A Dozen Steps to Avoid Third-Party Liabilities

Article courtesy of Professional Liability Agents Network. The following material is provided for informational purposes only. Before taking any action that could have legal or other important consequences, speak with a qualified professional who can provide guidance that considers your own unique circumstances.

Architects, engineers and other design professionals have long enjoyed the legal concept of “privity of contract.” Put simply, privity of contract is a common law principle that prevents any person from seeking the enforcement of a contract or suing on its terms unless they are a party to that contract. Each party owes a duty of care only to those with whom it has a contract. Generally, a contract cannot confer rights or impose obligations upon anyone who is not a party to the contract.

Not surprisingly, privity of contract is not absolute. Over the years, this legal principle has been gradually eroded by the courts. Judges and juries have ruled that third parties can indeed successfully sue a design professional (or other service provider) for damages even though they are not parties to a contract. Contractors, subcontractors, vendors and building occupants are among those third parties who have successfully claimed damages against design firms.

Here are some example court cases upholding privity of contract:

  1. A U.S. District Court in Pennsylvania ruled that an engineer did not have a duty to warn the public or government agencies when it discovered toxic beryllium during tests on a jobsite. The court found it sufficient that the engineer warned its client per their contractual agreement.
  2. A Court of Appeals in Texas ruled that an architect was not liable when a person was permanently injured when a residential balcony designed by the architect collapsed due to faulty construction. The court noted that the architect 1) did not have control of nor guaranteed or was responsible for construction, 2) did not notice the defect and 3) was only responsible to report known deviations to the client.
  3. The Supreme Court of Utah ruled that a subcontractor could not seek damages against an architect because of alleged design errors that resulted in the subcontractor having to file numerous requests for information and change orders, and incurring significant delays and cost overruns. The court said that the general rule in the jurisdiction prohibiting the recovery of pure economic loss due to negligence applies to a contractor’s or subcontractor’s claim against a design professional.

And here are two cases, where privity of contract was not upheld:

  1. The Massachusetts Supreme Court ruled that an architect was subject to a third-party claim when an airport hotel worker was electrocuted while attempting to repair an electric transformer. The Court noted that the architect failed to ensure that the contractor applied warning signs and wiring diagrams it had specified in the design documents, and, due to the seriousness of the risk, could be sued by decedents of the electrocuted worker.
  2. In one of the most far-reaching and recent rulings regarding third-party liabilities, the California Supreme Court upheld a Court of Appeals decision that a lead architect owed a duty of care to members of a homeowners’ association of a condominium complex it designed. The Supreme Court confirmed that the third-party liability applied to purely economic damages even where there is no contractual relationship between the residents and the designer. The Court reached this decision even though the architect’s contract with the client expressly disclaimed the existence of any third-party beneficiary of the obligations contained in the agreement.

If these court cases demonstrate anything it’s that court decisions are all over the board regarding third-party liabilities for design firms. However, decisions made within individual states and provinces tend to fairly consistent. For instance, the states of Missouri, Virginia, Utah and Texas tend to support privity of contract, whereas California and Massachusetts do not. It’s important to investigate the history of court cases in the jurisdictions within which you conduct business and do what you can to enhance your chances of avoiding third-party liabilities.

Avoiding Third-Party Liabilities

Regardless of the jurisdictions in which you operate, there are common sense steps you can take in your attempt to limit third-party liabilities. While there are no guarantees these steps will eliminate these liabilities, they are all worth discussing with your attorney and addressing in your client contracts.

