Enforceability of Limitation of Liability Clauses
Author: Saloni Shah and Joanna Kopcyzk
Limitations of Liability
Arizona courts uphold limitations of liability in sale contracts unless they are unconscionable. Ariz. Rev. Stat. Ann. §§ 47-2302, 47-2719 (West 2021). Limitations of consequential damages for personal injury caused by consumer goods are prima facie unconscionable, whereas limitations of damages for commercial or economic losses are not. Id. § 47-2719(C). Arizona courts rarely find unconscionability in a commercial setting. Salt River Project v. Westinghouse Elec. Corp., 694 P.2d 198, 205 (Ariz. 1984), abrogated on other grounds by Phelps v. Firebird Raceway, Inc., 111 P.3d 1003 (Ariz. 2005) (explaining that, under Arizona law, parties may contract to disclaim or limit any potential tort liability, but “they must expressly spell out their intention to do so”). Arizona courts will give effect to the intention of the parties where the parties are on equal footing and when the parties did in fact bargain for the contract provision. Id. at 213.
Limitations of liability appearing in professional service contracts are likewise enforceable. In 1800 Ocotillo, LLC v. WLB Grp., Inc., the Supreme Court of Arizona enforced a contract containing a term that a surveyor’s liability to its client for negligently performing work may not exceed the surveyor’s fees. 196 P.3d 222, 226 (Ariz. 2008) (en banc). In doing so, the court distinguished indemnity provisions from limitations of liability. Id. at 225. The court further noted that limitations of liability “may desirably allow the parties to allocate as between themselves the risks of damages in excess of the agreed-upon cap, which could preserve incentives for one party to take due care while assigning the risk of greater damages to another party that might be better able to mitigate or insure against them.” Id. at 226. However, the court acknowledged that such clauses may sometimes reflect coercion or improper bargaining. Id.; see also Airfreight Express Ltd. v. Evergreen Air Ctr., 158 P.3d 232, 239 (Ariz. Ct. App. 2007) (adopting rule that limitation of liability clauses do not apply where the party relying on the clause acted in bad faith); Sky Jet AG v. Honeywell Int’l Inc., No. CV-17-04709-PHX-GMS, 2018 WL 6620493 (D. Ariz. Dec. 18, 2018) (holding that a limitation of liability clause may not necessarily limit liability for a breach of covenant of good faith and fair dealing).
Arizona courts disfavor exculpatory provisions, requiring showings that the parties bargained for the limitation and were on equal footing prior to enforcement. Salt River Project Agric. Improvement & Power Dist., 694 P.2d at 213 (Ariz. 1984), abrogated on other grounds by Phelps, 111 P.3d 1003 (Ariz. 2005) (en banc). Exculpatory clauses are strictly construed against the party relying on them. Sirek v. Fairfield Snowbowl, Inc., 800 P.2d 1291, 1295 (Ariz. Ct. App. 1990) (“Not only should such attempts be clear and unequivocal, it seems reasonable that the language should alert the party agreeing to such a provision that it is giving up a very substantial right.”). Subrogation waivers, however, are not treated as exculpatory clauses. Travelers Indem. Co. v. Crown Corr. Inc., 589 Fed. App’x 828, 833 (9th Cir. 2014) (“Subrogation waivers do not present the same dangers as exculpatory clauses, because no risk exists that the injured party will be left without compensation, and subrogation waivers serve important policy goals.”) (applying Arizona law).
