by

Lawrence W. Falbe, J.D.

Partner, Quarles & Brady LLPFormer Adjunct Professor of Environmental Law, Northwestern University

Lessons from the Courts: How to Limit Your Professional Liability

• Importance of Legal Principles in Limiting Professional Liability

• Hypotheticals based on Reported Decisions

• Final Thoughts

Overview

• Economic Loss Rule (Moorman)• Contractual Limitations on Liability

(monetary)• Reliance / Privity• Standard of Care• Proving Damages

Key Legal Principles

Hypothetical #1 – Economic Loss

Client wishes to investigate the possibility of contamination on a prospective property purchase. Consultant proposes to Client to perform a Phase I at a cost of $5000. Consultant performs the Phase I, which reveals no Recognized Environmental Conditions (RECs). Client buys the property in reliance on the Phase I, but during construction, several unknown leaking USTs are discovered. Consultant is sued by Client claiming Consultant should have identified the existence of the USTs before Client purchased the property.

Consultant denies its Phase I was faulty, but in any event claims that it is liable for nothing more than the cost of the Phase I. Consultant argues that at worst, it failed to provide what it promised the Client, a competent Phase I report. Therefore Client’s damages are limited to $5000.

Is Consultant’s defense successful?

Hypothetical #1 - DiscussionIs Consultant’s defense successful?

Answer: It depends on the type of legal claim… and on what jurisdiction you are in.

Hypothetical #1 - DiscussionIf Client sues simply for breach of contract, Client can recover for only the benefit of the bargain, the value of which was $5000.

However, Client claims that it would not have purchased the property had it known of the leaking USTs… or, at least investigated further to estimate the costs of clean-up and subsequently tried to bargain down the price with the Seller. Client’s damages are not simply limited to the value of the contract with Consultant.

Solution: Client amends its Complaint to add a claim for Professional Negligence.

Hypothetical #1 - Discussion

Solution: Client amends its Complaint to add a claim for Professional Negligence.

Consultant Responds: Nope, nice try, but claims for professional negligence are barred by the Economic Loss Rule- known in Illinois as the Moorman Doctrine:

“When the defect is of a qualitative nature and the harm relates to the consumer’s expectation that a product is of a particular quality so that it is fit for ordinary use, contract, rather than tort, law provides the appropriate set of rules for recovery.”

For example, an engineer who negligently builds a bridge (something tangible) cannot be held liable for professional negligence; only for breach of contract – the damages being the value of the bridge, not any consequential damages flowing from the negligent design.

Hypothetical #1 - Discussion

However, Moorman is inappropriate where a professional relationship results in something intangible. A great many businesses involve an exchange of information as well as of tangible products.

In Tribune Company v. Geraghty & Miller, 1997 WL 438836 (N.D. Ill. July 25, 1997), Tribune Company sued Geraghty & Miller for failure to identify asbestos-containing materials after completing a Phase I ESA, which were identified in a later investigation by a different consultant.

Hypothetical #1 - DiscussionThe court held, “The contract between the Tribune and G&M defined the scope of the assessment to be performed and required G&M to produce a tangible report outlining G&M’s findings and conclusions. Nevertheless, the ultimate result of the relationship between the Tribune and G&M was something intangible. Like a legal brief, financial statement, or termite inspector’s report, the value of G&M’s services lies in the analytical work summarized in the environmental assessment report, not in the report itself. Unlike architectural or engineering plans, G&M’s report was not meant to result in any tangible structure, the characteristics of which could easily be embodied in contractual terms.”

Hypothetical #1 - DiscussionSimilarly, in Neumann v. Carlson Environmental, 429 F. Supp. 946 (N.D. Ill. April 20, 2006), Carlson conducted a Phase I ESA and a subsequent subsurface soil investigation to determine in USTs had impacted the property. Carlson determined that the soil did not contain any VOCs in excess of Illinois TACO limits, but a subsequent investigation by a different consultant identified several different VOCs in excess of TACO limits on the property. The property owner had to agree to remove the USTs, remediate the soil and deposit $300,000 into an escrow account to cover any further needed remediation.

