Every contract allocates risk, but not all contracts allocate risk equitably or in such a way that it also allocates the authority to manage the risk. A design firm should have a realistic understanding of the risks that might have an impact on the firm’s delivery of services and long-term financial health. In assessing the level of risk, the firm may face, it must objectively and subjectively determine if the firm’s resources, abilities, and authorities can manage the risks.
Some risks cannot be easily quantified; others are beyond a design firm’s ability to manage. When a design firm evaluates a project and client, it must identify and negotiate a fair allocation of risks.
If the design firm and client reach an understanding that a particular risk on a project is one over which the design firm has no direct control, then that risk should continue to be the client’s risk. Or if a particular risk would have such an adverse impact that the fee for the design firm’s services is disproportionate to the risk, the firm and client can agree to limit the design firm’s risk. In addition, the agreement could include the client protecting the design firm against third-party claims by defending and indemnifying the firm for any costs, losses, or damages from such claims.
Risk allocation can work in several ways. While clients often demand to shift risks away from them to the design firm or contractor, in many situations the risks should stay with the client. The logical principle is that each risk should generally be borne by the party best able to control and insure against that risk. Parties to a contract should acknowledge their respective duties and agree to the necessary authority and compensation to permit the discharge of their respective responsibilities.
On many projects, there is a disparity between the potential risks the client wants the design firm to assume and the amount of control the design firm has over those risks. In addition, the compensation may not be adequate to allow the design firm to use the appropriate practice management techniques to minimize the risk or to compensate it for the business decision of assuming the risk.
There are a variety of ways to achieve a fair allocation of liability risk on a contractual basis between a design firm and client. These contractual devices fall into two broad and sometimes interrelated categories, described below.
Indemnification obligations
The design firm could be defended against any claims and indemnified for any costs, including expenses, losses, or damages to it caused by risks beyond the firm’s control. Thus, if one party brings a meritless claim against the design firm, the indemnification provision could protect the firm and pay for the significant costs and non-billable time caused by such a claim.
Limitation of liability provisions
If risks are disproportionately high in comparison to the fee or ability of the design firm to control the risk factors, or if the design firm encounters unique risks or those for which no insurance is available, the liability to the client could be waived or limited.
Before negotiating any risk allocation provision, the design firm should consult with legal counsel to determine whether the suggested language is legally enforceable in the applicable jurisdiction and what risks the language transfers or limits. As a rule, courts will strictly construe the language of a limitation of liability clause or indemnification provision against the party seeking the benefit of the contractual obligation so such provisions must be specific and unambiguous.