Appointing an architect – Professional Indemnity Insurance and Contractual Limitation of Liability

Marcus Saunders, Senior Account Director, features in Constructing Excellence South West’s ‘Guide to appointing an architect’, which has recently been published.  The guide has been produced to assist those in the construction sector and looks at 10 key considerations including definitions of appointment, copyright, insurance and more.

In the guide, Marcus shares his insight on professional indemnity insurance and the contractual limitation of liability, and his article is reprinted below.

When mistakes are made on construction sites things can quickly become heated and expensive.

Clients facing costly remedial works and reduced profit margins will be anxious to claw back whatever they can from contractors or consultants.

But what happens when more than one party is to blame? Take, for example, a developer commissioning a new block of flats. The engineer could have been negligent in designing part of the structure. However, an architect responsible for the overall design may have negligently incorporated the engineer’s mistakes into its plans.

The basic legal position is that, whether or not a party is responsible for 100% of the client’s losses, the client can choose to sue any of the parties at fault for 100% of its losses.

If this happens, it is possible to retrospectively try and recover a share of those losses from other consultants who are at fault under the Civil Liability (Contribution) Act 1978. This however is usually expensive and time-consuming. Worse still, if the fellow consultants have gone bust, there will be no further cause of action.

Professional indemnity insurance is purchased to defend the consultant from claims where a client has incurred a financial loss. Professional indemnity insurance is the last line of defence and all consultants should actively endeavour to restrict the liability in the contractual documents, including appointments and collateral warranties.

Under any contractual agreement the consultant can try and exclude or limit liability during negotiations. Liability can be excluded for, amongst other things: negligence, misrepresentation, quality and fitness for purpose and consequential losses. Certain liabilities, however, can never be excluded, such as liability for personal injury, death, fraud or defective goods under the Consumer Protection Act 1987.

Consequential losses are losses which do not arise naturally from the breach of contract or breach of professional duty. Instead they arise from special circumstances which the negligent party was aware of at the time. Excluding consequential losses from agreements will leave the consultant liable only for losses directly caused by the consultants’ breach of duty.

It is unlikely that any client will allow a full exclusion of liability and the two most effected contractual limitations for the consultant is the inclusion of a net contribution clause or a limitation of liability clause.

The effect of a net contribution clause is that each individual consultant would only be held responsible for their own “fair and reasonable” or “just and equitable” share of the loss. So, if the engineer was 80% responsible and the architect was responsible for the remaining 20% share of the loss, each consultant would only be liable for their proportion. In order for the client to recover all of its losses in full, the client or the beneficiary of any applicable warranty would need to sue all parties.

Unfortunately, the client may be reluctant to agree such a clause in the contract negotiations as the effect is that, if one of the consultants went bust, they are unable to pursue the remaining consultants for all of their loss. They would be taking on the ‘insolvency risk’ themselves.

One counter argument is that it is the client who puts the team together and so the client is in a position to choose members of the team who are likely to be financially sound. The consultant simply inherits the team the client has put together.

Net contribution clauses were considered unlikely to be upheld in domestic projects out of concern that they might fall foul of protective consumer legislation. In a recent legal case, the comments indicated that a properly worded net contributions clause in a domestic contract might be upheld.

If a net contribution clause is not acceptable, a liability cap may be more acceptable to clients and ensures that any one consultant is not on the hook for unlimited losses. The main objective is to ensure that the professional indemnity insurance limit of indemnity is not exceeded, and the client and consultant agree to an amount that the client is satisfied provides reasonable protection. This additionally allows the consultant to budget for the expense of maintaining the professional indemnity insurance at an agreed level and also for a designated number of years, typically 12 years in commercial contracts.

Some consultants, instead of limiting the liability to the level of professional indemnity insurance, link their liability to the total fee earned on the project.

If the clients is implacably opposed to any form of limitation of liability, particularly to a net contribution clause and the consultant is satisfied that negotiations in that regard have come to an end, the consultant should seek written confirmation from the client that no other member of the team has such a limitation on liability. Any one consultant should not want to be the conspicuous party that has not limited its liability. Sensibly, the consultant should have a paper trail to show that it did try to limit its exposure.

With all of these scenarios, it should be remembered that, the extent to which you can successfully include them boils down to the respective parties’ negotiating positions.

Consultants are advised, therefore, to negotiate robustly at the outset to include net contribution clauses or liability caps into their contractual documents. Whether or not they will be successful depends on the strength of the bargaining positions of each party.

Download Constructing Excellence’s ‘Guide to appointing an architect’ by clicking here.