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1800 Ocotillo, LLC v. The WLB Group, Inc.: Arizona Supreme Court Upholds Liability-Limitation Clauses

Commercial Transactions Litigation Update Brian A. Howie

The Arizona Supreme Court issued an important decision for business lawyers in early November, rejecting public policy and other challenges to an often standard feature in commercial contracts - liability-limitation clauses. In 1800 Ocotillo, LLC v. The WLB Group, Inc., the Court considered two important questions with respect to such clauses: (1) whether they are unenforceable as contrary to public policy in Arizona; and (2) whether such clauses are effectively an "assumption of the risk" that is subject to Article 18, Section 5 of the Arizona Constitution and therefore always require submission to the jury.[1] The Court decided both questions in the negative, in a well-reasoned decision that should provide comfort for those transactional lawyers who include such clauses as a matter of course, as well as those litigators who seek to enforce them.[2]

Background

The lawsuit involved a dispute between The WLB Group, Inc. ("WLB"), an engineering and professional services firm, which entered into a contract with 1800 Ocotillo, LLC ("Ocotillo"), a developer planning to construct townhouses near a canal, to conduct a survey identifying boundary lines and rights-of-way. The contract contained a clause stating as follows:

Client agrees that the liability of WLB, its agents and employees, in connection with
services hereunder to the Client and to all persons having contractual relationships
with them, resulting from any negligent acts, errors and/or omissions of WLB, its
agents and/or employees is limited to the total fees actually paid by the Client to
WLB for services rendered by WLB hereunder.[3]

Thus, the clause capped WLB's liability (to Ocotillo), but the clause did not insulate WLB from all liability - i.e., did not operate as a "hold harmless" or indemnification provision - nor did the clause have any effect on WLB's liability to third parties.

WLB's survey failed to reflect accurately a right-of-way in which the canal operator claimed an interest. As a result of the mistake, the city of Phoenix denied Ocotillo certain building permits. Ocotillo sued WLB for negligence in preparing the survey, Ocotillo incurring additional costs from obtaining additional engineering services and designs, as well as construction delays. WLB defended the action by invoking the liability-limitation provision. Ocotillo argued that the clause was unenforceable as contrary to public policy, but the trial court rejected that argument and granted partial summary judgment to WLB, limiting WLB's potential liability to the total amount of fees it received on the project.[4]

On appeal, the court of appeals agreed that the liability-limitation clause did not violate public policy. The appellate court, however, also held - in response to an argument raised by Ocotillo for the first time on appeal - that the clause was subject to the provision of the Arizona Constitution that requires the defense of assumption of the risk to be submitted to the jury "in all cases whatsoever." Thus, the court of appeals ruled that the case must be remanded for a jury to decide whether to enforce the liability-limitation provision. WLB petitioned for review on the assumption of the risk issue, and Ocotillo cross-petitioned on the public policy issue.[5]

Clause Not Contrary To Public Policy

In an opinion authored by Justice Bales, the Supreme Court affirmed the appellate court's holding that the liability-limitation clause was not unenforceable as against public policy. The Court noted the judiciary's general reluctance to invalidate contractual provisions on public policy grounds, explaining that "[o]ur law generally presumes, especially in commercial contexts, that private parties are best able to determine if particular contractual terms serve their interests." Unless a provision violates a specific statute, a court should not invalidate it unless "the term is contrary to an otherwise identifiable public policy that clearly outweighs any interests in the term's enforcement."[6]

The Court rejected Ocotillo's assertion that WLB's liability-limitation clause was contrary to A.R.S. § 32-1159, an anti-indemnity statute governing professional services contracts between architects and engineers. That statute, the Court noted, was aimed at indemnification, hold harmless and duty to defend provisions, which eliminate any incentive on the part of the protected party to exercise due care. As the Court explained, however, the clause in the WLB-Ocotillo contract did not insulate WLB from all liability but merely capped it in an amount that "substantially preserves WLB's interest in exercising due care." The anti-indemnity statute therefore did not apply. The Court, however, did leave open the possibility that a liability-limitation provision could theoretically cap liability at such a low dollar amount that it effectively eliminates any incentive to exercise due care - but that was not the case with WLB's contract.[7]

The Court also refused to hold that limitation on liability provisions are generally unenforceable as contrary to a "judicially identifiable public policy." Such clauses, the Court wrote, may allow parties to allocate between themselves the risks of damages in excess of the agreed-upon cap and allow one party to assign the risk of greater damages to the other party, who "might be better able to mitigate or insure against them." To the extent that a limitation on liability clause may be the product of unequal bargaining power or coercion, the Court noted that other contractual doctrines (such as case law regarding effective consent) can address those concerns and protect against enforcement.[8]

Clause Not An "Assumption Of The Risk"

The Court vacated the appellate court's ruling that a limitation on liability clause was an assumption of the risk defense subject to Article 18, Section 5 of the Arizona Constitution, which holds that such defenses shall "in all cases whatsoever, be a question of fact and shall, at all times, be left to the jury." The Court began by observing that the original intent of that provision was to address those defenses that "effectively relieved a defendant of any duty of care by completely barring recovery by the injured party." Although the meaning of "assumption of the risk" has evolved in the last 100 years - with some commentators describing it as including liability-limitation provisions - the Court found "good reasons" to continue to define the defense in a manner consistent with its original meaning - i.e., as referring "only to defenses that effectively relieve the defendant of any duty."[9]

As the Court explained, the concerns raised by such defenses are not implicated by agreements such as the one between WLB and Ocotillo that "reasonably limit rather than eliminate liability." Moreover,

the benefits of such agreements in allowing parties to prospectively allocate potential
losses in excess of the cap would be largely lost if their enforceability turned in every
case on after-the-fact jury determinations.

