Client Contracts: Business Risk, Professional Liability & Insurance

Hanover Architects & Engineers Advantage

Client Contracts: Business

Risk, Professional Liability

& Insurance Coverage

continued

Many client-drafted contracts endeavor to transfer unreasonable risk to the design professional.

Many of these risks create liability exposures that go far beyond what is expected of you as a design

professional. To make the best management decisions, you need to know where professional liability

insurance coverage stops and business risks start.

Here are 21 contractual issues that can have a significant impact on your professional liability

exposure, your bottom line and your firm’s reputation.

1. Scope of Services

The scope of services is the foundation of your

professional services contracts and should always

be developed in collaboration with the client.

Agreeing on a scope of services starts with

explaining to the client what you can and can’t

provide. Consider drafting the scope of services

as an opportunity to both educate and learn,

and always include your project managers in the

process.

Your scope of services should be detailed and

specific. Vaguely-defined scopes are hard to

quantify and measure. Avoid words like “all”,

“comprehensive”, “thorough” and “complete”.

Always include a list of exclusions for services that

you are not going to provide.

2. Standard of Care

Standard of care provisions can raise the bar for

design professionals putting your professional

liability insurance coverage in danger. Words like

highest, best and superior, when used to describe

your professional responsibilities represent a

contractually assumed duty not covered by

professional liability insurance.

As a professional, the adequacy of your services

are measured against the acceptable practices of

other designers. The law does not require your

services to be free of errors and omissions:

It is his further duty to use the care and skill

ordinarily used in like cases by reputable

members of his profession practicing in the same

or similar locality under similar circumstances,

and to use reasonable diligence and his best

judgment in the exercise of his professional skill

and in the application of his learning, in an

effort to accomplish the purpose for which he

was employed.

Clark v. City of Seward, 659 P.2d 1227 (Alaska 1983)

The American Institute of Architects provides this

standard of care language:

§ 2.2 The Architect shall perform its services

consistent with the professional skill and care

ordinarily provided by architects practicing in the

same or similar locality under the same or similar

circumstances….

2007 AIA B 101 Owner Architect Agreement

Don’t let a poorly drafted standard of care

provision put your insurance coverage in question

3. Warranties, Guarantees, and Certification

Contract language that requires you to warrant,

guarantee or certify your services or construction

quality is a contractually assumed risk that is a

specific exclusion in most professional liability

insurance policies. Be on the alert for provisions

that require you to certify that construction

is in strict compliance with the plans and

specifications. The contract may also require you

to execute bank or other lender certifications

attesting to the quality of the completed

construction. Don’t.

4. Job Site Safety

Client contracts may include language that

can conceivably make you responsible for job

site safety. Circumvent wording that makes

you responsible for supervising construction

or approving the contractor’s safety program.

Professional liability insurance does not provide

coverage for liability arising out of the contractor’s

job site safety responsibilities.

5. Indemnities

Indemnity provisions are by far one of the most

challenging issues inherent in client-drafted

contracts. These contract clauses can transfer

unreasonable and uninsurable risk to design

professionals. Be wary of indemnity

provisions that:

• Require you to “defend” the indemnified parties.

Unlike general liability insurance, professional

liability insurance does not provide for an

immediate defense to indemnified parties.

• Make you responsible for indemnified parties’

wrongful acts. Professional liability insurance

coverage is limited to the design professional’s

negligent acts in the performance of their

professional services.

Recent case law in California emphasizes the

importance of carefully drafted indemnity

provisions that limits your liability to professional

negligence. With advice from legal counsel,

indemnity language should be similar to this

model provision:

Consultant agrees, to the fullest extent permitted

by law, to indemnify and hold harmless the Client,

its officers, directors and employees (collectively,

Client) against all damages, liabilities or costs,

including reasonable attorneys’ fees and litigation

costs, to the extent caused by the Consultant’s

negligent performance of professional services

and that of its sub-consultants or anyone for

whom the Design Consultant is legally liable

under this Agreement, as determined by judicial

or arbitration proceedings, excepting only those

claims, damages, liabilities or costs caused by

the negligent acts or negligent failure to act by

the Client. Neither the Client nor the Consultant

shall be obligated to defend or indemnify the

other party in any manner whatsoever for the

other party’s own concurrent or sole negligence

or alleged concurrent or sole negligence.

Nothing herein is intended to create a duty to

immediately defend the other party until and

unless negligence is established by judicial

proceedings or arbitration on the part of the

party charged with a defense tender hereunder.