Hypothetical #1 - DiscussionCarlson was sued and argued that the claim for professional negligence was barred by the Moorman doctrine. Following the Tribune case, the court held that Carlson’s particularized knowledge and expertise gave rise to a duty independent of contract with plaintiffs (its professional duty to provide an accurate environmental assessment) and because the primary service provided to plaintiffs was intangible, the Moorman doctrine does not bar a claim for professional negligence based on professional malpractice by an environmental consultant.

Hypothetical #1 - DiscussionDoes Moorman apply in other states? Yes, but they don’t call it Moorman, which was a specific Illinois case, so it is referred to generically as the “economic loss doctrine.”

A majority of jurisdictions follow the reasoning of the Tribune and Neumann courts.

See, e.g., Brandsmart USA of West Palm Beach, Inc. v. Della Ratta, Inc., 2003 WL 23926113 (S.D. Fla. December 3, 2003), where BrandSmart sued consultant Qore for allegedly defective Phase I, court held that “the economic loss rule does not bar a cause of action against a professional for his or her negligence even though damages are purely economic in nature and the aggrieved party has entered into a contract with the professional’s employer.”

But see Iron Partners, LLC v. Dames & Moore, 2009 WL 1587898 (W.D. Wash. June 8, 2009), holding that economic loss doctrine would apply to professional negligence claims based on allegedly defective Phase I report.

Hypothetical #2 – Monetary LimitationsConsultant, knowing now that it can be sued for professional negligence and that the economic loss doctrine exposes it to liability for negligence potentially far beyond the value of the contract, wants to figure out another way to limit its liability to a client if it messes up.

Solution: Consultant inserts a contractual limitation of liability into its standard Terms & Conditions in its contract with prospective clients that states that Consultant disclaims any and all warranties and is not responsible for any damages to client resulting from any errors or omissions in the report.

Consultant is then sued and raises the contractual limitation of liability as a defense.

Is Consultant’s attempt to disclaim all liability successful?

Hypothetical #2 - DiscussionIs Consultant’s attempt to disclaim all liability successful?

Answer: Probably not.

Reasoning: Most courts will hold that a limitation of liability is unenforceable if it violates public policy. Exculpatory provisions in professional service contracts are contrary to public policy because such clauses “are antithetical to a professional service relationship.” An exculpation clause is a contractual provision relieving a party from any liability resulting from a negligent or wrongful act. 66 WMD Associates, LLC v. Melick-Tully & Associates PC, 2011 WL 3503160 (N.J. Super. A.D. August 11, 2011).

Hypothetical #2 - DiscussionOkay – what about a limitation of liability that does not completely exclude damages for liability, but limits the monetary amount?

Answer: It depends. Courts first will look at the limitation of liability in terms of dollar amount in relation to the contract price to see if there is still an incentive to properly perform the contract. They will also look at the relative sophistication and bargaining position of the parties.

Hypothetical #2 - DiscussionIn 66 VMD Associates, VMD contracted with Melick-Tully & Associates (MTA), to perform several investigations and remediation costs estimates. MTA’s standard Terms & Conditions included the following paragraph:

14.1 Many risks potentially affect MTA by virtue of entering into this Agreement for Consulting Services on behalf of the Client. The principal risk is the potential for human error by MTA. For Client to obtain the benefit of a fee which includes a nominal allowance for dealing with MTA’s liability, Client agrees to limit MTA’s liability to Client and to all other parties for claims arising out of MTA’s performance of the services described in this Agreement. The aggregate liability of MTA will not exceed $25,000 for negligent professional acts, errors or omissions…

Hypothetical #2 - DiscussionFor the particular contract at issue in 66 VMD Associates, the client VMD had paid $19,826.35 to MTA. VMD sued MTA, claiming professional negligence. MTA raised the liability limitation provision as a defense and claimed that VMD’s damages were capped at $25,000. VMD countered that the limitation on liability clause was unenforceable as against public policy, and was impermissible in professional services contracts.

Hypothetical #2 - DiscussionHeld: Public policy does not disfavor limitations of liability in professional services contracts, at least where there is no significant disparity in bargaining position between the two parties. The court stated that the contracts were “negotiated and executed between two experienced and knowledgeable parties.” Moreover, the $25,000 limitation of liability “provided ample motivation for MTA to perform diligent work because it exposed MTA to damages…. $5,000 in excess of its entire fee.”

Hypothetical #2 - DiscussionDiscussion Points: What would have happened if the client had not been a sophisticated real estate developer, experienced with hiring consultants and negotiating professional services contracts?