Because the liability-limitation clause at issue did not relieve WLB of all liability (nor did it have that effect) and did not abrogate WLB's duty toward Ocotillo, it was not an assumption of the risk subject to Article 18, Section 5.[10]

Conclusion

The Ocotillo decision should provide reassurance to business lawyers who include liability-limitation clauses in standard form contracts - as well as to those litigators who seek to enforce them. First, such clauses will be upheld, provided that they do not cap liability at a dollar amount so low as to effectively eliminate any incentive on the part of the protected party from exercising due care.[11] More generally, the decision is a strong statement that the Court recognizes the important benefits obtained by allowing contracting parties to allocate risks between themselves in the bargaining process.

Second, such clauses will not be subject to Article 18, Section 5 of the Arizona Constitution. A contrary result would have precluded the possibility of summary judgment in every case involving liability-limitation provisions and necessitated submitting all those cases to the jury. The Ocotillo decision, however, gives the green light to trial courts to grant summary judgment (or partial summary judgment) in such cases, thus preserving one of the primary benefits of such provisions.

For more information, please contact Brian Howie at 602-229-5405 / bhowie@quarles.com or your Quarles & Brady attorney.

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This article originally appeared in the December 2008 edition of The Arizona Business Lawyer (a publication of the State Bar of Arizona), and is being reprinted with permission.




[1] 2008 WL 4763314, at *1 (Ariz. Nov. 3, 2008).
[2] Id.
[3] Id.
[4] Id. An interesting question not addressed by the Court is whether WLB invoked the economic loss rule to defend the action, given that Ocotillo and WLB were in privity of contract, and Ocotillo's lawsuit claimed purely economic losses. Under these circumstances, a negligence action generally is barred. See Carstens v. City of Phoenix, 206 Ariz. 123, 125-26 (App. 2003) ("The economic loss rule bars a party from recovering economic damages in tort unless accompanied by physical harm, either in the form of personal injury or secondary property damage"); see also Hayden Bus. Ctr. Condominiums Ass'n v. Pegasus Dev. Corp., 209 Ariz. 511, 516 (App. 2005) ("[T]he economic loss rule . . . precludes a party from circumventing contract remedies by recasting a contract claim as a tort") (citing Apollo Group, Inc. v. Avnet, Inc., 58 F.3d 477, 481 (9th Cir. 1995)).
[5] 2008 WL 4763314, at *1.
[6] Id. at *2.
[7] Id. at *2-3. The Court also held that the liability-limitation provision did not violate several other Arizona statutes cited by Ocotillo - including A.R.S. § 10-2234 (a statute governing liability for shareholders in professional corporations); A.R.S. § 29-846 (a statute governing liability for members in limited liability companies); and A.R.S. § 29-1025(A) (a statute governing a partnership's liability for losses caused by the actions of its partners). Id. at *3-4. The Court held that none of these statutes applied to WLB, which was a traditional corporation, not a professional corporation, an LLC or a partnership.
[8] Id. at *4-5. Ocotillo urged the Court to follow decisions in two cases from other jurisdictions (Alaska and Georgia), but the Court declined. In one case (Alaska), there was legislative history indicating that the state intended to include liability-limitation provisions within the scope of an anti-indemnification statute - legislative history that did not exist with respect to A.R.S. § 32-1159. 2008 WL 4763314, at *4. The court in the other case actually had cited the Arizona Court of Appeals decision in Ocotillo and had construed the clause in the WLB-Ocotillo contract as a limitation on liability provision and not an indemnity provision; therefore, the other case was not helpful to Ocotillo's argument. Id. at *4-5.
[9] Id. at *6-7. The Court also concluded that none of its prior decisions, including Phelps v. Firebird Raceway, 210 Ariz. 403 (2005) (interpreting Article 18, Section 5), and Salt River Project Agric. Improvement & Power Dist. v. Westinghouse Elec. Corp., 143 Ariz. 368 (1984) (discussing provisions that relieve of a party of any duty of care), resolved the question of whether a liability-limitation provision is subject to Article 18, Section 5. 2008 WL 4763314, at *6.
[10] Id. at *6-7.
[11] Based on this decision, capping liability at the total amount of fees received by the protected party is probably a good rule of thumb. As the Court explained, "The fees undoubtedly were WLB's main reason for undertaking the work. Thus, WLB retains a substantial interest in exercising due care because it stands to lose the very thing that induced it to enter into the contract in the first place." Id. at *3. It is unclear whether the Court would have reached the same conclusion had the liability cap been lower.