A recent design-build case, Mistry Prabhuda Manji Eng. Pvt. Ltd. v Raytheon Engineers & Constructors, Inc., provides insight into the judicial interpretation of contract clauses that purport to limit liability of engineers/contractors. In commercial settings, explained the court, a limitation of damage clause will rarely be found unconscionable in the absence of oppression and unfair surprise. Risk managers need to take note that, generally speaking, courts will enforce the terms of the contract that result from arms' length negotiations between two commercial entities.
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).
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.
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.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.