This article examines a recent design-build case, Mistry Prabhuda Manji Eng. Pvt. Ltd. v Raytheon Engineers &
Constructors, Inc., 213 F Supp 2d 20 (US DC, Mass 2002).
The Facts
Contracts requiring a design-build engineering firm to supply "basic
engineering packages" for licensing and technology transfer agreements for
the design and construction of a processing plant for sodium hydroxide (caustic
soda) contained a liquidated damages clause capping the engineer's
liability at 10 percent of its fee. They also contained a waiver of
consequential damages clause waiving "special, indirect, incidental, or
consequential damages of any kind." In response to the project owner's
suit against the engineer for failure of the plant to achieve commercial
production, the court enforced these clauses to limit the available
recovery.
The plaintiff's complaint against the contractor alleged breach of
contract, misrepresentation, and fraud. With regard to the counts of the
complaint alleging misrepresentation and fraud, the court dismissed these
because they were barred by the 2-year statute of limitations. In response to
the defendant's argument that the breach of contract claim should also be
dismissed based upon the waiver of consequential damages and the liquidated
damages clauses, the plaintiff argued that the clauses should not be enforced
because the clauses were unconscionable, were based on material
misrepresentations, and were the product of mutual mistake.
The waiver clause provided:
Article XV Waiver of Consequential Damages. In no event shall Seller
[contractor] be liable to [owner] whether in contract, warranty, tort
(including negligence or strict liability) or otherwise for any special,
indirect, incidental or consequential damages of any kind or nature
whatsoever.
The liquidated damages clause provided:
Article VIII Liquidated Damages. In the event that the Caustic Prill Unit
fails to produce Caustic Soda beads during the performance test even though
all the conditions described in Article VII hereof have been satisfied and
despite [contractor's] efforts to correct said failure, for each 5
percent or part thereof shortfall below the level warranted in Article VII,
hereof, [contractor] will pay to [owner] an amount equal to 5 percent of the
lump sum fee received by [contractor] for the failed Caustic Prill Unit.
However, [contractor's] maximum limit of liability under the Agreement as
to any failed Caustic Prill Unit shall be 10 percent of the Lump sum fee
received by [contractor] for the failed Caustic Prill Unit. These payments
are the exclusive remedies provided to [owner] under this Agreement. Except
as provided in the Article VII, Contractor shall have no other liability
whether in contract, warranty, tort, or otherwise.
The plaintiff, project owner, tried to get around the liquidated damages
clause by arguing that it only applied in the event that the Unit failed the
performance test. Since there was never a performance test, it argued the
limitation clause had no effect.
The Ruling
In interpreting the contract on this matter, the court explained that
"the intention of the parties is a paramount consideration." Intent
must be ascertained from the contract document itself when the terms are clear
and unambiguous. The court concluded that the clause makes clear that although
the 5 percent cap appears to apply in the event of a performance test failure,
the 10 percent cap applies to any claim under the Agreement regardless of
whether or not performance tests were performed. The court emphasized that
"When combined with the extremely strong liability-limiting language of
the entire clause, these phrases make clear that the intention of the parties
was to limit [owner's] recovery under any circumstance to ten percent of
the fee it paid to [contractor]."
The court also rejected the project owner's argument that the clauses
were "unconscionable" and should not be enforced. The court said that
the test under Pennsylvania jurisprudence for unconscionability is "an
absence of meaningful choice on the part of one of the parties together with
contract terms which are unreasonably favorable to the other party." It
further explained that the principle underlying the concept is to prevent
oppression and unfair surprise, but that it is not intended to disturb the
"allocation of risks because of superior bargaining power."
In other words, just because a party has greater bargaining power and
negotiates a more favorable and even onerous deal does not make the deal
unconscionable in the absence of oppression and unfair surprise. In commercial
settings, explains the court, a limitation of damages clause will rarely be
found unconscionable.
In this case, the owner claimed that it was a small unsophisticated Indian
company that trusted "an American behemoth" when its president flew
to Philadelphia to sign the deal. It made no changes to the contract and did
not seek counsel to assist with its negotiation. Although the court described
this as a "sympathetic picture," the court concluded that the
scenario did not suggest any lack of meaningful choice. In its conclusion with
regard to this issue, the court said
There is nothing in the record to suggest unfair surprise.... The clauses
were not hidden boilerplate. The one point which gives this court pause is
whether a 10 percent cap creates an adequate incentive to perform. However,
there is no indication that the profit margin was any higher than 10 percent.
Therefore, [owner] has not demonstrated unconscionability. (Mistry Prabhuda Manji Eng. Pvt. Ltd. v Raytheon Engineers &
Constructors, Inc., 213 F Supp 2d 20 (US DC, Mass 2002)).
Risk Management Note
This case provides valuable insight into the judicial interpretation and
application of contract clauses that purport to limit liability of engineers
and contractors. There is a striking similarity in the project owner's
arguments with those that have been raised in so many other reported cases.
This decision should be a reminder to every commercial entity entering a
contract for the design or construction of a project that, generally speaking,
courts will enforce the terms of the contract that result from arms' length
negotiations between two commercial entities. This is true even if one of the
parties was significantly smaller than the other and did not have equal
bargaining clout.
The key, as explained by this court, is whether the damage limitations would
be unconscionable. In my own legal practice, I have had more than one client
tell me that they wanted to ignore my advice and sign onerous contracts in
which they would to be giving away substantial rights to the other party—with
the expectation that they could convince a court that they signed the contract
as a result of duress, coercion, or unequal bargaining position and that the
clause should be void as against public policy or as unconscionable.
My advice has been that a court would not be impressed with their arguments
for much the same reasons stated by the court in this case. Plus, my clients
have had competent legal assistance with their contracts and this makes their
chances of getting a court to let them out of a bad deal even more unlikely.
Note, however, that the court provides significant pointers in drafting an
enforceable limitation of liability clause, when it states that the clause in
this case was not "hidden boilerplate" and that the question of
whether a 10 percent cap creates an adequate incentive to perform gave the
court pause.
I typically advise clients to make clauses such as indemnification,
limitation of liability (LoL), and waiver of consequential damages clear and
pronounced in the contract. If an LoL clause might be subjected to close
judicial scrutiny, it may even be advisable to have your client separately
initial or sign their name beside the clause so they cannot later claim they
were surprised to learn of its presence in the contract.
In addition, you should be careful to make the LoL amount reasonable. If it
is too small in comparison to the size of the fee or the significance of the
potential damages that could occur, a court may refuse to enforce it. Most
important of all, the decision of this court demonstrates the value of seeking
contract language where appropriate to limit the liability or the types of
damages that can be recovered.