What if the fee paid had ended up being in excess of the limitation ($25,000) – what if, in fact, the fee paid was $50,000. Might the judge have ruled that it was the practical equivalent of an exculpation clause? (Consider - Was that limitation specifically negotiated or was that a “boilerplate” limit that just happened to work out in this case?)

Practice Tip: Ensure that any specific liability limitations are comfortably in excess of the value of the contract, to provide the “sufficient economic compulsion” to complete the work diligently. Often, limiting liability to the value of the contractor’s professional liability insurance is acceptable by clients.

Hypothetical #3 – Reliance/PrivityConsultant knows that environmental reports such as Phase Is often fall into the hands of persons other than the client who contracted for and paid for the report. Consultant therefore next tries to limit its liability (at least to third parties) by making sure that the contract for its Phase I services states very clearly that the report is for the exclusive use of the party who hired it (the “Client”). Consultant expressly states that only the Client may rely on the Phase I that will be produced, and that express written authorization by Consultant is required before any other party can rely on the Phase I (and theoretically sue Consultant for professional negligence). Consultant states this in the contract Terms & Conditions but also inserts it into the text of each environmental report it produces.

Is Consultant’s scheme to limit liability only to the Client legally effective?

Hypothetical #3 – DiscussionIs Consultant’s scheme to limit liability only to the Client legally effective?

Answer: Generally yes. Most courts will uphold a contractual limitation on who is entitled to rely on a professional report.

“Absent privity of contract, or the functional equivalent of privity of contract… entities have no right to recover from Impact [the consultant] either for breach of contract or professional negligence.” Southern Wine & Spirits of America v. Impact Environmental Engineering, 104 A.D.3d. 613 (N.Y. Sup. Ct. 2013). “Further, the parties’ agreements contained a clause in which Impact disclaimed any intention to benefit third parties, and there is no evidence of any provisions in the parties’ agreements granting enforceable rights to any entity other than Impact.”

Hypothetical #3 – Discussion

In Grand Pier Center LLC v. ATC Group Services, 2008 WL 4933971 (N.D. Ill. Nov. 14, 2008), Raymond Chin, a principal of RM Chin and Associates (RMC) was the managing member of Grand Pier LLC, an entity formed to purchase property in the Streeterville area of Chicago. RMC (not Grand Pier) contracted for a Phase I ESA from ATC.

ATC’s Phase I allegedly did not identify a former gaslight mantle manufacturer that used radioactive thorium on the subject property and over 10,000 tons of radioactive contaminated soil had to be removed from the Grand Pier site. Grand Pier LLC sued ATC for professional negligence. ATC argued that its contract was with RMC, not Grand Pier (even though they were related parties) and that ATC owed no duty to Grand Pier given that a reliance limitation was included in the RMC contract.

Held: Grand Pier was not a foreseeable user of the Phase I report and had no right to rely on the report.

Hypothetical #3 – Discussion

Interestingly in the Grand Pier case, ATC had granted Grand Pier permission to rely on a Phase II report it had prepared (but not the Phase I). Grand Pier tried to argue that permission to rely on one report constituted permission to rely on all of the reports involved in the case. The Court found no evidence in the language of the reports to support this argument and rejected it.

Hypothetical #3 – Discussion

Food for Thought: In Mercy Center, Inc. v. JLC Environmental Consultants, Inc., 2005 WL 4441855 (N.Y. Sup. Ct. Dec. 12, 2005), the court deemed a sub consultant (Advanced Cleanup Technologies) who performed ground-penetrating radar services for consultant JLC, to have potential liability to plaintiff Mercy Center, who hired JLC, even though there was no contract between Mercy and Advanced.

Hypothetical #3 – Discussion

Held: The Mercy Center court stated, in finding potential liability against Advanced under the theory of negligent misrepresentation:

“This is not a case where the defendant is being sued by a member of the public at large, who happened to rely on figures, statistics, or facts which the defendant prepared while oblivious to the existence of the relying party. Advanced was retained by JLC to conduct a radar survey of a particular parcel of real property. It cannot be denied as a matter of law that Advanced possessed a clear understanding that such a survey was being performed preparatory to reliance by some party having an ownership interest, or responsibility, vis-a-vis the surveyed property…. The law does not require that Advanced knows the precise name of the individual, just that it knows there exists such an individual, whose use of the report is… the end and aim of the transaction.”

