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Legalese: Liquidated damages and indemnities

Legalese Signing up to contract clauses that insurers will not cover is signing a blank cheque, says Mark Klimt

Two of the commonest clauses that Design and Build contractors seek to foist upon architects are also often the hardest to resolve: liquidated damages and indemnities.

Blanket indemnity provisions, stipulating that the consultant shall indemnify the client against all claims and other losses arising from the consultant’s default, are sought in many appointments. They can be found both for specific losses, such as those arising from breach of copyright, and for broader exposure resulting from any default in the consultant’s performance of its services. But these indemnities are harder to dislodge from contracts with contractor-clients, which are themselves likely to be subject to indemnities in their contract with the employer. This seems to strengthen the argument that, once a breach by the consultant is established, the consultant should accept all itsconsequences and make reparation.

Consultants’ typical insurance policies either expressly exclude liabilities arising under indemnity clauses or do
so implicitly by offering protection for liabilities legally flowing from breach of professional duty but not for liabilities going beyond that. The perennial problem with indemnities is that they could involve exposure for losses that go beyond what would otherwise legally flow.

Aside from a technical limitation that could extend liability, the main issue is the nature of the attracted losses. In English contract law, there are rules governing what can be claimed against a party upon breach of contract, with some losses being too remote and irrecoverable because they are not considered to have been within the reasonable contemplation of the parties when they entered the contract. Also, there is an implied obligation on a party suffering loss to take steps to mitigate it, rather than allowing the consequences of the breach to continue unabated. Arguably, where a client has the benefit of an indemnity, that obligation is ousted and, furthermore, the client is entitled to recover all loss embraced by the indemnity wording. Nor would there be any incentive on the client to reduce its losses if it knows that it has the benefit of a comprehensive indemnity from its consultant.

The response, therefore, to a client that argues that an indemnity is perfectly fair because the consultant should stand behind the consequences of its actions, is to confirm that the consultant is prepared to stand behind those legally enforceable consequences, but not prepared to sign, and does not have insurance for, a blank cheque for possible breaches, without reflecting the accepted rules of legal recoverability.

The arguments for and against penalty/liquidated damages are similar. A contractor will commonly have a liquidated damages clause in its building contract with the employer and will seek an equivalent clause in its consultant’s appointment. But this ignores the difference between contractors’ and consultants’ loss cultures, reflected in the general exclusion of such losses from consultants’ insurance policies. A typical insurance wording will exclude liability for liquidated damages, save to the extent that liability would have existed in the absence of such a clause. So insurers’ criteria involve what would generally be recoverable at law, regardless of any other wording that their insured consultants might have agreed. In the case of liquidated damages clauses, there are two criteria.

First, it must be demonstrated that the clause was triggered by the consultant’s breach of professional duty. Second, the level of liquidated damages must not exceed the losses that would anyway be recoverable in law as a result of such breach. Anything beyond that should be resisted in contract negotiations because it will be deemed a penalty and won’t be backed by insurance.

Indemnities and liquidated damages clauses are indeed often difficult issues to resolve in contract negotiations, but at least architects can, hand on heart, trot out the old cliché: ‘Sorry, but my insurers…’

Mark Klimt is a partner at Fishburns. He is legal adviser to the RIBA and operates the RIBA Legal Helpline

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