Thursday, June 27, 2013

Seventh Circuit Considers Relationship of Contractual Liability Cap, Economic Loss Rule and Contractual Indemnification

Seventh Circuit Considers Relationship of Contractual Liability Cap,
Economic Loss Rule and Contractual Indemnification

       In a recent decision of the United States Seventh Circuit Court of Appeals, it considered how to apply a contractual provision limiting one party to a contract maximum liability against both the economic loss doctrine and state law limiting contractual indemnification terms.  In this case, the Court found that the contractual limit on maximum liability would be enforced, and that a failure to do so would, in effect, undercut the economic loss rule.  SAMS Hotel Group, LLC v. Environs, Inc., __ F.3d __, 2013 WL 2402824 (7th Cir. May 31, 2013).
      SAMS Hotel Group, LLC entered into an architectural agreement with Environs for the design of a hotel.  That contract provided for a fee of $70,000 and as well contained a provision providing, inter alia, that the maximum damages that could be available to the land owner would be that $70,000 fee.  The building was constructed, nearly completely, when it was discovered that numerous defects existed such that it had to be demolished.  The owner brought suit against the architect claiming $4 million in damages.
      Sitting in diversity, the District Court struck the owner’s claims for negligence, finding them to be barred by the economic loss rule, i.e., the plaintiff cannot recover for economic damages asserted in tort where a contract governs the relationship of the parties.  2011 WL 809048.  Having dismissed that count, there was a bench trial on the breach of contract claim, in which the owner prevailed.  However, having prevailed, he was limited to recovering the $70,000 fee and, consequent to that cap, nothing beyond that.  2012 WL 3139765.  He then appealed to the Seventh Circuit.
      Applying Indiana law, the Seventh Circuit wrote:
The general rule of freedom of contract includes the freedom to make a bad bargain.  2013 WL 2402824, *6.
      Based upon the fact that the contract was entered into between sophisticated commercial entities with equal bargaining power (i.e., it did not involve a consumer contract or a contract of adhesion), the Court of Appeals enforced the maximum liability provision of the agreement.  The Court reasoned that ignoring the contractually agreed to maximum liability would permit an end-run around the economic loss rule.  With respect to the effort to recharacterize the liability cap as a contractual indemnification, the plaintiff’s theory being that contractual indemnification must “clearly and unequivocally” shift liability for another party’s simple negligence, the Court found that the liability cap would not be so interpreted.  Rather, while liability caps “serve to establish a contractual ceiling” on the damages that may be awarded, indemnification works to insure a party against his own negligence.  2013 WL 2402824, *3.  Ergo, the two would not be treated as distinguishable, and the heightened standard applied to indemnification clauses will not be applied to liability caps.

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