Hypothetical #3 – Discussion

Caution: Some courts have found that liability can be imposed on a consultant even in the absence of contractual privity (typically the tort of negligent misrepresentation) where there is:

1) an awareness by the maker of the statement that it is to be used for a particular purpose;2) reliance by a known party on the statement in furtherance of that purpose; and3) some conduct from the maker of the statement linking it to the relying party and evincing its understanding of that reliance.

Ridge Seneca Plaza v. BP Products North America, 2008 WL 5244014 (W.D.N.Y. Dec. 16th 2008).

Hypothetical #3 – Discussion

Caution: Be aware of actions that can cause the appearance of a “special relationship” that could lead a party (and a court) to believe that it could reasonably rely on the consultant’s advice, even in the absence of a contractual relationship (and typical disclaimers).

Consider: What might a court rule if Consultant was hired to do a Phase I by the owner of a property, and then was asked to discuss the results with a prospective buyer – even if the buyer does not pay for a reliance letter, or potentially ever receive a copy of the Phase I? Could the prospective buyer bring a claim against Consultant even if no privity of contract existed?

Practice Tip: Resist the temptation to “be a good consultant” and – even if requested by your Client -- discuss the results of a Phase I with anyone else who might be able to make a claim that they relied to their detriment on your work.

Hypothetical #3a – Reliance Letters

Consultant’s policy is that if a third party wants to rely on its work, it will issue a “Reliance Letter” for $500 that will entitle the recipient to fully rely on the Phase I just as if the third party had originally commissioned it (as provided under ASTM 1527-13, section 4.6).

Consultant provides such a letter to a third-party for a previously issued Phase I that is still viable under E1527-13. However, the third-party then claims it relied on the report to its detriment and sues Consultant for malpractice, claiming $2,000,000 in damages.

Consultant defends on the basis that the original Terms & Conditions in the contract for the Phase I limits its liability to $50,000. Is Consultant’s defense legally valid?

Hypothetical #3a – Reliance Letters

Consultant defends on the basis that the original Terms & Conditions in the contract for the Phase I limits its liability to $50,000. Is Consultant’s defense legally valid?

Answer: Maybe (probably) not. Anecdotally, a Texas trial court ruled that where a consulting firm agreed to sell a copy of its Phase I report (identifying no RECs) to a prospective developer for a property for $180, and buried drums and battery cases were discovered, the court held that the developer was not bound by the contractual limitations in the original contract with the original client. Moreover, since the consultant charged the developer a fee (albeit a nominal fee), the court held that the consultant owed the developer the benefit of their professional expertise. Settlement costs were reportedly close to $1,800,000. Legally, this result should probably be expected where the developer paid value to the consultant and had no way to be apprised of the original terms of the contract.

Hypothetical #4 – Standard of CareConsultant was retained to perform a Phase I ESA on a property located next to a public park. Consultant, under cost pressures to perform competitive Phase Is, begins using an intern to help with Phase I investigations. Consultant sends Intern out alone to do the site visit. Intern sees nothing constituting a REC and the Phase I otherwise identifies no RECs. It turns out later that a municipal landfill was present under the public park, and some of the waste had been disposed of over the lot line onto the subject property. There was no visible evidence of the former landfill. Consultant is sued for professional negligence for failure to identify the former landfill and recommend Phase II testing.

Consultant defends by stating that the ASTM E1527-13 practice does not require that the environmental professional to conduct the site visit himself or herself.

Is conformance to the ASTM Phase I standard an absolute defense against professional negligence?

Hypothetical #4 – Standard of Care

Is conformance to the ASTM Phase I standard an absolute defense against professional negligence?

Answer: It’s something of a trick question. In this scenario, we can’t say the Intern was unqualified as a rule, since the Phase I standard states that “the interviews and site reconnaissance shall be performed by a person possessing sufficient training and experience necessary to conduct the site reconnaissance and interviews in accordance with this practice, and having the ability to identify issues relevant to recognized environmental conditions in connection with the property.” E1527-13 sec. 7.5.1

It really depends on the person’s training and capabilities, intern or not.

