes, or because the service user fails to apply good risk management.

"If a hotel provides a safe at the front desk, why should the hotel's owners have to face unlimited liability for valuables a guest decides to keep in a room? You also have to consider the greater good: If hotels had to face unlimited liability, there'd be far fewer of them. Does America really want to jeopardize its engineering profession? Fair's fair, especially because most clients aren't willing to pay you to do everything you can do to limit risk -- your own and the client's."

Armed with that viewpoint, ASFE members went about the task of educating their clients, colleagues, and peers about LoL. Private-sector clients would be the "toughest nuts" to crack, they assumed, but they were wrong. As long as the engineers approached the subject properly, progress came remarkably easily. "What's this new provision?" a client representative would ask an ASFE member, pointing to the LoL clause. The ASFE member would then launch into a discussion about risks and benefits, how the LoL tended to level the playing field, techniques available to keep risks in check, and how the effective management of risk benefited the entire project, while also contributing to a greater good by helping to achieve win/win outcomes for all parties.

The risks and benefits part was simple to explain. Most private-sector projects -- office buildings, apartment communities, retail centers, single-family housing developments, et al. -- yield returns many, many times larger than a design professional's hoped-for gain. In the case of a shopping center, for example, the developer could expect net returns in the tens of millions of dollars, while a design profession could expect a net return of about 10 percent (if that) of fee. It would be unfair to require the design professional to accept millions of dollars worth of risk in order to earn a profit amounting to perhaps a tenth of 1 percent of that sum. Given that the owner had the most to again, the owner should be willing to accept the most risk. And besides, the engineers explained, the owner had any number of techniques available to manage that risk, starting with the selection of quality-oriented firms and mutual development of service scopes designed to deal with known risks.

By considering what might happen, the engineers explained, the owner would not eliminate problems, but certainly would be able to deal with most that arose quickly, while they were still small. This approach would benefit the project, the engineers explained, because men of good will are far more likely to demonstrate that good will when it doesn't cost a lot. When it does, insurance companies get involved, then in come the lawyers whose mission is to maximize the client's gain and/or minimize its loss. In fact, litigation supports a greater good only when it presents an acceptable alternative to physical violence.

In 1969, discussions of such issues were extremely rare. Architects didn't talk about them, nor did civil engineers. As such, one of the LoL provision's most important effects was spotlighting the topic of risk. And because of that, private-sector owners became far more aware of it and far more open to dealing with it intelligently.

ASFE's model LoL language has evolved considerably since 1969, as has the variety of provisions offered. The most commonly used approach is epitomized by the sample that follows, taken from ASFE's Limitation of Liability: A Handbook for Design and Environmental Professionals, Second Edition:

LIMITATION OF LIABILITY

In order for CLIENT to obtain a lower fee from CONSULTANT, among other benefits, and in order for CONSULTANT to reduce its residual risk created by providing services to CLIENT, CLIENT and CONSULTANT agree that, to the fullest extent permitted by law, CONSULTANT's total aggregate liability to CLIENT is limited to $50,000 or the fee, whichever is higher, for any and all of CLIENT's injuries, damages, claims, losses, expenses, or claim expenses arising out of this AGREEMENT from any cause or causes. Such causes include, but are not limited to, CONSULTANT's negligence, errors, omissions, breach of contract, breach of warranty, strict liability, negligent misrepresentation, statutory liability, or other acts giving rise to liability based upon contract, tort, or statute. CLIENT understands that dollar limits higher than $50,000 are available, and that CONSULTANT might be willing to waive the limitation of liability altogether. (If CLIENT wishes to discuss other limits or the possibility of waiving this provision, and the resulting impact on CONSULTANT's retained risk and fee, CLIENT shall so notify CONSULTANT in writing. If CLIENT fails to issue such notification prior to accepting this AGREEMENT, through signature or, without signature, by orally or in writing authorizing CONSULTANT to commence services, CLIENT shall be deemed to have accepted the limit of $50,000 or the fee, whichever is higher.) This provision takes precedence over any conflicting provisions of this AGREEMENT.

