Anti-Indemnity Statutes: A Threat to Limitation of Liability Clauses?

By K&L Gates attorneys Richard F. Paciaroni and Janet M. Serafin

Limitation of liability clauses are frequently relied upon in design and/or construction contracts to manage risk by limiting the damages recoverable from contractors and design professionals.  Historically, these clauses have generally been upheld, particularly when the contracting parties are both sophisticated entities.  However, a growing concern over the trend of design professionals requiring contracting partners to indemnify them, despite the former’s own negligence, caused most states to adopt anti-indemnity statutes.  What remains somewhat uncertain is how these anti-indemnity laws affect the enforceability of limitation of liability clauses.  Two recent cases have invalidated a limitation of liability clause under the relevant anti-indemnity statute.  While these cases still represent the minority view, they beg the question of the prudence of continued reliance on such clauses, particularly in jurisdictions which have not yet ruled on the issue.

CAUSE FOR CONCERN:  CASES INVALIDATING LIMITATION OF LIABILITY CLAUSES

The leading case invalidating a limitation of liability clause under an anti-indemnity statute is City of Dillingham v. CH2M Hill Northwest, Inc., 873 P.2d 1271 (Alaska 1994).  In City of Dillingham, the Alaska Supreme Court found that Alaska’s anti-indemnity statute prevented parties from bargaining away liability to any extent.  In so holding, the critical observation by the court was that the Alaska legislature had considered – and rejected – an amendment to the anti-indemnity statute that would have explicitly exempted limitation of liability clauses.  Therefore, the court concluded that the scope of the anti-indemnity statute extended beyond its plain language to include limitation of liability clauses.  A limitation of liability is thus void and unenforceable under Alaska law.

Similarly, in an unreported case, Omaha Cold Storage Terminals, Inc. v. The Hartford Ins. Co., No. 8:03CV445, 2006 WL 695456 (D. Neb. Mar. 17, 2006), the United States District Court for the District of Nebraska held that a provision limiting a party’s liability for its own negligence to $100,000 violated Nebraska’s anti-indemnity statute, which prohibits indemnification for one’s own negligence.  The court concluded that any clause insulating or limiting a person’s liability for its negligent acts violated Nebraska’s public policy and anti-indemnity statute.

These two cases clearly represent the minority view on this issue, but because not all jurisdictions have considered the validity of limitation of liability clauses under the state’s relevant anti-indemnity statute, the possibility exists that other states may follow City of Dillingham in voiding such provisions.

FREEDOM TO CONTRACT AND THE MAJORITY VIEW

In the majority of cases to consider the issue, limitation of liability clauses have been upheld under the anti-indemnity laws.

In 1995, the Third Circuit examined whether Pennsylvania’s anti-indemnity statute applied to a contractual clause limiting an architect’s liability to $50,000.  Valhal Corp. v. Sullivan Assoc., Inc., 44 F.3d 195 (3rd Cir. 1995).  Noting that “the terms of the statute pertain only to indemnity and hold harmless provisions,” the court concluded that the anti-indemnity statute had no applicability to the limitation of liability clause.  In so holding, the court noted the difference between indemnification, which holds the indemnitee harmless from all liability, and a limitation of liability, where the amount of liability is merely capped.  Additionally, the court explained that while indemnity clauses are disfavored in Pennsylvania and are therefore subject to stringent standards, limitation of liability provisions are not disfavored and likewise are not subject to stringent standards.  The court concluded that, “[s]o long as the limitation which is established is reasonable and not so drastic as to remove the incentive to perform with due care, Pennsylvania courts uphold the limitation.”  Valhal Corp., 44 F.3d at 204.  Therefore, the court found that the limitation of liability clause did not violate Pennsylvania’s anti-indemnity statute.

Likewise, an appellate court in New Mexico recently enforced a limitation of liability clause which was challenged under New Mexico’s anti-indemnity statute.  In Fort Knox Self Storage v. Western Techs., 142 P. 3d 1 (N.M App. Ct. 2006), the court held that limitation of liability clauses are distinct from indemnification clauses because “there is a significant difference between contracts that insulate a party from any and all liability and those that simply limit liability.”  Fort Knox, 142 P.3d at 6.  The court noted that the amount of the limitation of liability was a significant factor in the court’s decision to uphold the clause.  Quoting Valhal Corp., the court found that clauses limiting liability are “enforceable as long as they are ‘reasonable and not so drastic as to remove the incentive to perform with due care.’”  Id.  The court concluded that the liability cap, which was many multiples of the fee that the engineering firm was paid by its client, left the firm “exposed to substantial damages” and did not negate its liability.

Similarly, in Long Island Lighting Co. v. Imo Delaval, Inc., 668 F.Supp. 237 (S.D.N.Y. 1987), the district court in New York held that a limitation of liability clause for injuries to persons or property is valid under New York’s anti-indemnity statute.  The court explained that the anti-indemnity statute “proscribes exempting contractors from liability for injuries to persons or property.”  While the parties’ agreement exempted the defendant from liability for economic losses, “the [a]greement merely limits [defendant’s] liability [for injuries to persons or property].”  (Emphasis in original.)  Therefore, the court upheld the limitation of liability provision as valid and enforceable.