Ariz. Rev. Stat. Ann. § 32-1159 (West 2021) invalidates provisions in construction contracts or architect-engineer professional service contracts that purport to indemnify a promisee against liability for damages caused by the promisee’s sole negligence. In 2019, Arizona amended its legislation by adding Ariz. Rev. Stat. Ann. § 32-1159.01, voiding indemnity agreements in construction and architect-engineer dwelling contracts. Under this recent amendment, Arizona law explicitly declares indemnification provisions in construction contracts related to a dwelling purporting to indemnify any party for a loss or damage resulting from the indemnitee’s negligence or any party other than the indemnitor is void as a matter of public policy. Ariz. Rev. Stat. Ann. § 32-1159.01(A) (West 2021). However, a contractor who is responsible for the performance of a construction contract may indemnify a person for whose account the construction contract is not being performed and who enters into a contract with a contractor allowing the contractor to enter on or adjacent to its property to perform the construction contract for others. Ariz. Rev. Stat. Ann. § 32-1159.01(B). An additional insured’s endorsements or collateral to a construction contract involving a dwelling does not obligate the insurer to indemnify the additional insured for the percentage of fault that is allocated to that such person. Ariz. Rev. Stat. Ann. § 32-1159.01(C). Any covenant affecting a construction contract or architect-engineer professional service contract that requires the promisor to defend the promise is explicitly limited to defending claims arising out of or related to the promisor’s work or operations. Ariz. Rev. Stat. Ann. § 32-1159.01(C).
Arizona law, however, excepts certain third-party contracts from this general rule. The newly added section of this law does not apply to: (1) agreements to which the state or a political subdivision is a party; (2) agreements entered into by agricultural improvement districts; (3) indemnification of sureties on payment or performance bonds; (4) agreements between insurer and its named insured; (5) agreements between insurers and its additional insureds; (6) agreements between insurer and its insured “under a single insurance policy or contract for a defined project or workplace, except that such agreement may not require or allow one or more insureds under the agreement to indemnify, to hold harmless or to defend any other insured under the agreement beyond the limitations of subsections A, B and C of this section”; (7) a public service corporation’s rules approved by the corporation commission. Ariz. Rev. Stat. Ann. § 32-1159.01(F)(1)-(7) (West 2021).
Enforceability of Waiver of Consequential Damages Clauses
Arizona courts have not directly addressed the enforcement of waiver of consequential damages clauses in the construction context, but it appears that they may likely enforce such clauses given that they enforce limitation of liability clauses in other contexts. The Arizona Supreme Court has emphasized the societal benefits arising from the freedom of parties to contract and warned accordingly that courts are “hesitant to declare contractual provisions invalid on public policy grounds.” 1800 Ocotillo, LLC v. WLB Grp., Inc., 196 P.3d 222, 224–26 (Ariz. 2008) (determining that clause in professional services contract limiting the firm’s liability for negligence to total fees paid was not unenforceable as contrary to public policy and holding: “We also decline to hold that liability-limitation clauses are generally unenforceable as contrary to a judicially identified public policy. Such clauses may desirably allow the parties to allocate as between themselves the risks of damages in excess of the agreed-upon cap, which could preserve incentives for one party to take due care while assigning the risk of greater damages to another party that might be better able to mitigate or insure against them.”).
In the context of transactions for the sale of goods, the Arizona Uniform Commercial Code allows a buyer to recover consequential damages from the seller under appropriate circumstances. See Ariz. Rev. Stat. §§ 47-2711 – 47-2714, 47-2715(2). However, Arizona code section 47-2719 permits the buyer and the seller to contract to limit or exclude consequential damages unless the limitation or exclusion is found to be unconscionable or where the circumstances cause the contractually specified limited or exclusive remedy to fail of its essential purpose. See Kalil Bottling Co. v. Burroughs Corp., 619 P.2d 1055, 1058–59 (Ariz. App. 1980) (clause barring consequential damages failed of its essential purpose and was thus unenforceable because the seller “could not and did not repair or replace” defective goods).
Application of Economic Loss Doctrine
Arizona courts adopt an “intermediate” approach to the economic loss doctrine for products liability cases and a “pure contract” approach for construction defect cases. See Salt River Project Agric. Improvement & Power Dist. v. Westinghouse Elec. Corp., 694 P.2d 198, 209–10 (Ariz. 1984); Flagstaff Affordable Hous. Ltd. P’ship v. Design Alliance, Inc., 223 P.3d 664, 667–70 (Ariz. 2010) (en banc). The former bars tort recovery for purely economic losses in products liability situations except in dangerous situations to persons or property; the latter adopts maintains that breach of contract or warranty are the only appropriate remedies for purely economic losses in the construction context. See Salt River, 694 P.2d at 209–10 (Ariz. 1984) (products liability); Flagstaff Affordable Hous., 223 P.3d at 667–70 (construction contracts).