The amount of the actual limit is, typically, negotiated between the firm offering the LoL and the client, and, in just about all cases, it should be part of the overall risk-management strategy embraced by the agreement, given that the scope of service, general conditions, schedule, and fee all affect and/or are affected by risk. Still, a recent survey reveals, $50,000 or the fee, whichever is higher, tends to be the most commonly used limit. That same survey also shows that, while LoL is widely accepted in the private sector, it is resisted in the public sector. Interviews with ASFE members indicate that public entities are reluctant to authorize an LoL because, its representatives say, "doing so increases the public's risk." But that's a fallacious outlook in general and, more often than not, a smokescreen for a penny-wise/pound-foolish approach to project design that has caused local government to become the number-one riskiest client an engineering firm can deal with. Consider these facts:

• High-quality engineering firms are as astute in their business pursuits as they are in their technical pursuits. Firms that blithely accept every risk that "comes down the pike" cannot expect to stay in business for long, nor should astute clients even want to deal with them, given that a firm that's incapable of recognizing its own risks will be incapable of recognizing its clients' risks. In other words, local jurisdictions that prefer to deal with firms that are willing to act as de facto insurance policies severely limit the number of firms from which they can select, and few of them will be recognized as leaders in their field.
  
  
• Making matters worse, some local jurisdictions are so quality-blind, they select firms not so much based on their qualifications as the fee they are willing to accept (in addition to the onerous terms and conditions). The assumption seemingly is that, as long as services are performed under the supervision of licensed professionals, the outcome will be acceptable. Forgetting about the fact that hundreds of thousands of claims against design professionals doom such an outlook to the dustbin of history, one can only guess how those who subscribe to such theories would respond were their son or daughter seriously ill and in need of immediate medical intervention. Would they seek out the best, most qualified physician they could find? Or would they be content with the services of any licensed practitioner?

"Aha!" some might exclaim at this point. "But physicians cannot limit their liability." (There are certain jurisdictions, however, such as Texas, that place limits on the amount of damages that patients in medical malpractice cases can be awarded against physicians.) While that may be true, they are known to help lower their risk exposure through "defensive medicine"; i.e., prescribing any number of tests to help minimize their risk at the expense of their patients and their patients' insurers or HMOs. FYI, the terms "defensive engineering" and "defensive architecture" refer to the same types of practices; things design professionals do to help lower risks when they have to deal with inadequate scopes of service and/or unlimited risk. It's also worthwhile to remember that physicians do not face liability from as many parties as engineers do; e.g., everyone who drinks the water treated by a system they design. Note, however, that it may also not be true, given that liability is always limited to one's assets, and assets can be limited artificially by a variety of means that can render one judgment-proof. More to the point: When the service is genuinely important; when the service outcome will vary depending on the performance of the service provider, it's just basic common sense that the most value will be provided by the most qualified provider, providing that provider is willing to perform for a reasonable fee.

Long story short: Public entities do not limit their liability by refusing to limit the liability of the design professionals they retain. They limit their liability by specifying the most competent firm from the largest possible universe of firms, and by developing a scope of service that anticipates known risks, thus helping to prevent certain problems in full while permitting rapid response to others while they are still nascent; i.e., molehills.

As to the broken-record comment that "we have limited budgets to work with. We don't have the money luxury that the private sector has," wake up! Not having enough money to do things right does not justify doing them wrong and winding up with problems that must be resolved, adding a premium that exceeds what it would have cost to have done it right to begin with! What? You have enough money to pay for the mop-up, but not enough to prevent the spill? Surely you've heard than an ounce of prevention is worth a pound of cure. Use LoL as a reason to discuss the entire issue of risk and what can be done to manage it effectively. If you are unwilling to pay the fee required for the service provider to do everything reasonable that can be done to help minimize risk, then be willing to limit the provider's liability as compensation for the fee savings you derive by requiring the provider to face heightened third-party exposures -- both personal and corporate --for years to come. The result will be projects that are better designed, that proceed to completion with fewer problems, and that last longer and serve better in the process. That can hardly be termed an approach that increases the public's risk.

This article originally appeared in the September/October 2006 issue of Water & Wastewater Products, Vol. 6, No. 5.

This article originally appeared in the 09/01/2006 issue of Environmental Protection.