In Colorado, Contractual Limits on Liability are Treated Differently from Other Exculpatory Provisions

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In Colorado, and in many other states, exculpatory clauses are a complete bar to liability and are strongly disfavored. As such, Colorado law requires that exculpatory provisions be closely scrutinized for fairness, unconscionability, and ambiguity. If an exculpatory clause completely relieves a party from all liability for its negligence, but it is ambiguous, the clause will be unenforceable. This can have dire consequences for contracting parties who think they are insulated from liability and allocating their risk and contingencies along that belief, just to find the clause is unenforceable, leaving them exposed to significantly more liability.

Akin to exculpatory provisions are limitation of liability clauses. Limitations of liability clauses –specifically caps on damages – do not completely shield a party from all liability for its wrongdoing. In the past, Colorado courts have sometimes referred to limitation of liability clauses and exculpatory clauses interchangeably, but there are significant distinctions between them, meaning they could, and should, have different treatment under the law.

In a recent Colorado Court of Appeals case decided September 23, 2021, Johnson Nathan Strohe, P.C. v. MEP Engineering, Inc., 2021 COA 125, the Colorado appellate court addressed whether contractual limitation of liability clauses should be examined and construed differently than contractual exculpatory clauses. The court concluded: yes.

In Johnson, an architect hired an engineer to provide engineering consulting services for the mechanical, plumbing, and heating components of an apartment building. The contract between the parties had a limitation of liability clause that limited the engineer’s damages to twice the amount of its fees, amounting to a total maximum exposure of $193,000. Issues arose with the mechanical, plumbing, and heating components, leading the owner of the apartment building to file claims against the architect and recover $1.2 million. The architect, in turn, sought to recoup those amounts from the engineer, claiming the damages were due to the engineer’s negligence. The architect argued that the limitation of liability clause was ambiguous and should be treated like an exculpatory clause, making it void due to its ambiguity. The trial court determined that the limitation of liability clause was unambiguous and enforceable, dismissing the case against the engineer after the engineer deposited sufficient funds to cover any potential liability under the limitation of liability clause. The appellate court reversed, finding the clause was ambiguous because it can reasonably be interpreted in more than one way. However, the appellate court concluded that the clause was not void merely because it was ambiguous, distinguishing exculpatory clauses and limitation of liability clauses.

According to the appellate court in Johnson, the key difference between the clauses is the degree to which a wrongdoer remains liable. Because limitation of liability clauses do not provide a complete bar from liability, they should not be subject to the same strict rigors and scrutiny as exculpatory provisions. In particular, the appellate court in Johnson held that ambiguous limitation of liability clauses are still valid. Instead, if a limitation of liability clause is ambiguous, courts will apply ordinary principles of contract interpretation and look to other evidence outside the language of the contract to determine the meaning of the ambiguous limitation of liability clause.

While the Colorado appellate court broadly stated that all limitation of liability clauses are distinct and different from exculpatory clauses, that must be read some strong caveats. The best understanding of the court’s conclusion is that it clearly applies to limitation of liability clauses that are caps on damages. The term “limitation of liability,” however, is broader than just caps on damages. A limitation of liability clause can limit liability as to the type of damages (i.e., consequential damages waivers), or limit liability by the type of claims (i.e., waiving rights to assert intentional tort claims), or limit liability by shifting responsibility (i.e., indemnity). Some of these limitation of liability provisions have different treatment under the law and are viewed more or less favorably, often as strictly or more strictly (indemnity clauses) as an exculpatory provision.

Another issue left open by the Colorado appellate court was how to handle a contractual cap on damages that limits damages so severely to just a nominal amount, such that the wrongdoer is insulated from nearly all liability. The appellate court in Johnson strongly suggested that such contractual limitations might also be exculpatory in nature and subject to stricter scrutiny. However, determining what is nominal in any given circumstance is certainly not clear and was not addressed by the Johnson court.

What is abundantly clear from Johnson is that any time a construction professional wants to protect itself from liability – whether it’s a cap on damages, an indemnity clause, a waiver of rights, or some other limitation – the contract needs to be explicit, unambiguous, and clear. Even harsh exculpatory clauses and damages caps can be enforceable when clear and made between sophisticated entities in arms-length transactions.