6. Estimates

Managing project costs during the design phase

is critically important for project owners and

highly risky for design professionals. Failing to

keep project costs in check can put you on the

“hook” for significant project delay costs. The

American Institute of Architects attempts to limit

this exposure by providing the owner five viable

options:

§ 6.6 If the Owner’s budget for the Cost of

the Work at the conclusion of the Construction

Documents Phase Services is exceeded by the

lowest bona fide bid or negotiated proposal, the

Owner shall:

1. give written approval of an increase in the

budget for the Cost of the Work;

2. authorize rebidding or renegotiating of the

Project within a reasonable time;

3. terminate in accordance with Section 9.5;

4. in consultation with the Architect, revise the

Project program, scope, or quality as required

to reduce the Cost of the Work; or

5. implement any other mutually acceptable

alternative

§ 6.7 If the Owner chooses to proceed under

Section 6.6.4, the Architect, without additional

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compensation, shall modify the Construction

Documents as necessary to comply with the

Owner’s budget for the Cost of the Work at

the conclusion of the Construction Document

Phase Services, or the budget as adjusted under

Section 6.6.1. The Architect’s modification of the

Construction Documents shall be the limit of the

Architect’s responsibilities under this Article 6.

2007 AIA B 101 Owner Architect Agreement

The “free redesign” addressed in § 6.6.4 and

§ 6.7 is a tradeoff for avoiding exposure to the

Client’s delay costs.

A better approach is to retain the services of

a qualified cost estimating firm that is better

suited to help the Client keep the project in

budget during the design phase. In a perfect

world, the client would contract directly with this

construction cost professional.

7. Consequential Damages

Clients may ask you to assume the risks of

consequential damages. These types of damages

are very speculative and hard to quantify. To limit

this far-reaching exposure, design professionals

should negotiate a mutual waiver of

consequential damages.

§8.1.3 The Architect and Owner waive

consequential damages for claims, disputes

or other matters in question arising out of or

relating to this Agreement. This mutual waiver is

applicable, without limitation, to all consequential

damages due to either party’s termination of this

Agreement, except as specifically provided in

Se c tion 9.7.

2007 AIA B 101 Owner Architect Agreement

8. Code Compliance

Code compliance is a primary design

accountability. Be careful, however, to avoid

contract language that places unrealistic

expectations on your design. Limit your duty for

code compliance to applicable design codes and

avoid language that requires “full” compliance

with “all” codes. Such language can be construed

as a guarantee that may not be covered by

professional liability insurance.

The varying interpretations that can be applied to

even the most longstanding, time-tested building

codes are equally problematic. Look at how often

code issues impact the construction process.

Despite all the code reviews and approvals leading

up to the issuance of the building permit, there are

almost always code issues identified during routine

field code inspections. The American Institute

of Architects attempts to address this issue in its

2007 Owner Architect Agreement:

§3.1.5 The Architect shall, at appropriate times,

contact the governmental authorities required

to approve the Construction Documents and the

entities providing utility services to the Project. In

designing the Project, the Architect shall respond

to applicable design requirements imposed

by such governmental authorities and by such

entities providing utility services.

2007 AIA B 101 Owner Architect Agreement

9. Dispute Resolution

Mediation is recognized in the design/

construction industry as the preferred approach

to resolving claims. Question Clients that don’t

include contract provisions that provide for

mediating disputes as the first course of action.

Many professional liability insurance carriers

provide policy deductible credits for disputes

resolved through the mediation process.

10. Inspection

The word inspection implies an expectation that

the design professional has a duty to assure that

all the construction, when completed, is in full

compliance with the contract documents.This

is an unrealistic requirement, even if the design

professional has a fulltime site presence during

construction. Preferred language uses the word

“observe” and limits the evaluation to the specific

work observed:

9.02 Visits to Site

Engineer will make visits to the Site at

intervals appropriate to the various stages of

construction as Engineer deems necessary

in order to observe as an experienced and

qualified design professional the progress that

has been made and the quality of the various

aspects of contractor’s executed Work. Based

on information obtained during such visits

and observations, Engineer, for the benefit of

Owner, will determine, in general, if the Work

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is proceeding in accordance with the Contract

Documents. Engineer will not be required to

make exhaustive or continuous inspections

on the Site to check the quality or quantity of

the Work. Engineer’s efforts will be directed

toward providing for Owner a greater degree of

confidence that the completed Work will conform

generally to the Contract Documents. On the

basis of such visits and observations, Engineer

will keep Owner informed of the progress of the

Work and will endeavor to guard Owner against

defective Work.

