Design firms need to be vigilant about clauses and language that have the potential to significantly expand their risk while undermining their insurance protection.
As project managers, owners, and their attorneys have become more aggressive in their efforts to reengineer contractual agreements with project participants, AEC firms need to be increasingly vigilant about language being inserted and omitted in their contracts. Without careful review, they may be taking on significantly more risk while losing the critical financial protection otherwise available under their professional liability insurance policies.
In the past, the process of reviewing design contracts was fairly straightforward; owners, contractors, and design firms typically relied on the standard AIA or EJCDC documents, which have proven over time to provide fair and equitable treatment of all parties. Although under certain circumstances some revisions may have been needed, they typically were minor. These changes usually involved relatively easy to spot adjustments that rarely required the issuance of reservation of rights letters.
Those contracts were negotiated among all parties involved to be fair and balanced, as well as fully insurable. Design contracts and the construction contracts associated with the projects were coordinated so that responsibilities were clear. In situations where agreements didn’t use the standard professional association documents, they were typically brief with balanced terms that didn’t even contain indemnity clauses (as all indemnity is owed without a contract). In some cases, they were essentially simple letters of agreement.
Today, however, contracts often present several potential coverage issues. By and large, the challenges inherent in these modified agreements stem from blurring of responsibilities, the misidentification of design professionals as contractors or venders, and payment provisions that allow for the withholding of payment for unadjudicated issues.
Beware of elevated standard of care. The coverage issues can put designers in a difficult position with their insurance carrier, lead to substantial uninsured costs, and make the resolution of claims more challenging. Frequently, the standard of care definition is elevated with clauses throughout the contract that imply perfection. The words “negligence” and “negligent” have virtually disappeared from many new design contracts even though the only thing your professional liability policy provides coverage for is your negligence.
In many current contracts, the definitions of standard of care often include superlatives. Notably, warranty language and other clauses imply perfection that redefine the standard of care. Express warranties are not covered under professional liability insurance policies, so claims involving “Breach of Warranty” may not be covered. When reviewing any proposed contract, be sure to watch for and avoid words like “complete,” “all,” “highest,” and “strict,” and phrases like “fit for intended the purposes” or “to the satisfaction of the client.”
Watch broad indemnification language. Another issue: Today, nearly every contract requires indemnity of parties other than the client. However, if those parties demand indemnity, those costs will not be covered under a professional liability insurance policy. In addition, prevailing party clauses appear in many design contracts, and attorney fees awarded as a result of these clauses will not be covered. These issues alone can result in six- or seven-figure awards that are not covered by professional liability insurance.
AEC firms also need to be aware of potential issues surrounding dispute resolution clauses. They often have resolution requirements for laws and venues in the jurisdiction of the home office location of the client. Although this is not necessarily a coverage issue, it can cost time and money should a dispute arise.
Furthermore, jury waivers are present in nearly every design contract these days; although not a coverage issue, having a jury increases the potential for appeal or settlement. Juries often want to hear the perspectives of design professionals so removing them from the process is tantamount to agreeing to one, unpaid, arbitrator.
Last, but not least, be sure to review the payment provisions. Is there a pay when paid provision? Can the owner withhold fees for issues they perceive as errors or omissions without adjudication? What is the stated time-period for payment following submission of the invoice? If the client doesn’t pay you in a timely manner, are you entitled to charge and receive interest or reimbursement for the cost of recovering your fees? Requiring payment can be instrumental in avoiding claims, so don’t let your account receivables get too large or too old.
As their clients continue to move away from standard contracts, design firms need to be vigilant about clauses and language that have the potential to significantly expand their risk while undermining their insurance protection. The time is right for design firms to sharpen their focus on contract hygiene and, if necessary, to seek assistance of experienced attorneys and insurance advisors to make sure their agreements are fair, equitable, and insurable.
Lauren Martin is a risk manager and claims specialist at Ames & Gough. She can be reached at lmartin@amesgough.com.