  • Include a third-party or “intended beneficiary” clause in your client contracts. Set expectations by having a clause stating that you and your client agree that your firm has no contractual relationship with contractors, subcontractors, vendors and other appropriate third parties. Also state that your services are intended for the sole use and benefit of your client and are not intended to create any third-party rights or benefits for any other person or entity. Such a clause may not be enforceable in all jurisdictions, so check your prevailing laws.
  • Include a carefully defined and “closed” scope of services clause in your client contract. It is important to list all of the services you agree to perform for your client’s sole benefit and then note that your services are limited to those set forth in the agreement. State that you shall have no other obligations or responsibilities beyond those listed.
  • Consider offering construction observation services as part of your scope. Performing these services gives you the opportunity to address the contractors questions and concerns, spot potential problems early in the construction process and document your observations and recommendations for your client. If your client refuses your offer to provide construction observation services, document that fact, including your client’s signed acknowledgement that such services were offered but turned down. Seek an indemnity when providing design without contract administration/construction observation services.
  • Emphasize to the client the importance of contractor selection and offer to take part in the process. Contractor prequalification helps ensure that the selected contractor has the experience needed to performed the required services on the project. It can also help identify whether the contractor has a history of being litigious against project owners or lead designers. A pre-bid meeting among the owner, contractor and lead designer gives you the chance to answer any design questions a contractor may have and help eliminate potential misunderstandings and mistakes.
  • Make it clear in your contract that you are not responsible for construction means and methods nor jobsite safety, and that these are the sole responsibility of the contractor. Put it in writing that the contractor has all responsibility for construction means, methods, scheduling, sequencing, jobsite safety and compliance with construction documents and directions from the project owner. Suggest that your client include a similar clause in its contract with the contractor confirming its responsibilities. Make sure your actions on the jobsite support the fact that you are not responsible for construction.
  • Include a modification clause in your client contract. Specify that you are not responsible for any damages, including those to third parties, resulting from modifications made to your design or specified materials by a construction manager, value engineer or other party to the project selected or approved by the owner.
  • Require all subconsultants you and your client have selected and approved for the project to be appropriately qualified and to have adequate professional liability insurance. Speak with your attorney about requiring subconsultants to indemnify you and the client. Similarly, encourage your client to require the contractor and subcontractors to have adequate liability insurance. If you are the only “deep pockets” on the design and construction team, you become a primary target for a claim and dramatically increased your third-party liabilities.
  • Manage and limit shop drawing reviews. Some contractors have been known to inundate lead designers with shop drawing reviews, resulting in a slowdown in construction and eventual claims for delays from contractors, subcontractors, vendors and other third parties. As much as you can, put limits on your shop drawing responsibilities. Set guidelines on what type of shop drawings you agree to review and have the contractor comply with an approved submittal processes per a reasonable schedule.
  • Beware of diminution of value when providing conditions surveys. When providing conditions surveys for a client seeking to purchase a piece of property, you may face a claim from the property’s current owner if your survey uncovers a condition that reduces the value of the property. To avoid this liability, have your client seek protection for the both of you by having the property owner agree to waive any claim regarding a loss of property value due to the discovery of conditions.
  • Avoid certifications and guarantees to third parties. Third parties to a project, such as a bank or other lender, may ask the lead designer to certify that certain conditions are met regarding the project — e.g., that an existing structure meets current codes. Whenever possible, avoid giving such certifications, which can be interpreted as guarantees. Instead, only give an “opinion” that such conditions have been met. Qualify your opinion to make it clear that you are not guaranteeing or warranting that a condition exists.
  • Avoid condominium projects. Perhaps nowhere is third-party liability more of a threat than with condominiums and other multi-unit residential complexes. Consider: A design team provides its services to a condo developer. Months or years later, often after the developer has been dissolved, a homeowners’ association and its team of attorneys goes after the design team when alleged shoddy materials and workmanship come to light. Those designers with the biggest assets often become the prime targets in a claim.

Third Party Reliance Letters

Our twelfth tip for avoiding third-party liability deserves special attention because it represents a growing concern for today’s design firms. We are seeing more and more requests for design firms to provide reliance letters to third parties.

What is a reliance letter? It’s a document that gives a third party the right to rely upon the accuracy of a survey or report originally prepared for someone else. For instance, a developer may hire an environmental consultant to conduct a Phase 1 site assessment on a piece of property it is considering purchasing for a project. A lender who is potentially providing the developer a loan to fund the purchase of the property may request a reliance letter from the consultant. The letter would give the lender the right to rely on the accuracy of the site assessment report in making its decision to provide funding.

The increase in liability is obvious. Suddenly you have a written document that is essentially a contract with the lender. You no longer have the protection provided by privity of contract. What was traditionally a third party is now a client.

The obvious solution to preserve the privity of contract theory would be to refuse to provide reliance letters. In some situations, you can refuse such requests and the project goes on uninterrupted. In other situations, however, you may find it preferable to help your client and provide them the assistance they request to secure financing or otherwise move the project forward.

If you do decide to provide reliance letters, it is crucial that you and your legal representative take control of the process and establish the content of the letter according to your terms and conditions. You need to identify the exact surveys or reports the reliance letter applies to and establish limitations regarding who can use the report, how the report can be used and for how long.

In the reliance letter you should establish that you exercised reasonable skill and strove to meet the prevailing standard of care in executing the survey or report. You need to maintain all of the protections that you set forth in your original contract with your primary client, including specific statements that you do not warrant nor guarantee that your report is 100% accurate and is only an opinion based upon limited information and testing.

Also, speak with your insurance agent or broker to verify that the reliance letter does not create any uninsurable liabilities. Finally, if you do decide to issue a reliance letter, charge an equitable fee that reflects your time invested and a potential increase in liabilities.

Can We Be of Assistance?

We may be able to help you by providing referrals to consultants, and by providing guidance relative to insurance issues, and even to certain preventives, from construction observation through the development and application of sound human resources management policies and procedures. Please call on us for assistance. We’re a member of the Professional Liability Agents Network (PLAN). We’re here to help.

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