Ambiguity Does Not Doom a Limitation of Liability Clause

Facts of the Case

An architect, Johnson Nathan Strohe, P.C. (the "Architect"), designed an apartment building in Denver, Colorado. The Architect contracted with MEP Engineering, Inc. (the "Engineer"), to provide the mechanical, plumbing, and electrical engineering services for the building. The Engineer drafted the subconsulting contract and sent it to the Architect for execution. The Architect executed the contract with no edits.

The contract between the Architect and Engineer had the following provision:

Limitation of Liability: In light of the limited ability of the Engineer to affect the Project, the risks inherent in the Project, and of the disparity between the Engineer's fees and the potential liability exposure for problems or alleged problems with the Project, the Client agrees that if the Engineer should be found liable for loss or damage due to a failure on the part of MEP-ENGINEERING, INC., such liability shall be limited to the sum of two thousand dollars ($2,000 or twice the Engineer's fee whichever is greater) as consequential damages and not as penalty, and that is liability exclusive.

When the new apartment building neared completion, problems were discovered with the heating and plumbing. The Engineer designed and implemented changes and repairs. Subsequently, the Architect discovered more problems requiring repair. The Architect hired a different engineer to help resolve the newly discovered problems.

Despite efforts to resolve the issues, the owner of the apartment building filed a claim in arbitration against the Architect to recover for problems with the heating and hot water systems in the building. The Engineer was not a party to the arbitration. The arbitrator awarded the owner $1.2 million in damages to the owner against the Architect.

The Architect then sued the Engineer, alleging negligence in the design of the heating and hot water systems, and sought to recover the amount the owner was awarded against the Architect in arbitration: $1.2 million.

In the Architect's lawsuit, the Engineer raised the limitation of liability clause in the agreement between the Architect and the Engineer. The Engineer argued to the trial court that its liability could not exceed "the sum of $2,000 … or twice the Engineer's fee whichever is greater."

In response, the Architect raised several arguments hoping to convince the trial court to not enforce the limitation of liability clause. First, the Architect argued the limitation of liability clause was "too vague, confusing, and ambiguous" to be enforceable. The Architect further argued that the repairs for which it sought recovery fell outside the scope of the contract, and as a result, the damages from these repairs were not subject to the cap found in the limitation of liability clause. The Architect also argued the limitation of liability clause did not address the sort of fees or costs it sought to recover.

The trial court disagreed with the Architect and found the limitation of liability clause to be "unambiguous and enforceable."

The Engineer moved to deposit with the trial court funds equaling twice its contractual fee, in keeping with the limitation of liability clause's language, plus interest. Coupled with this, the Engineer asked for the trial court to dismiss the Architect's lawsuit. The trial court agreed and dismissed the lawsuit with prejudice.

The Architect appealed, and two issues merit a closer look. First, the Architect argued the trial court was wrong, and the clause was ambiguous. Second, because the limitation of liability clause was ambiguous, it should not be enforced.

Was the Limitation of Liability Clause Ambiguous?

The Colorado Court of Appeals agreed with the Architect that the limitation of liability clause was ambiguous. The primary intent of a court's interpretation is to determine and then carry out the intent of the parties. To do that, a court must look at the entire agreement and not just clauses or phrases in isolation.

In its review, the Colorado Court of Appeals concluded the trial court did not account for the language in the limitation of liability clause talking about "consequential damages." When accounting for the consequential damages language, which is a legal term of art, the court concluded the limitation of liability clause was ambiguous.

The Colorado Court of Appeals explained that "consequential damages" are legally distinct from "actual damages." The court said that the limitation of liability clause may "only appl[y] to consequential damages" or perhaps all damages under the engineer's contract are considered consequential damages, or maybe even the parties were not using the clause in its legal meaning. Regardless, these questions could not be answered on the face of the agreement.

To add to the confusion, the Colorado Court of Appeals noted that the limitation of liability clause also said that liability under the clause was "exclusive," which means what? Though the Engineer argued the "consequential damages" language and the "liability exclusive" language was merely "unartful" phrasing, the court could not tell without more.

The conclusion of the Colorado Court of Appeals was that the clause was not clear and unambiguous, so the trial court's finding was reversed. The trial court would need to do more to determine what it was the parties intended to agree to.

Unenforceable Exculpatory Clause

Arguing further, the Architect argued that if the limitation of liability clause was not expressed in clear and unambiguous language, then it must be void because exculpatory clauses are only enforceable if they are expressed in clear and unambiguous language.

The Colorado Court of Appeals made a significant distinction. Exculpatory clauses completely shield one party from liability for its negligence. However, this limitation of liability clause still exposed the contracting party, the Engineer, to a bargained-for level of liability.

The Colorado Court of Appeals explained why exculpatory agreements are subject to such strict review: Exculpatory clauses are a complete bar to liability, and society wants to hold entities responsible for their negligence. If that responsibility is completely negated by a contract designed to absolve one of the parties from the consequences of its own negligence, there is a danger that the standards of conduct that the law has developed for the protection of others may be diluted.

On the other hand, a limitation of liability provision is generally enforceable. Limitations of liability leave the party that claims to benefit from the protection of a limitation of liability clause exposed to a bargained-for level of liability. Supporting this conclusion, the Colorado Court of Appeals noted other courts have found a significant difference between contracts that insulate a party from all liability and those that simply limit liability.

In this case, the clause in the Engineer's contract was not an exculpatory clause. The limitation of liability clause did not shield the Engineer completely or nearly completely from the consequences of the Engineer's liability. Because it was not an exculpatory clause, this limitation of liability clause was not subject to the strict review that an exculpatory clause would be. Instead, the court held this limitation of liability provision should be construed using the ordinary principles of contract interpretation.

The Colorado Court of Appeals agreed with the Architect that the limitation of liability clause was ambiguous. However, like other ambiguous contract provisions, the meaning is a question of fact that courts must determine using ordinary methods of contract interpretation.

Limitation on the Holding

This holding is limited. This case involves parties that in the eyes of the law are "sophisticated." Strong policy considerations allow sophisticated parties, like businessowners, to allocate risk among themselves. Had one of the parties to this limitation of liability clause been a consumer, such as a residential homeowner, the outcome would not have been the same, and the clause probably would not have been enforced.

Lessons Learned

A multitude of lessons can be garnered from this case.

• Ensure that contract provisions, especially those subject to close judicial scrutiny, are drafted with precision. Avoid legal jargon unless both parties fully understand the terms. Consider including definitions for clauses to prevent ambiguity.
• Always read the agreement carefully. While it's unclear if the architect in this case did so, it's evident that no edits were made. Taking the time to review the contract thoroughly can prevent future issues. It is advisable to have legal advisers review the agreement, even for small projects, as they can lead to significant claims.
• When signing agreements with clauses that shift or limit liabilities, it is crucial to understand their implications. Determine whether the language is exculpatory, merely a cap on liability, or if the cap is so low that it effectively becomes exculpatory.
• Last of all, recognize the nature of the parties involved. Different rules and obligations apply depending on whether you are dealing with sophisticated commercial entities or consumers.