AIA Standard Form Is an Acceptable "Allocation of Risk" between "Sophisticated Business Actors"

One of the ways the American Institute of Architects (AIA) family of documents attempts to allocate risk has been found to be enforceable. The clause that determines when the statute of limitations begins to run—not the length of the time period—has been found to be enforceable and not against public policy. This was despite the argument that the provision was at odds with the applicable public policy and should not be enforced.

In Harbor Court Associates, et al. v Leo A. Daly Company, et al., 179 F3d 147 (4th Dist 1999), the plaintiffs—Harbor Court Associates and Murdock Development Company (HCA/Murdock)—were the developers of the Harbor Court Complex in Baltimore, Maryland. HCA/Murdock contracted with the design firm, Leo A. Daly Company (Daly), for Daly to act as the architect for the complex, which included condominiums, offices, a hotel, health club, and parking garage.

With some minor modifications, the parties utilized the standard form of agreement prepared by the AIA to document the agreement for the architect's services. In addition to the choice-of-law provision, which provided that the contract was governed by the laws of the state of Daly's principal place of business, the agreement contained the following provision in Article 11.3.

As between the parties to this Agreement: as to all acts or failures to act by either party to this Agreement, any applicable statute of limitations shall commence to run and any alleged cause of action shall be deemed to have accrued in any and all events not later than the relevant Date of Substantial Completion of the Work, and as to any acts or failures to act occurring after the relevant Date of Substantial Completion, not later than the date of issuance of the Final Certificate of Payment.

Construction on the Harbor Court project began in mid-1984, and the Final Certificate of Substantial Completion was issued on September 11, 1987. Aside from some minor chipping and cracking in the outer brick veneer, the facility existed without any problems until April 1996. At that time, a 15-foot square area of brick "exploded off" the face of the building. According to the experts retained following the "explosion," the facility had "fundamental and latent defects in design and construction." The "brick explosion" occurred more than 3 years after the issuance of the Final Certificate of Substantial Completion.

HCA/Murdock originally filed suit against the general contractor on September 20, 1996, in the Circuit Court for Baltimore City. The suit was removed to the U.S. District Court for the District of Maryland, and the contractor joined its subcontractors. The architect, Daly, was eventually added to the lawsuit. HCA/Murdock's allegations against Daly were based on negligence and breach of contract and indemnity.

Daly asked the court to enter judgment in its favor, contending that HCA/Murdock's lawsuit was barred by the statute of limitations. Daly argued that pursuant to Section 11.3 of the parties' contract, the September 11, 1987, date of the issuance of the Final Certificate of Substantial Completion was the date Maryland's 3–year statute of limitations began to run. As a result, Daly contended that the action filed by HCA/Murdock was time barred.

The district court sustained Daly's motion under the law of Maryland and held that because the cause of action accrued in September 1987 by contract, HCA/Murdock's claim brought in 1996 was beyond the 3-year period allowed.

HCA/Murdock's argued against the enforceability of Section 11.3 of the AIA contract. It stated that Maryland courts apply the "discovery rule," which holds that a cause of action accrues when the [plaintiff] in fact knew or reasonably should have known of the wrong. Therefore, to enforce the contractual provision of Section 11.3 would violate the public policy of the State of Maryland. HCA/Murdock's position was that the "discovery rule," as applied in Maryland, had attained the status of public policy, and the parties were not free to contract that public policy away.

Under HCA/Murdock's argument, the statute of limitations would not begin to run until April 1996, because the "defect" was "latent." Since it was a latent defect, HCA/Murdock neither knew, nor could it have known, of the defect prior to April 1996 when the failure actually occurred. On the date of the failure, HCA/Murdock would have "discovered" the defect, the wrong would have become known, and the statute would begin to run. Thus, the lawsuit would have been timely if it was filed any time prior to April 1999. As a result, the suit filed against Daly, HCA/Murdock argued, was well within the limitations period.

HCA/Murdock also claimed that since Daly was based in Nebraska, that under the choice-of-law provision in the contract, the law of Nebraska should have been applied to determine the enforceability of Article 11.3 in the dispute instead of the law of Maryland, as used by the district court.