2007 AIA B 101 Owner Architect Agreement

11. Stop Work

Contract terms that place a duty on you to

stop construction presents significant risks.

First, stopping construction can expose you to

contractor delay claims. Just as critical, stop work

authority can make you liable for failing to take

action to protect worker safety. The authority to

stop work should rest with the project owner and

not you.

12. Limited or No Construction

Phase Services

When it comes to construction phase services,

clients can be penny wise and pound foolish.

Looking for ways to trim their project budgets,

some clients view construction phase services

as a “can do without” expense. As a design

professional, you need to explain that your

participation in the construction process is vital to

overall project success.

If you fail to convince your client of the value of

construction phase services, consider negotiating

contract language that addresses your concerns:

The Client chooses not to retain the Consultant to

perform construction phase services. The Client,

therefore is responsible for, but not limited to

the following:

• Site observations

• Contractor performance

• Submittal review and approval

• Contract document interpretation

• Site observations

• Change order review and approval

• Review and approval of contractor

payment applications

• Certificates of substantial and final

completion

• Preparation and disposition of punch lists

• Responding to contractor requests

for information

• Administration of any operational and

maintenance training including collection

operational and training manuals

The Client shall assume full responsibility for any

and all changes made to the Contract Documents

during construction. The Client agrees to waive

any claims against the Consultant arising in any

way related to such changes.

13. Ownership of Documents

As hard as you try to retain ownership of your

design documents, clients try even harder to

secure the right to reuse your designs. The middle

ground in this struggle is to grant the client a

limited license to use your design. The license

limits the use to constructing, using, maintaining

and altering the Project.

You should also ask the client to provide

protection should they reuse your design without

your involvement:

9.02 Visits to Site

§7.3 Upon the execution of this Agreement, the

Architect grants to the Owner a nonexclusive

license to use the Architect’s Instruments of

Service solely and exclusively for the purposes

of constructing, using, maintaining, altering

and adding to the Project, provided that the

Owner substantially performs its obligations,

including prompt payment of all sums when

due, under this Agreement. The Architect shall

obtain similar nonexclusive licenses from the

Architect’s consultants consistent with this

Agreement. The license granted under this

section permits the Owner to authorize the

Contractor, Subcontractors, Sub-subcontractors,

and material or equipment suppliers, as well

as the Owner’s consultants and separate

contractors, to reproduce applicable portions of

the Instruments of Service solely and exclusively

for use in performing services or construction for

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the Project. If the Architect rightfully terminates

this Agreement for cause as provided in Section

9.4, the license granted in this Section 7.3

shall terminate.

§7.3.1 In the event the Owner uses the

Instruments of Services without retaining

the author of the Instruments of Service, the

Owner releases the Architect and Architect’s

consultant(s) from all claims and causes of action

arising from such uses. The Owner, to the extent

permitted by law, further agrees to indemnify and

hold harmless the Architect, and its consultants

from all costs and expenses, including the cost of

defense, related to claims and causes of action

asserted by any third person or entity to the

extent such costs and expenses arise from the

Owner’s use of the Instruments of Service and

this Section 7.3.1. The terms of this Section 7.3.1

shall not apply if the Owner rightfully terminates

this Agreement for cause under Section 9.4.

2007 AIA B 101 Owner Architect Agreement

14. Hazardous Materials

Hazardous materials come with the project

owner’s site and the risks associated with their

removal should stay with the project owner.

You should avoid contract language that makes

you responsible for identifying and removing

hazardous materials. Clearly define what

constitutes a hazardous material by referencing:

CFR Title 40:PART 261—Identification and Listing

of Hazardous Waste

15. Prevailing Party Attorney’s Fees

Prevailing party attorney fees are a contractually-

assumed obligation that is not covered by

professional liability insurance. Additionally,

agreeing on who’s the prevailing party can be

questioned depending on the outcome of the

legal proceedings. For example, is a client that

sues for $1,000,000 and gets a $1,000 verdict the

prevailing party?

16. Insurance Requirements

Clients often don’t have a complete

understanding of the insurance coverages

appropriate for design professionals. They may

simply apply contractor insurance requirements

that really aren’t applicable and sometimes not

even available in the marketplace.

There are two common problems specific to

professional liability insurance. First, professional

liability insurance policies do not permit the client

to be added as an additional insured. Secondly,

professional liability insurance is most often

offered on a claims-made basis, whereas client

contracts may require you to have an occurrence-

based policy.