As applied to products liability cases, Arizona law has “a three-factor test for determining, on a case-specific basis whether to apply the economic loss doctrine to claims involving a defective product. This approach analyzes 1) the nature of the product defect; 2) the manner in which the loss occurred; and 3) the type of loss or damage that resulted. Salt River, 694 P.2d. at 210; Miidas Greenhouses, LLC v. Global Horticultural, Inc., 244 P.3d 579, 582-83 (Ariz. Ct. App. 2010) (affirming application of the three-factor test). In particular, the three-factor test considers whether the damages involve “economic loss … accompanied by physical damage to person or other property,” whether the product defect was “unreasonably dangerous,” and whether the damages occurred in a “sudden, accidental manner.” Salt River, 694 P.2d. at 207, 209.
Expansion to Construction Cases
The Arizona Supreme Court has specifically extended its application of the economic loss doctrine to construction cases but has declined to use the three-factor test outlined in Salt River. Flagstaff Affordable Hous., 223 P.3d at 670 (“Whatever the wisdom of continuing to apply Salt River’s three-factor test in products liability cases, we decline to extend it to construction defect cases.”); see also Travelers Indem. Co. v. Crown Corr, Inc., No. CV 11-0965, 2011 WL 6780885, at *10 (D. Ariz. Dec. 27, 2011), aff’d, No. 12-15170, 2014 WL 5488191 (9th Cir. Oct. 31, 2014) (“Under Arizona law, the economic loss doctrine prevents a plaintiff who contracts for construction from recovering in tort for purely economic loss, unless the contract otherwise provides.”). Arizona courts have adopted an application of the economic loss doctrine that is closer to the “pure contract” approach. See Flagstaff Affordable Hous., 223 P.3d at 670-71 (“[I]n the context of construction defects, we adopt a version of the economic loss doctrine and hold that a plaintiff who contracts for construction cannot recover in tort for purely economic loss, unless the contract provides otherwise.”). However, the parties to a construction contract can waive application of the economic loss rule and “contractually agree to preserve tort remedies for solely economic loss, just as they may otherwise specify remedies that modify common law recovery.” Id. at 670.
Application Restricted to Parties in Privity
The economic loss doctrine is not applied to non-contracting parties, at least in the construction defect context. Sullivan v. Pulte Home Corp., 306 P.3d 1, 3 (Ariz. 2013) (quoting Flagstaff Affordable Hous., 223 P.3d at 670-71) (“We decline to extend the doctrine to non-contracting parties. … Our express, limited holding in Flagstaff Affordable Housing was that ‘a contracting party is limited to its contractual remedies for purely economic loss from construction defects.’ It follows that ‘[r]ather than rely on the economic loss doctrine to preclude tort claims by non-contracting parties, courts should instead focus on whether the applicable substantive law allows liability in the particular context.’”)); see also Embrey v. Burrows Concrete, L.L.C., No. 1 CA-CV 13-0427, 2014 WL 2592593, at *2 (Ariz. Ct. App. June 10, 2014) (“Sullivan made clear that the doctrine does not apply where the parties lack contractual privity.”).
Fraudulent Inducement Claims
It remains an open question as to whether the economic loss rule applies to fraudulent inducement claims in Arizona. In applying the rule to such a claim in an unpublished opinion, a division of the Court of Appeals of Arizona stated that “[t]he economic loss rule will not always bar a claim for fraud in the inducement; however, it may be a bar in a case where the claimant does not seek to rescind or reform the contract induced by fraud, but essentially affirms the contract by seeking contract damages under a tort theory.” Maricopa Inv. Team, LLC v. Johnson Valley Partners, LP, No. 1 CA–CV 12–0047, 2012 WL 5894849 at *2 (Ariz. Ct. App. Nov. 23, 2012). The Court in Maricopa Inv. Team further held that the rule should apply to inducement claims where “there has been no injury except that anticipated and bargained for under the contracts between the parties.” Id. at *3. In 2015, The Arizona federal court declined to apply the economic loss rule to a fraudulent inducement claim, noting that the Supreme Court of Arizona had not spoken on the issue. Jes Solar Co. v. Matinee Energy, Inc., No. CV 12-626 TUC DCB, 2015 WL 10943562, at *4 (D. Ariz. Nov. 2, 2015).
