AIA Standard Form Is an Acceptable "Allocation of Risk" between "Sophisticated
Business Actors"
September 2000
The Fourth Circuit court has ruled the accrual
provision in AIA 11.3 to be enforceable. The court held that the clause, which
determines when the statute of limitations begins to run, is not against public
policy.
by Kenneth
A. Slavens
Brown & James,
P.C.
One of the ways the American Institute of Architects (AIA) family of documents
attempts to allocate risk has been found to be enforceable. The clause that
determines when the statute of limitations begins to run—not the length of the time period—has
been found to be enforceable and not against public policy. This was despite
the argument that the provision was at odds with the applicable public policy
and should not be enforced.
In Harbor Court Associates, et al. v Leo A. Daly
Company, et al., 179 F3d 147 (4th Dist 1999), the plaintiffs—Harbor Court
Associates and Murdock Development Company (HCA/Murdock)—were the developers
of the Harbor Court Complex in Baltimore, Maryland. HCA/Murdock contracted with
the design firm, Leo A. Daly Company (Daly), for Daly to act as the architect
for the complex, which included condominiums, offices, a hotel, health club,
and parking garage.
With some minor modifications, the parties utilized the standard form of
agreement prepared by the AIA to document the agreement for the architect's
services. In addition to the choice-of-law provision, which provided that the
contract was governed by the laws of the state of Daly's principal place of
business, the agreement contained the following provision in Article 11.3.
As between the parties to this Agreement: as to all acts or failures
to act by either party to this Agreement, any applicable statute of limitations
shall commence to run and any alleged cause of action shall be deemed to
have accrued in any and all events not later than the relevant Date of Substantial
Completion of the Work, and as to any acts or failures to act occurring
after the relevant Date of Substantial Completion, not later than the date
of issuance of the Final Certificate of Payment.
Construction on the Harbor Court project began in mid-1984, and the Final
Certificate of Substantial Completion was issued on September 11, 1987. Aside
from some minor chipping and cracking in the outer brick veneer, the facility
existed without any problems until April 1996. At that time, a 15-foot square
area of brick "exploded off" the face of the building. According to the experts
retained following the "explosion," the facility had "fundamental and latent
defects in design and construction." The "brick explosion" occurred more than
3 years after the issuance of the Final Certificate of Substantial Completion.
HCA/Murdock originally filed suit against the general contractor on September
20, 1996, in the Circuit Court for Baltimore City. The suit was removed to the
U.S. District Court for the District of Maryland, and the contractor joined
its subcontractors. The architect, Daly, was eventually added to the lawsuit.
HCA/Murdock's allegations against Daly were based on negligence and breach of
contract and indemnity.
Daly asked the court to enter judgment in its favor, contending that HCA/Murdock's
lawsuit was barred by the statute of limitations. Daly argued that pursuant
to Section 11.3 of the parties' contract, the September 11, 1987, date of the
issuance of the Final Certificate of Substantial Completion was the date Maryland's
3-year statute of limitations began to run. As a result, Daly contended that
the action filed by HCA/Murdock was time barred.
The district court sustained Daly's motion under the law of Maryland and
held that because the cause of action accrued in September 1987 by contract,
HCA/Murdock's claim brought in 1996 was beyond the 3-year period allowed.
HCA/Murdock's argued against the enforceability of Section 11.3 of the AIA
contract. It stated that Maryland courts apply the "discovery rule," which holds
that a cause of action accrues when the [plaintiff] in fact knew or reasonably
should have known of the wrong. Therefore, to enforce the contractual provision
of Section 11.3 would violate the public policy of the State of Maryland. HCA/Murdock's
position was that the "discovery rule," as applied in Maryland, had attained
the status of public policy, and the parties were not free to contract that
public policy away.
Under HCA/Murdock's argument, the statute of limitations would not begin
to run until April 1996, because the "defect" was "latent." Since it was a latent
defect, HCA/Murdock neither knew, nor could it have known, of the defect prior
to April 1996 when the failure actually occurred. On the date of the failure,
HCA/Murdock would have "discovered" the defect, the wrong would have become
known, and the statute would begin to run. Thus, the lawsuit would have been
timely if it was filed any time prior to April 1999. As a result, the suit filed
against Daly, HCA/Murdock argued, was well within the limitations period.