17. Limitation of Liability

There are times where negotiating a limitation

of liability provision may be both appropriate

and justified. When project risks outweigh the

potential rewards, limiting your liability is smart

business and good risk management. Exposing

your professional liability insurance limits and

deductible on a difficult project where success

is questionable should be counterbalanced with

thoughtful consideration.

When a limitation of liability provision is the right

course of action to pursue, you need to make sure

that your proposed provision is more than a “cut

and paste” from an online article, white paper or

legal manuscript:

• Limitation of liability provisions need to be

carefully drafted

• Dollar values should be reasonable

• Don’t arbitrarily use insurance policy limits to

define the limits of your liability

• Remember available insurance proceeds may be

less than insurance policy limits

• Enforcement of limitation of liability provisions

vary from state to state

• Seek guidance of legal counsel

18. Third-Party Action Over Provisions

Client contracts may include provisions that are

commonly referred to as third-party action over

indemnities. These provisions make you liable

for the bodily injury of your employees beyond

the benefits provided by workers’ compensation

insurance (WC). This is one example:

To the fullest extent permitted by law,

Consultant’s indemnification obligations shall not

be limited in any way by any limitation on the

amount or type of damages, compensation, or

benefits payable under workers’ compensation

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acts, disability acts, or other employee benefits

acts, and shall extend to and include any actions

brought by, or in the name of, any employee of

Consultant or others for whom the Consultant is

legally liable.

As an illustration, let’s assume that one of your

employees gets injured on a construction site.

The Injured employee sues the Project Owner. In

turn, the Project Owner invokes the third-party

action over Indemnity. This effectively voids your

protection under WC which limits your employee’s

claim against you to WC benefits.

These third-party action over provisions constitute

contractually-assumed liabilities that are not

covered by professional liability insurance.

19. Site Inspections

Project Owners can shift unreasonable risks

by drafting contract provisions that make you

responsible for any and all problems with their

building sites. These seemingly innocuous and

boiler plate provisions often go unchallenged

when negotiating client contracts. But as this

provision demonstrates, site evaluation provisions

can be just as problematic as any client-drafted

provision:

A/E shall visit proposed project site, as required,

to obtain total details of specifics required for

renovation work, including but not limited to,

demolition, architectural, structural, mechanical,

electrical, etc., in order to fully complete

drawings and specifications without omission.

Such visit shall include thorough inspection of

normally enclosed or inaccessible areas such as

spaces above ceilings, within walls or chases,

and in pipe crawl spaces under basement floors.

Where necessary, A/E shall arrange to have walls

or ceilings broken, or have excavations made to

physically determine existing conditions.

You are better off if your contracts do not

include a site inspection provision. But when

faced with one, the first thing you want to do is

change “inspection” to “evaluation” next, you

want to be sure that you are not being asked to

do the impossible. Limit your site evaluations

to a visual review of existing site conditions. If

the client wants more, address the options that

can be taken including selective demolition and

destructive testing. Remember, however, that the

client should always retain the risks associated

with their sites. DON’T GUARANTEE THAT

ALL EXISTING SITE CONDITIONS WILL BE

IDENTIFIED.

20. Project Performance Warranties

When negotiating client contracts, you may be

confronted with contract language similar to these

two provision:

Consultant shall be responsible to see that the

Project as designed can operate as a functional,

efficient, high-quality facility.

and

Consultant warrants that its Services performed

under this Agreement and the Contract will

provide a proper design fit for its intended

purpose

21. Flow-Down Provisions

Flow-down provisions are common in the design/

construction industry. Prime consultants and

surveyors often see language similar to this:

First Tier: Client-Prime Professional

The Contract Documents consist of (1) this

Agreement; and (2) the Prime Contract, between

the Owner and Contractor.

This flow-down provision provides for the terms

and conditions of the owner prime professional

contract to be passed down to the Prime

professional’s subconsultants:

Second Tier: Prime Professional – Consultant

Architect agrees to incorporate by reference

into all contracts with its Project consultants and

subconsultants this Agreement, requiring such

consultants and subconsultants to acknowledge

and be bound by its terms.

Flow-down provisions are problematic in that:

• They are often considered as unimportant fine

print and therefore simply ignored

• They are confusing to interpret and apply

• They often transfer uninsurable risks to design

and surveying professionals

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• And they frequently don’t establish any order

of precedence between the documents

incorporated via the flow-down provision

If at all possible, avoid flow-down provisions

and when you can’t, review all incorporated

documents, in detail, seek clarification

when faced with conflicting and ambiguous

language and always have your contract take

precedence over all contracts/documents that are

incorporated via a flow-down provision.