Contracting Diseases: Mishaps in contract drafting, limitation of liability edition

One of the problems I regularly encounter with new clients is that they have come to me too late to do the most good. This frequently happens in the area of drafting contracts relating to their business or project. Many people say they want a “simple” contract, or they think they know what they’re signing, or that they trust the other party to the deal, so they don’t need to overthink what they’re doing. A recent decision by a Federal Court in Indiana demonstrates how costly this kind of “penny-wise” thinking can be.

SAMS Hotel Group, LLC set out to build a new hotel. Unfortunately, the architecture firm the company retained to provide the design work for the project apparently did not employ or even consult with a registered professional structural engineer for the project. The county building officials later found structural design defects, which resulted in the condemnation of the structure and its ultimate demolition before the hotel ever opened its doors to the public.

SAMS sued its architect, Environs, Inc. The trial court held that Environs breached the applicable standard of care by failing to involve a structural engineer and for failing to timely inspect the project during construction. SAMS proved damages in the amount of $4.2 million.

Now the story turns truly tragic for the developer. Environs incorporated a clause in its contract with SAMS that sought to limit its liability:

The Owner [SAMS] agrees that to the fullest extent permitted by law, Environs/Architects/Planners, Inc. total liability to [SAMS] shall not exceed the amount of the total lump sum fee due to negligence, errors, omissions, strict liability, breach of contract, or breach of warranty.

SAMS, as the “Owner” under the applicable contract, paid Environs a lump sum fee of $70,000. The court enforced this limitation of liability provision and held that SAMS could recover only $70,000 of its $4.2 million loss, even though the source of Environs’ liability arose out of negligence rather than a breach of the parties’ contract. The United States Court of Appeals for the Seventh Circuit affirmed the trial court’s ruling. It noted, under Indiana law, that sophisticated parties aren’t entitled to protection from even the apparently unfair terms of the contracts they sign:

[T]he general rule of freedom of contract includes the freedom to make a bad bargain.

Parties are free to enter into any kind of contract they like, but just know that if you assume you are sophisticated enough not to need a lawyer’s assistance with your contract, the court just might agree with you and hold you to what you signed.

The complete order of the Federal District Court for the Southern District of Indiana can be read here.

The complete opinion of the Seventh Circuit Court of Appeals can be read here.

Matt Drewes contributed this article. Matt is a Shareholder with Thomsen Nybeck.  He is the head of the firm’s eight-member Community Association Representation Group and the firm’s Creditors’ Remedies Group, and practices in the areas of business and real estate litigation and transactions, employment law, construction litigation, community association law, debtor/creditor law, and insurance. He has been included in the annual list of Minnesota’s Rising Stars for several years, and has been quoted in print publications such as the Minneapolis StarTribune, Minnesota Lawyer, Habitat Magazine, and on various websites including Yahoo!Finance.com, Bankrate.com, MSN.com, HOALeader.com, and elsewhere on issues involving construction litigation, community associations, and real property issues. He can be reached at mdrewes@tn-law.com or by phone at 952.835.7000.

Minnesota Supreme Court Reverses Court of Appeals; Gives Advice On How to Preserve Claims and Avoid Spoliation (An Update on Miller v. Lankow)

On February 25, 2010, I first wrote about the case of Miller v. Lankow.  At the time, I explained why the Minnesota Court of Court of Appeals’ decision that upheld the district court’s dismissal of the plaintiff’s case seemed extreme and inconsistent with existing law.  (Read that post here).  The Minnesota Supreme Court apparently agreed, and on August 3, 2011 it reversed the dismissal and sent the case back to the district court for further proceedings.  (Read the Minnesota Supreme Court’s Opinion here).

Without going into too much detail, the facts of the case involve a property owner who discovered water intrusion problems, which the seller claimed to have fixed, were still causing problems and resulted in mold and other damage.  The buyer provided notice to the seller and the contractors who were involved that he had discovered these defects and that he would pursue legal action if the parties did not reach a resolution.  Several parties attended an inspection at the property where they had the opportunity to view some of the damage.   The contractors and former owners knew they might be sued, but they did not request the ability to conduct further investigation into the cause or extent of the damage.  The owner later repaired the damage without telling the defendants exactly when he planned to start.

After the owner sued the property sellers and contractors for construction defects, water intrusion, fraud and a seller’s failure to disclose defects, the defendants claimed they were not given a sufficient opportunity to inspect the cause and extent of the damage.  They asked the district court to exclude the evidence the plaintiff gathered because they claimed they did not have a similar opportunity to review the same evidence before it was removed and destroyed.  The district court agreed, ordering that the plaintiff may not use any evidence of the defects and damage that the defendants did not see, which was a sanction for “spoliation” (i.e., destroying evidence).  Without this evidence, the plaintiff had no case, and the district court concluded that the case must be dismissed.  The plaintiff appealed to the Minnesota Court of Appeals, which held that the district court had not abused its discretion by sanctioning the plaintiff and dismissing the case.

The concern the Court of Appeals’ decision raised for me was the notion that, even if the defendants have notice of the claim of damage and the potential for litigation, the plaintiff might still have to wait to make repairs to his home while the defendants seemed to be in no particular hurry to investigate the claims against them.  Sometimes, particularly where water intrusion is at issue, prompt repairs are necessary to avoid further property damage and even personal injury.

The Minnesota Supreme Court agreed that legitimate concerns about destroying evidence before others have had a chance to inspect it must be weighed against the reasonableness of asking the party in control of the evidence to maintain it.  The Supreme Court held that, as has always been the case, the party with custody of evidence has a “duty” to preserve relevant evidence to permit other parties to inspect the evidence for use in litigation.  It also remains true that  party who breaches this duty may be sanctioned for spoliation, whether or not the breach was committed intentionally or in bad faith.

