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February 21, 2014
In a recent 5-4 decision, the Washington Supreme Court cast doubt on a company's ability to limit its liability for economic losses arising out of a contract dispute. The court allowed a property owner to sue an engineering firm for lost profits even though the parties' contract barred such recovery.
In Donatelli v. D.R. Strong Consulting Engineers, the Donatellis hired an engineering firm to help them develop vacant land they owned in King County.
The project did not go according to plan and the real estate market collapsed before the project was completed. When the Donatellis lost their property through foreclosure, they sued the engineering firm for more than $1.5 million in lost profits.
The engineers asked the trial court to dismiss the big-dollar negligence claims because the parties' contract contained a provision limiting the engineering firm's liability to the amount of its fee for “any injury or loss on account of any error, omission, or other professional negligence.” The engineers had offered to waive this limitation for a modest additional fee, but the Donatellis declined.
In past decisions, the Washington Supreme Court explained that under the “economic loss rule,” a plaintiff could not recover damages for negligence when the parties' relationship was based on a contract and the plaintiff suffered only economic damages, not personal injuries or property damage.
In a nearly identical 1994 decision, the Supreme Court rejected a negligence claim against an architect and engineer who were blamed for causing construction delays and cost overruns. The court held that parties can contractually limit liability for economic losses arising from construction delays.
In its recent decision, however, the court focused on events that occurred before the contract was signed, specifically the engineers' estimate of the project's cost and timing.
As with many construction contracts, it took longer and cost more than originally estimated. Such possibilities are usually addressed in the contract through specific completion dates, written change orders, liquidated damage clauses and, yes, liability limitations. Yet the court ruled that the engineers had a duty independent of the parties' contract to not make negligent misrepresentations.
The court did not rule that the engineers were liable, only that the case could proceed in the trial court on a theory that the engineers could be liable if they made negligent misrepresentations that induced the Donatellis to enter into the contract in the first place.
As a result of this decision, engineering, architectural, construction, and other professional service companies may now face damage claims they thought they were contractually protected against. This area of the law continues to evolve. In the interim, businesses can take some steps in an attempt to protect themselves from negligence claims:
Integration clause. A well-drafted integration clause could help reduce the risk of a court finding tort-based duties outside the parties' written contract.
Representations. The contract should expressly state that neither party relies on the other party's representations before entering the contract, and that each party had an independent opportunity to evaluate the contract and relies solely on its own conclusions.
Allocation of economic loss. Despite the court's ruling, the contract should still spell out that the parties have negotiated the risk that either party may suffer economic loss and allocated the risk according to the terms of the contract.
Choice-of-law. Although not possible in many transactions, contractually selecting another state's law to govern the contract — presumably a state with the clarity Washington lacks — may avoid Washington's uncertainty in this area.
Insurance. Engineers, architects and other professionals should have adequate professional liability insurance, though the court's decision will likely cause premiums to increase.
Scott A. Smith is a business and real estate lawyer at Riddell Williams, where he chairs the firm's Litigation Practice Group. James H. Wendell is an associate at Riddell Williams, and a recent graduate of the University of Washington School of Law, where he was editor-in-chief of the Washington Law Review.