HCA/Murdock also claimed that since Daly was based in Nebraska, that under
the choice-of-law provision in the contract, the law of Nebraska should have
been applied to determine the enforceability of Article 11.3 in the dispute
instead of the law of Maryland, as used by the district court.
On appeal, the Federal Court of Appeals, Fourth Circuit, agreed with the
district court and Daly. It agreed that Maryland applied the "discovery rule."
In fact, the court noted that a review of the case law in Maryland revealed
that at one time, Maryland had applied the rule that the cause of action accrued
on the "date of the wrong," regardless of the injured party's knowledge of the
wrong.
The court noted that Maryland had found that the "date of the wrong" rule
sometimes resulted in a party forfeiting a cause of action before it even knew
the wrong had been committed (as would be the case in this dispute). The court
explained that to alleviate this situation of "blameless" ignorance, the Maryland
courts, like many other states, developed and applied the "discovery rule."
The court of appeals acknowledged that if the provisions of 11.3 were enforced,
the parties would "circumvent" the "discovery rule." The court found that the
State of Maryland had not explicitly prohibited the parties from reaching a
different agreement. The court framed the issue before it as being whether,
under Maryland law, an attempt by sophisticated parties to contract around a
rule developed for the protection of the blameless and unwary is unenforceable
as against public policy.
The court first acknowledged the commitment in Maryland to protecting an
individual's efforts to structure their own affairs through contract. As a result,
the court concluded that the State of Maryland would not prevent the parties
from contracting around the state's rule on the establishment of the date the
statute of limitations begins to run. The court noted as follows.
This is especially true where, as here, the parties to the agreement
are sophisticated business actors who sought, by contract, to allocate business
risk in advance. That is, rather than rely on the "discovery rule," which
prolongs the parties' uncertainty whether or if a cause of action will lie,
the parties to this contract sought to limit that period of uncertainty
by mutual agreement to a different accrual date.
The court responded to the argument that the benefit of the provisions of
11.3 were unbalanced in favor of Daly, an argument often advanced in opposition
to such risk allocation clauses. It pointed out that even if the provisions
of 11.3 only benefited Daly, when the contract was being negotiated, HCA/Murdock
was free to reduce the compensation it was willing to offer the architect or
even to hire a different architect. The court went on:
... HCA/Murdock are sophisticated business actors that determined, in
the unfettered exercise of business judgment, that the bargain they received
from [Daly] was adequate consideration for the surrender of the discovery
rule's potential advantages. Now, having received the benefit of their bargain,
[HCA/Murdock] wish to obtain by appeal to "public policy" considerations
the benefit of Daly's as well. We are confident that the Maryland high court
would not allow them to do so.
The Fourth Circuit also found that the only courts which had, at that time,
considered a contractual accrual date provision had each enforced it. See the
following cases.
- Old Mason's Home of Kentucky, Inc. v Mitchell,
892 SW2d 304 (Ky App 1995)
- Orinskany Cent. School Dist. v Edmund J. Booth
Architects, 206 AD2d 896, NYS2d 160 (NY App Div 1994), aff'd 85 NY2d
995, 630 NYS2d 960, 654 NE2d 1208 (NY 1995)
- Keiting v Skauge, 198 Wis2d 887, 543
NW2d 565 (Wis App 1995)
The court then turned to the questions of whether Nebraska law should have
been applied, and, if so, would the result have been different. Though the court
thought the issue presented a "substantially closer question" under Nebraska
law, the provisions of 11.3 were enforceable even under Nebraska law.
The reason the issue was thought to be a much closer question under Nebraska
law was that, for over 100 years, Nebraska had refused to enforce any contractual
provision purporting to alter the limitations period provided by statute by
holding that such provisions were against public policy. In the Harbor Court case, the court of appeals concluded
that the provision at issue governs not the time in which an action, once accrued,
may be brought, but rather establishes the moment at which such an action accrues.
The court found these to be distinct concepts. After further analysis, the court
concluded that the provisions of 11.3 were equally enforceable under Nebraska
law.
The Harbor Court case reinforces the freedom
of commercially sophisticated parties to allocate their risk by contract and
to have some assurance that the courts will not disturb that allocation. The
accrual provision in AIA 11.3 may not provide a way to manage the risks of liability
to third parties, strangers to the contract, but it does allow the management
of risk presented by certain claims.
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