Hypothetical #4 – Standard of Care

It really depends on the person’s training and capabilities, intern or not – but also what actions the person took or did not take, irrespective of their training/experience.

So, how do we evaluate that? In the context of a lawsuit for professional negligence, it will probably turn on expert testimony concerning the industry standard, as applied to the specific facts of the case.

See, e.g., Watco v. Pickering Environmental Consultants, Inc., 2007 WL 1610093 (Tenn. Ct. App. June 5, 2007). In Watco, the “intern” was a college graduate who had just received a bachelor of science degree in physics, and performed the site visit after two weeks of training by the environmental professional, Mr. Pickering.

Hypothetical #4 – Standard of Care

Mr. Williams, an expert for the plaintiff testified regarding the standard of care that should apply in the case, and focused on several aspects of the Pickering Phase I, including whether conducting interviews of nearby property owners would have revealed anecdotes of the former landfill, and whether the search of county record had been sufficiently thorough.

However, Mr. Williams admitted on cross examination that there was nothing observable on the site visit in terms of the existence of the former landfill (it was, after all, three feet below the surface) that would have indicated to anyone, regardless of experience, that a recognized environmental condition existed on the subject property as a result of the former landfill.

Hypothetical #5 – Proving DamagesDespite Consultant’s best efforts and diligence, Consultant is sued by Client, who alleges that failure to identify contamination on a piece of property has resulted in significant monetary damage to the Client. Client claims that had it known of contamination that Consultant’s investigation should have identified, it could have avoided buying the property, negotiated a lower purchase price, asked the seller to conduct remediation, or various other actions that it could not take.

Consultant, backed into a corner, says “prove it.”

Is Consultant successful?

Hypothetical #5 – DiscussionIs Consultant successful?

Answer: Maybe – it depends entirely on the facts. But here’s what to look for:

In Chartis v. Aqua Services Engineers, Inc., 2014 WL 2730442 (N.D. Cal. June 16, 2014), Lowe’s Companies hired consultant Aqua Sciences Engineers (ASE) to perform Phase I services, and subsequent Phase II testing, for a prospective store site. After the purchase closed (for $26 million), Lowe’s discovered significant contamination on the property, resulting in cleanup costs of $1,050,103. Chartis, Lowe’s insurer, paid the cleanup costs and then sued ASE as Lowe’s subrogee.

AES argued to the jury that Chartis had no evidence that Lowe’s would not have consummated the transaction even if it had known about the contamination and no evidence that Lowe’s would have paid any less for the property had it known. In short, there was no evidence that Lowe’s would have done anything differently.

Hypothetical #5 – DiscussionHeld: Lowe’s failed to prove it suffered any damages as a result of “relying” on the ASE report.

While witnesses for Lowe’s testified that they “relied” on the ASE report, none of them were able to explain what the course of that reliance was. While Lowe’s testified that it waited for the Phase I report to close on the property, there was no testimony that about what Lowe’s would have done if it had known the report was inaccurate. Lowe’s representatives admitted they were not necessarily surprised to find out the property was contaminated. Lowe’s also admitted that in the overall scope of the project ($26 million), $1 million for remediation costs was not something Lowe’s considered significant. There was no testimony that Lowe’s would not have purchased the property, tried to negotiate a lower purchase price (and that such an agreement would have been possible), or even that Lowe’s would have extended its due diligence period to conduct further investigation.

1. Under ASTM, there are only two possible conclusions to a Phase I: Either there are no Recognized Environmental Conditions, OR, there are no Recognized Environmental Conditions except for ___________.

2. Stick to rendering an opinion on whether there are RECs, HRECs, CRECs or de minimis conditions. Do not use non-ASTM-language such as “environmental concerns” or “environmental issues.”

3. Do not caveat or modify statements regarding RECs such as “there are no Recognized Environmental Conditions that would have a negative impact on the property.”

Final Thoughts

4. Do not use “weasel” language such as “there does not appear to be any clear evidence of recognized environmental conditions.”

5. Where possible, avoid giving non-ASTM opinions such as “we believe the property is suitable for commercial development.”

6. Don’t assume T&C for a Phase I carries over to the Phase II.7. Think twice before issuing a reliance letter to pick up a few

extra bucks, and if you do, include the original terms and conditions (or include new ones) to limit your liability in the same way as the original contract.

Final Thoughts