An unpublished case from the Ninth Circuit similarly considered whether Washington’s anti-indemnity statute barred the enforcement of a limitation of liability provision.  In Kelly v. Heron Ridge, Inc., 16 Fed. Appx. 695 (9th Cir. 2001), the court upheld the limitation provision.  Like the cases discussed above, in so holding, the Ninth Circuit distinguished between indemnifying against liability and merely limiting liability.

In a recent case addressing the validity of a limitation of liability clause between an engineering firm and the owner of an apartment complex, the Georgia Court of Appeals found that the clause was enforceable because it violated neither public policy nor Georgia’s anti-indemnity statute.  Lanier at McEver, L.P. v. Planners & Eng’rs Collaborative, Inc., 646 S.E. 2d 505 (Ga. App. 2007).  In so holding, the court joined the majority view in distinguishing a limitation of liability clause from a “full release” or exculpatory provision.  The court noted that, “the damages limitation clause in the instant case does not exculpate [the engineering firm] from any wrongful conduct or release them from liability.  Instead, it merely limits the amount of damages [the apartment complex owner] may recover from [the engineer].”

In addition to case law which distinguishes limitation of liability provisions from anti-indemnity statutes, some states, like California, have specific statutory exceptions to the anti-indemnity statute for limitations of liability.  When the California Legislature enacted its anti-indemnity statute, it also enacted an exception which explicitly permits parties to continue to limit their respective liability to each other.  In Markborough California, Inc. v. Superior Court, 227 Cal. App. 3d 705 (1991), the California Court of Appeals considered whether a limitation of liability clause fell within the exception to the anti-indemnity statute.  The court held that “a provision in a construction contract limiting a party’s liability to the developer of the property for damages caused by the engineer’s professional errors and omissions is valid under [the exception to the anti-indemnity statute] if the parties had an opportunity to accept, reject or modify the provision.”

Moreover, states where a limitation of liability provision has not been challenged under the anti-indemnity laws continue to uphold limitations of liability unless they are unconscionable or otherwise void by public policy.  For the time being, at least, these states recognize the practice of contractually allocating risk through liability limitations.

The court holdings a that limitation of liability is distinct from indemnity is the majority view in the United States.  This majority approach recognizes that there is a difference between indemnification, which removes the incentive to act with due care, and a limitation of liability, which merely allows parties to allocate risk through contract and, assuming that the limitation is reasonable, does not remove the incentive to act with due care.

ENGLISH APPROACH TO LIMITATIONS ON LIABILITY AND INDEMNIFICATION

Generally, under the laws of England, the position that parties to a contract may freely agree to the obligations that they are prepared to accept extends to liability exclusion and limitation of liability clauses.  As a general rule, the courts do not tend to find indemnity clauses to be invalid unless they are deemed to be “unreasonable.”  However, under the Unfair Contract Terms Act 1977 (“UCTA”), liability for death or personal injury due to one’s negligence can never be excluded by a contractual provision.  These losses or damages arising out of a party’s negligence may be excluded by an indemnity clause or limited subject to a “reasonableness” test.

Under the language of the UCTA, any “restriction” or limitation of liability is treated the same as an “exclusion.”  Hence, limitations of liability for damages arising out of a party’s negligence for death or personal injury are void under the UCTA.  However, the UCTA does not preclude limiting liability for negligent acts other than death or personal injury, subject to a reasonableness test.

CONCLUSION

The majority view in the United States is that limitation of liability clauses are not barred by state anti-indemnity laws.  It is probable that jurisdictions which have not yet addressed this issue will follow the majority.  However, due to the significant importance placed by contractors and design professionals on limiting liability as a risk allocation device, the uncertainty of the law in this area in many jurisdictions is unsettling.  While it is unlikely that the untested jurisdictions would follow City of Dillingham, based on Alaska’s unique legislative history, one unpublished opinion in Nebraska has already done so, and it is impossible to say with certainty that no other court will do likewise.

In jurisdictions which have specifically upheld limitations of liability provisions under anti-indemnity laws, or where the legislature has included an explicit exception for limitation of liability provisions, one can feel confident that such limitations will continue to be upheld.  While there is reason to believe that limitations of liability provisions will continue to be upheld in these jurisdictions, this uncertainty should be met with caution on the part of contracting parties and prudence dictates that design professionals and contractors consult with their attorneys to assess the likelihood that a limitation of liability clause in any specific contract will be upheld.

As discussed above, the basic rationale behind anti-indemnity statutes is that liability for negligent acts provides an incentive for parties to act with care, and indemnity removes that incentive.  Therefore, limitation of liability clauses are most likely to be upheld when the liability for which the contracting party remains responsible is sufficient to serve as an incentive to make the party act with due care.  As a result, contracting parties should be certain that the limitation of liability provision in a contract is reasonable, or risk running afoul of the public policy expressed in the anti-indemnity statutes.