Strong Contractual Terms Can Deflect Tort Liability

Well drafted contracts provide an effective means to mitigate tort liability. In particular, contractual risk allocation provisions can assist companies in better controlling their litigation disposing of claims when they arise.

In an article titled, “Minimizing Tort Liability with the Right Terms,” which appeared in Law360 on February 29, 2012, Shook Hardy & Bacon authors, Paul A. Williams,Charles C. Eblen andKristina L. Burmeister, discuss the importance of various contractual provisions in blunting tort liability.
To illustrate their point, the SH&B lawyers discuss the Third Circuit’s opinion in Greenspan v. ADT Security Servs., Nos. 10-2901, 10-202 (3d Cir., Sept. 20, 2011). The case involved property damage claims resulting from a fire at the plaintiffs’ Pennsylvania residence. The Plaintiffs sued ADT for breach of contract and negligence, claiming that ADT insufficiently repaired and monitored their fire alarm system.

On appeal, the Third Circuit agreed with ADT that the contract’s risk allocation provisions provided a valid defense against all of plaintiff’s claims, including gross negligence. The court ruled that plaintiff could recover in contract only, not tort, because the common law did not impose a separate tort duty to monitor an alarm system. By strictly enforcing the contractual risk allocation provisions in the contract, jurisprudence such as Greenspan provides business with the ability to mitigate tort risk and litigation costs through well drafted contracts.

Increasingly, plaintiffs are attempting to broaden what should be contractual disputes into tort litigation. Greenspan is a perfect example of this trend. In addition to a well drafted contract, defendants are often able to escape tort liability by invoking the economic loss rule. In practice, courts have generally applied the economic loss rule either when the loss claimed in tort is the subject matter of a contract between the parties, or when the plaintiff asserts product liability claims and the defect harmed the product only and not people or other property.

The SH&B article advises that an effective risk-allocation framework should contain the following provisions:

• Waiver of Subrogation;
• Limitation of Liability;
• Limitation of Action;
• Insurance Requirements; and
• Indemnity Clause

In drafting each of these provisions, it is necessary to be mindful of the legal requirements underlying each of these contractual terms. General contractual construction rules to keep in mind include:

1. An effective contract spells out the expectations to ensure that the waiver of subrogation provision is deemed a true waiver of subrogation and not merely an exculpatory provision;

 2. The waiver of subrogation provision should provide that the customer agrees to procure insurance for damages that might arise in connection with the performance of the contract and that the company be named as an additional insured;

 3. The customer should be required to waive all right of recovery beyond the proceeds of his insurance policy and agree that his insurer will not have a right of subrogation against the company;

 4. Each of these contractual provisions should be placed under separate headings in the contract so that they do not blend into and become obscured by other provisions in the contract;

5. Effective contracts should be signed by both parties and definitively indicate if the contract contains more than one page. The customer should sign or initial each page of the contract, or acknowledge that she has read and agrees to all terms and conditions of the contract on each page;

6. It is good practice for language disclaiming consequential damages or otherwise limiting recovery under warranty appear conspicuously in the contract, preferably in bolded caps; and

7. Indemnification provisions should explicitly state that the company has the right to select its own counsel to represent it in any action subject to the indemnification clause in the contract.

What’s Next?

Now that the company has a well drafted, legally binding contract with the customer, the company must take steps to ensure that it doesn’t misplace the contract. The SH&B authors point out that document management is essential to the defensive use of a contract in litigation. If the contract at issue cannot be found, it may be difficult to assert contractual offenses and may unnecessarily expose the company to significant liability.

 Or, as famed criminal defense lawyer, Johnnie Cochran, might have cautioned, “If you lose it, you can’t use it!”