Other Property and Integrated Systems
Arizona adopts a straightforward approach in determining whether a system made of up component parts constitutes one product or several: “where the components are sold separately or are provided by different suppliers, [the components are separate properties, but] we find no justification or support for [the] rule [that components are separate properties] where both components are provided by one supplier as part of a complete and integrated package.” Arrow Leasing Corp. v. Cummins Arizona Diesel, Inc., 666 P.2d 544, 549 (Ariz. Ct. App. 1983) (quoting Northern Power & Eng’g Corp. v. Caterpillar Tractor Co., 623 P.2d 324, 330 (Alaska 1981)). However, the United States District Court for the District of Arizona has interpreted Arizona’s law on the economic-loss doctrine to require affirmative proof that the items at issue are “other property” in applying the doctrine to bar tort recovery. See Crown Corr, 2011 WL 6780885 at *12 (applying the economic-loss doctrine to bar tort claims for damages to stadium speakers by subcontractor where plaintiff failed to prove that speakers were not part of the whole stadium that was the subject of the contract).
Enforceability of No Damages for Delay Clauses
The enforceability of no damages for delay provisions in Arizona depends on whether the contract at issue pertains to a public or a private project. Arizona Rev. Stat. § 34-221(F) provides that in the context of public contracts, “[A] contract for the procurement of construction shall include a provision that provides for negotiations between the agent and the contractor for the recovery of damages related to expenses incurred by the contractor for a delay for which the agent is responsible, which is unreasonable under the circumstances and which was not within the contemplation of the parties to the contract.” See also Arizona Rev. Stat. § 41-2617. In Tech. Constr., Inc. v. City of Kingman, the City argued that a “no liability” clause in the public construction contract barred the contractor’s recovery of delays. 278 P.3d 906, 910-11 (Ariz. Ct. App. 2012). The Court of Appeals rejected the City’s argument, finding that the City was liable for delays pursuant, in part, to Arizona Rev. Stat. § 34-221(F). Id.
Arizona courts have not conclusively addressed the enforceability of no damages for delay clauses in private construction contracts. However, in an unreported, non-precedential 2018 decision, the Court of Appeals of Arizona acknowledged that no damages for delay clauses are generally enforceable, but many states recognize an “active interference” exception to the enforcement of such clauses. See Sw. Concrete Paving Co. v. SBBI, Inc., No. 1 CA-CV 17-0294, 2018 WL 2307002, at *2 (Ariz. Ct. App. May 22, 2018). The court ultimately concluded the contractor had waived this argument by not raising it in the proceedings below. See id. at *3.
Strict Interpretation of Contract
Arizona courts hold that “a contract should be read in light of the parties’ intentions as reflected by their language and in view of all the circumstances. If the intention of the parties is clear from such a reading, there is no ambiguity.” Smith v. Melson, Inc., 659 P.2d 1264, 1266 (Ariz. 1983). “A general principle of contract law is that when parties bind themselves by a lawful contract” with clear and unambiguous terms, the court must give effect to the contract as written. Grubb & Ellis Mgmt. Servs., Inc. v. 407417 B.C., L.L.C., 138 P.3d 1210, 1213 (Ariz. Ct. App. 2006). The Arizona Supreme Court noted, however, that “[w]hen interpreting an agreement, the court may always consider surrounding circumstances.” Melson, 659 P.2d at 1267. Indeed, Arizona courts acknowledge that parol evidence may be used when either “‘an ambiguity exists on the face of [a] document or the language admits of differing interpretations.’” Johnson v. Earnhardt’s Gilbert Dodge, Inc., 132 P.3d 825, 828 (Ariz. 2006) (quoting Standage Ventures, Inc. v. State, 562 P.2d 360, 362 (Ariz. 1977)). Arizona courts also acknowledge that parol evidence may be used to determine the intention of the parties if “‘the judge … finds that the contract language is ‘reasonably susceptible’ to the interpretation asserted by its proponent.’” Id. at 828 (quoting Taylor v. State Farm Mut. Auto Ins. Co., 854 P.2d 1134, 1140 (Ariz. 1993)). That said, Arizona courts hold that, although an ambiguity is resolved against the person drafting a contract, this is a secondary rule that is applied only if the intent of the parties is unclear after “the application of primary standards.” Polk v. Koerner, 533 P.2d 660, 662 (Ariz. 1975).
