Standard of Care and Indemnity Clauses: The Contract Language That Voids a Design Firm's Coverage

What is the standard of care and why does the wording matter?

The standard of care is the legal measure of your professional obligation, and the insurable version of it is the care and skill ordinarily exercised by members of your profession practicing under similar circumstances in the same locality at the same time. Professional liability policies are written to cover failures to meet that standard. Contracts frequently attempt to raise it, using language like highest standard, best practices, in accordance with the most stringent applicable requirements, or free from defects and errors. Any of those creates an obligation above ordinary negligence, and a breach of a heightened standard may be found even where you were not negligent, which means your insurer may decline to cover the resulting liability. That is not a technicality. It is the difference between a covered claim and a personal one.

• Insurable language: the care and skill ordinarily exercised by similar professionals under similar circumstances.
• Uninsurable language: highest standard, best, defect-free, error-free, warranty, guarantee.
• Watch for warranties of fitness for a particular purpose slipped into scope descriptions.
• Watch for certifications that certify facts you cannot verify, which become warranties in practice.
• Proposed edit: strike heightened language and restate the ordinary standard of care expressly.

Which indemnity language is insurable and which is not?

The insurable indemnity is narrow. A provision requiring you to indemnify the client for losses to the extent caused by your negligent performance of professional services tracks what your policy covers. Two common variations do not. Broad form indemnity, requiring you to indemnify the client for any claim arising out of the project regardless of who was negligent, obligates you for the client's own fault, which policies exclude and many states restrict by statute. And an indemnity that includes the client's attorney fees and defense costs as a duty to defend creates an immediate obligation to fund defense before any determination of fault, which professional liability policies generally do not cover because the duty arises from contract rather than from negligence.

• Insurable: indemnity limited to damages caused by your negligent acts, errors, or omissions.
• Problematic: any indemnity for claims arising out of or related to the work regardless of fault.
• Problematic: a duty to defend, which triggers before fault is determined.
• Problematic: indemnity for consequential damages, lost profits, or delay.
• Many states have anti-indemnity statutes limiting these clauses; they vary considerably by jurisdiction.

How do defense costs inside the limit change your economics?

Dramatically, and most firms underestimate it. Professional liability for design firms is almost always written with defense costs inside the limit, meaning every dollar spent defending you reduces the money available to settle. A construction defect case with expert witnesses, destructive testing, and multiple parties can consume 200,000 to 500,000 dollars in defense before a mediation. On a 1,000,000 dollar policy, that means half the limit may be gone before the negotiation starts. Two practical responses. First, size the limit with defense in mind, which for firms doing institutional or multifamily work usually means 2,000,000 dollars or more rather than the 1,000,000 dollars an owner's minimum requires. Second, understand the deductible structure, and look for a policy with a reduced deductible when a claim is resolved through mediation, which many carriers offer as an incentive.

What about limitation of liability and waiver of consequential damages?

These are the two clauses that protect you, and they are worth more than an extra million of limit. A limitation of liability clause caps your total exposure on the project, commonly at your fee, at a multiple of your fee, or at a stated dollar amount, and courts in most jurisdictions enforce them between sophisticated commercial parties. A mutual waiver of consequential damages removes the client's ability to claim lost profits, lost rent, loss of use, and delay damages, which are usually the largest and least insurable components of a claim. Public owners often refuse both, and institutional owners frequently negotiate. The practice worth adopting is asking for both in every proposal as standard terms rather than treating them as an unusual request, because a clause you never requested is one you certainly will not get.

• Limitation of liability capping total exposure, often at fee or a multiple of fee.
• Mutual waiver of consequential damages, including lost profits, delay, and loss of use.
• A mutual limitation is easier to negotiate than a one-sided one.
• Confirm the cap survives and is not undermined by a broad indemnity elsewhere in the agreement.

What contract obligations create uninsurable exposure?

Several, and they cluster in the schedule, the budget, and the certifications. A promise to complete design by a date certain creates liability for delay that professional liability does not cover, since delay damages are typically excluded. A promise that construction cost will not exceed a stated budget creates a guarantee, and cost estimating claims are excluded or sublimited on many forms. Certifications of completion, of code compliance, or of payment applications create representations you may not be able to support, and courts sometimes treat them as warranties. Agreements to provide services outside your professional scope, such as means and methods, site safety, or construction management, pull you into exposures that belong to the contractor and that your policy may exclude.

• Schedule guarantees and liquidated damages for design delay.
• Cost estimate guarantees and any promise that construction cost will not exceed a figure.
• Certifications that certify compliance or completion rather than professional opinion.
• Assumption of site safety responsibility, which belongs to the contractor.
• Requirements to name the owner as additional insured on professional liability, which carriers rarely permit.

Ready to review your design firm program and contracts?

If your last five contracts were signed without a review of the standard of care and indemnity language, that is where your uninsured exposure is sitting. Grandbay Financial Services reviews design firm programs alongside the agreements they support. Book a review at calendly.com/grandbayfinancial.