At a time when those in the construction industry are murmuring about green shoots and a possible upturn in activity, the terms of construction contracts and in particular the allocation of risk between parties are coming into sharp focus. There is a balance to be struck between the legitimate interests that contractors and consultants have in protecting their business and the employer’s expectations that it will have recourse to its construction team for mistakes. Where this balance sits between the parties will depend upon the sector, the project, and the financial climate.
Given the margins construction firms are operating with, increasing numbers of claims and the growing influence of international organisations (who may own a growing number of consultancy firms and have a different approach to risk), when negotiating contracts, one of the points often discussed between parties is the inclusion of financial caps on liability in construction contracts and appointments.
Points for Consideration
The three aspects to consider with regards to a financial cap are: (i) the level, (ii) the basis (each and every claim or in the aggregate) and (iii) the exclusions. Often parties focus on the level of the cap whereas focusing on the basis and the exclusions may allow a compromise to be reached more quickly.
Caps on liability may be expressed in different ways – for example as a lump sum, as a multiple of fees or by reference to the level of PI insurance maintained. On this last point, an employer should be wary of this. If the relevant party fails to maintain its PI insurance or lowers the level then the level of the cap may diminish significantly.
Parties often set a cap at the level of and on the same basis as the professional indemnity insurance to be maintained under the contract or appointment. Whilst this may be sensible it is worth reiterating that these are separate and distinct clauses. An obligation to maintain a certain level of professional indemnity insurance does not, in itself, act in any way to limit a party’s liability.
An employer may wish to exclude the following from the cap on liability: wilful default or abandonment, litigation costs and insurance monies. It may, for example, be more cost effective for a contractor to choose to walk away and pay the amount its liability is capped at than complete the project and face other losses. It should also be noted that liability for personal injury or death caused by negligence cannot be capped.
It important to check whether a cap on liability covers all related contracts or whether it is “stand alone”. For example, if there is a cap in an appointment which is then re-stated in collateral warranties granted pursuant to the appointment, the granters may find that they are providing a fresh cap on liability to each counterparty (rather than there being one cap on liability that applies to the whole project).
Current Market Practice
Our experience of the current market is that engineering firms (in particular the larger practices) will often seek a financial cap on liability: often based upon a multiple of their fee (indeed this is envisaged in the Association of Consulting Engineers’ standard terms and conditions.
Clients (and their funders) will generally resist this but may accept a cap on liability set at the level of, and importantly, on the same basis as the required professional indemnity insurance. Whilst it is understandable that consultants feel they should not be exposed to a huge liability for a modest fee, it is difficult to persuade a client that the party designing the foundations and structure of, for example, a £20million office building will have a maximum liability of, for example, £3million if it falls down. Obviously, it is not just engineers seeking caps on liability - other professions will also press for limitations on liability.
Market practice for contractors will largely depend upon the sector: broadly speaking, contracts for construction projects based on SBCC/JCT standard building contracts do not tend to include an overall cap on liability and the SBCC/JCT standard building contracts only contain provision for express caps on liability in relation loss of use, loss of profit and other consequential losses flowing from design defects. Liquidated damages for delay may also act as a limit on liability for the contractor.
For more complex projects (particularly large scale public sector projects or engineering and infrastructure projects), then it is more common see a an overall limit on liability at, for example, the Contract Price or a percentage of the Contract Price but subject to certain exclusions for example those mentioned above. The actual percentage is likely to depend upon the contract value and the contractor’s balance sheet: what can it bear? The NEC3 contract for example has option X18 which contains an overall cap on liability subject to limited exclusions (e.g. liquidated damages, loss to the Employer’s property, which is a separate cap).
Any limitation on liability should be carefully considered and assessed based on where the risks of the project lie and who is best placed to take responsibility for them, whether it is acceptable to cap or limit liability for any of those risks and, what insurances would best assist all parties from the effects of those risks if the worst should happen.