On appeal, the Federal Court of Appeals, Fourth Circuit, agreed with the district court and Daly. It agreed that Maryland applied the "discovery rule." In fact, the court noted that a review of the case law in Maryland revealed that at one time, Maryland had applied the rule that the cause of action accrued on the "date of the wrong," regardless of the injured party's knowledge of the wrong.

The court noted that Maryland had found that the "date of the wrong" rule sometimes resulted in a party forfeiting a cause of action before it even knew the wrong had been committed (as would be the case in this dispute). The court explained that to alleviate this situation of "blameless" ignorance, the Maryland courts, like many other states, developed and applied the "discovery rule."

The court of appeals acknowledged that if the provisions of 11.3 were enforced, the parties would "circumvent" the "discovery rule." The court found that the State of Maryland had not explicitly prohibited the parties from reaching a different agreement. The court framed the issue before it as being whether, under Maryland law, an attempt by sophisticated parties to contract around a rule developed for the protection of the blameless and unwary is unenforceable as against public policy.

The court first acknowledged the commitment in Maryland to protecting an individual's efforts to structure their own affairs through contract. As a result, the court concluded that the State of Maryland would not prevent the parties from contracting around the state's rule on the establishment of the date the statute of limitations begins to run. The court noted as follows.

This is especially true where, as here, the parties to the agreement are sophisticated business actors who sought, by contract, to allocate business risk in advance. That is, rather than rely on the "discovery rule," which prolongs the parties' uncertainty whether or if a cause of action will lie, the parties to this contract sought to limit that period of uncertainty by mutual agreement to a different accrual date.

The court responded to the argument that the benefit of the provisions of 11.3 were unbalanced in favor of Daly, an argument often advanced in opposition to such risk allocation clauses. It pointed out that even if the provisions of 11.3 only benefited Daly, when the contract was being negotiated, HCA/Murdock was free to reduce the compensation it was willing to offer the architect or even to hire a different architect. The court went on:

... HCA/Murdock are sophisticated business actors that determined, in the unfettered exercise of business judgment, that the bargain they received from [Daly] was adequate consideration for the surrender of the discovery rule's potential advantages. Now, having received the benefit of their bargain, [HCA/Murdock] wish to obtain by appeal to "public policy" considerations the benefit of Daly's as well. We are confident that the Maryland high court would not allow them to do so.

The Fourth Circuit also found that the only courts which had, at that time, considered a contractual accrual date provision had each enforced it. See the following cases.

• Old Mason's Home of Kentucky, Inc. v Mitchell, 892 SW2d 304 (Ky App 1995)
• Orinskany Cent. School Dist. v Edmund J. Booth Architects, 206 AD2d 896, NYS2d 160 (NY App Div 1994), aff'd 85 NY2d 995, 630 NYS2d 960, 654 NE2d 1208 (NY 1995)
• Keiting v Skauge, 198 Wis2d 887, 543 NW2d 565 (Wis App 1995)

The court then turned to the questions of whether Nebraska law should have been applied, and, if so, would the result have been different. Though the court thought the issue presented a "substantially closer question" under Nebraska law, the provisions of 11.3 were enforceable even under Nebraska law.

The reason the issue was thought to be a much closer question under Nebraska law was that, for over 100 years, Nebraska had refused to enforce any contractual provision purporting to alter the limitations period provided by statute by holding that such provisions were against public policy. In the Harbor Court case, the court of appeals concluded that the provision at issue governs not the time in which an action, once accrued, may be brought, but rather establishes the moment at which such an action accrues. The court found these to be distinct concepts. After further analysis, the court concluded that the provisions of 11.3 were equally enforceable under Nebraska law.

The Harbor Court case reinforces the freedom of commercially sophisticated parties to allocate their risk by contract and to have some assurance that the courts will not disturb that allocation. The accrual provision in AIA 11.3 may not provide a way to manage the risks of liability to third parties, strangers to the contract, but it does allow the management of risk presented by certain claims.