But a custodial party’s duty to preserve evidence is not boundless.

*     *     *

[T]he duty to preserve evidence must be tempered by allowing custodial parties to dispose of or remediate evidence when the situation reasonably requires it.

The Court identified a three-factor test for evaluating a case of spoliation:

“(1) the degree of fault of the party who altered or destroyed the evidence; (2) the degree of prejudice suffered by the opposing party; and (3) whether there is a lesser sanction that will avoid substantial unfairness to the opposing party and, where the offending party is seriously at fault, will serve to deter such conduct by others in the future.”

(citing Schmid v. Milwaukee Electric Tool Corp., 13 F.3d 76, 79 (3d Cir. 1994)).  “[S]anctions are not appropriate when the custodial party has a legitimate need to destroy evidence, and it appears from the totality of the circumstances that noncustodial parties have received sufficient notice to protect themselves by taking steps to inspect or preserve the evidence and nevertheless do nothing.”

The Court went on to offer recommendations to avoid a sanction for spoliation.  Ideally, an owner will call a meeting or send a letter “indicating the time and nature of any action likely to lead to destruction of the evidence, and offering a full and fair opportunity to inspect.”  Obviously, any notice of the meeting or of an offer to inspect should be in writing.

People might be amazed to realize that this issue is just one hurdle to sustaining a successful case for construction defects.  There also are notice requirements under certain statutory warranties (as well as other requirements to satisfy prior to commencing suit), as well as statutes of limitation which differ from claim to claim and the little-known statute of repose.  There also are agreements by which a party may have reduced the time during which it has to raise a claim for construction defects.  To help navigate the issues that exist, parties should consult with an attorney knowledgeable in the area of construction and construction defects.  At Thomsen Nybeck, we know these issues, and we can help.  Find out more at www.tn-law.com or call us at 952.835.7000.

Entry by Matt Drewes.  Matt Drewes is a Shareholder with Thomsen Nybeck.  He is the head of the firm’s nine-member Community Association Representation Group and co-leads the firm’s construction litigation group.  Matt practices in the areas of business and real estate litigation, construction litigation, community association law, debtor/creditor law, insurance and employment.  He has been quoted in articles appearing in the Minneapolis StarTribune, Minnesota Lawyer, and on websites such as Yahoo!Finance.com, Bankrate.com and HOALeader.com, and has been included in Minneapolis/St. Paul Magazine’s list of Rising Stars for several years.  He can be reached at mdrewes@tn-law.com.

Hard Lesson For Property Owner: Fixing Your Leak Risks Sinking Your Case.

The Minnesota Court of Appeals dealt a heavy blow to property owners on December 22, 2009. 

The case is Miller v. Lankow, 776 N.W.2d 731 (Minn. Ct. App. 2009).  In it, the Court of Appeals held that Miller’s claims of defective construction and fraudulent efforts to conceal those defects should be dismissed because he fixed the damage to his home. 

The issue is called spoliation (that’s not a typo, but the concept is akin to “spoiling” evidence).  The goal in preventing spoliation is to ensure that parties in litigation are not hindered in their ability to respond to someone else’s claims by being denied the ability to investigate evidence in another’s sole possession or control.  For example, in a construction defect case, such as Miller, spoliation can arise when the property owner repairs damage without first telling the responsible party about the potential claim the owner has against that party. 

At about the time this case was decided, I addressed this very subject in an interview with www.HOAleader.com when they called me to talk about construction defect issues in common interest communities.  It’s a pay site, but you can read a free version of the article here.  The rule is simple, if you’re going to fix your problem (a reasonable desire, especially when the problem is a water leak), you must first alert the parties allegedly responsible for the damage. 

The concept of providing notice to the defendants of the alleged defects is not new.  This actually happened in Miller, which is what makes the outcome so shocking.  The defendants in this case knew plaintiff’s allegations, and they knew they were likely to be sued.  But they were in fact rewarded for their apparent refusal to investigate Miller’s clear claims that there were defects, and that the defects were fraudulently concealed.  The notice of the owner’s claims has not historically required notice of the specific work to be performed or of the specific date the work would occur.  The Court of Appeals has now changed this. 

The Court of Appeals held that the owner’s failure to tell the parties of his plans to repair the mold and rot created by ongoing water leaks was cause to deny him the opportunity to present any evidence of those conditions at trial.  The decision to exclude photographs, testimony, and other evidence of the mold and rot present in the walls of Miller’s home was fatal to his claims, and the case was dismissed for lack of evidence.  The dissenting judge leveled a blistering criticism at the majority for enhancing the burden on plaintiffs, particularly under the facts of the Miller case, saying that the majority judges were “simply wrong.”

I do not know whether Miller could have proven his case even with all the evidence at his disposal.  There may have been no defects and no fraud.  The point, however, is that Miller was denied the opportunity to present his evidence.  This case stands now as the perfect example of why we continue to advise clients that a well-crafted letter should be provided to potential defendants in even the most simple construction dispute or case of alleged misrepresentation.  If you own or manage residential or commercial property, and you believe your property suffers from defective construction, faulty repairs, or your seller failed to disclose a problem with the property, contact Thomsen Nybeck to make sure you clear all the hurdles.

Entry by Matt Drewes.  Matt Drewes is a Shareholder with Thomsen Nybeck.  He is the head of the firm’s 10-member Community Association Representation Group and co-leads the firm’s construction litigation group.  Matt practices in the areas of business and real estate litigation, construction litigation, community association law, debtor/creditor law, insurance and employment, and has been included in Minneapolis/St. Paul Magazine’s list of Rising Stars for several years.  He can be reached at mdrewes@tn-law.com.