Prompt Payment Requirements (Public/Private)
Arizona Public –
Ariz. Rev. Stat. Ann. §§ 34-221, 41-2576, 41-2577 (2022) (owner to prime 14 days after invoice certified and approved; invoices deemed certified and approved 7 days after invoice received unless owner issues written objection; final payment 60 days after acceptance – any retention for longer than 60 days requires written justification; prime to sub/sub to lower tier 7 days after payment unless otherwise agreed, except no contract may materially alter right to prompt payment; interest at 1% per month starting after payment due date; prompt pay requirements extend to design professionals contracted by contractor or subcontractor).
Arizona Private –
Ariz. Rev. Stat. Ann. §§ 32-1181 to -1188 (2022) (owner to prime within 7 days of certification and approval unless otherwise agreed; invoices deemed certified and approved 14 days after invoice received unless owner issues written objection; prime to sub/sub to lower tier 7 days after receipt of each progress or final payment unless sub/lower tier fails to provide invoice; interest at 1.5% per month beginning on the eighth day; attorneys’ fees and costs to successful party in any action or arbitration).
False Claims Statute
Federal False Claims Act – 31 U.S.C. § 3729-3733 –
Many states have enacted false claims statutes modeled on the federal False Claims Act (referenced as the “FCA” throughout this survey). 31 U.S.C. §§ 3729-3733. State analogues to the FCA aim to address claims involving state and local governments instead of the federal government. This summary identifies the FCA’s state analogues for construction claims. It does not address false claims statutes for other subjects, such as health care claims, applications for public assistance, or insurance claims.
The FCA defines “claim” as any request or demand for money or property where the government will provide or reimburse any portion of that money or property. Id. § 3729(b)(2). The FCA imposes civil liability for any of seven separate acts including: 1) knowingly presenting a false claim for payment; 2) knowingly making a false record or statement to obtain approval of a claim; 3) conspiring to obtain approval of a false claim; 4) knowingly delivering less than the amount of money or property owed to the government; 5) delivering a receipt for government property without knowledge of the receipt’s veracity and with intent to defraud; 6) knowingly purchasing or receiving public property from a government employee or member of the Armed Forces illegally; and 7) knowingly making or using a false record or statement to decrease a payment obligation to the government. Id. § 3729(a)(1).
A person found guilty of any of the above acts is liable to the government for: 1) a civil penalty between $5,000 and $10,000, as adjusted by inflation; 2) three times the amount of damage sustained by the government; and 3) the costs of a civil action brought to recover damages sustained by the government. Id. § 3729(a)(1-3). The FCA, however, allows mitigation of the penalty if the violator cooperates with the government’s investigation. Courts may reduce the violator’s liability to two times the amount of damage sustained by the government when the violator: 1) provides all of the information known about that violation to the investigative team within 30 days of gaining such knowledge; 2) provides the information without actual knowledge of the investigation and before the government files charges; and 3) fully cooperates with the government’s investigation. Id. § 3729(a)(2).
Arizona – N/A
Licensing Requirements for Construction Managers
Arizona law requires contractors to be licensed with the state. Ariz. Rev. Stat. Ann. §§ 32-1121 to -1129. Arizona’s statutory definition of a “contractor” includes “consultants who represent that they are able to supervise or manage a construction project for the property owner’s benefit, including hiring and firing specialty contractors, scheduling work on the project and selecting and purchasing construction material.” Id. § 32-1101 (emphasis added). This definition effectively incorporates construction managers within its regulatory scheme for contractors. Accordingly, construction managers whose work fits within the foregoing definition are also required to be licensed as a contractor with the state of Arizona.