Careful review of certifications with your legal counsel and insurance advisor will enable you to better address the needs of your clients and lenders.
Although design professionals often are asked or required by clients to issue certifications, many simply sign certification agreements without reviewing them carefully. Unfortunately, this may leave them with large uninsured liability exposures.
The most widely used certifications applicable to design professionals include: lender certifications, which “certify” a project can be built within the budget or construction loan amount; certification for contractor payments, which require careful review, but generally don’t pose significant risks for design professionals when they include appropriate caveats; and certificate of Substantial Completion, which may pose significant risks for design professionals, who in effect are certifying a project was constructed and completed according to their plans and specifications.
A number of insurance companies and professional associations currently offer risk management guidelines for design professionals concerning certification. Victor O. Schinnerer, managing general agent for CNA and a leading underwriter of professional liability insurance for AEC firms, provides a list of questions for design firms to consider.
One of the key issues for AEC firms when a lender requires certification is whether the language in the agreement – or simply the provision of the certification – establishes a claim of detrimental reliance by a third party. For example, consider the following language from a standard certification form required by a lending institution:
“... Engineer is executing this Consent, Agreement and Certificate to induce Lender to advance funds under the Loan Agreement; and Engineer understands that Lender would not do so but for Engineer’s execution and delivery for this Consent, Agreement and Certificate.”
This should be a red flag; the legal concepts of “inducement” and “detrimental reliance” give the lender cause (where it otherwise didn’t exist) to sue the design professional. This implied responsibility also falls outside the design professional’s “standard of care” and could result in an uninsured claim.
Meanwhile, language from two other sample certification agreements points out other potential issues for AEC firms.
Example 1: Engineer’s agreement. While not all stipulations in a certification increase a design professional’s potential liability, some may have financial or other consequences. Consider the following paragraph:
Use of Plans. Engineer agrees that BANK and its agents shall have the right to possess and use all the Plans and Specifications, the Ideas, designs and concepts contained therein, and all modifications thereof, in connection with the completion of the Project, without payment of any additional fees or charges for such use.
Note the underlined text. Ideally, a design firm would maintain control of its work product or at least be indemnified for any subsequent re-use or misuse.
Example 2: Assignment of Engineering Contract. Another type of certification agreement calls for the design professional to assign the engineering contract to the lending institution. These agreements may contain problematic language or express warranties or guarantees that can result in significant and uninsured liabilities for design firms. Consider the following paragraph from a sample agreement:
Whereas, this Agreement is given by the Engineer to (BANK) in connection with (BANK’s) disbursement of acquisition, development and/or construction loan funds (the “Loan”) for improvements to __________ (the “Borrower”), and it is intended that BANK shall rely upon the contents and accuracy of this Agreement in going forward with such financing ….
Here, the underlined wording appears to make granting the loan contingent upon the engineer’s certification, which goes beyond the design firm’s responsibility under the “standard of care.” Thus, design firms should seek to strike that text.
A subsequent paragraph from the same sample agreement reads:
Now, therefore for value received, the receipt of which is hereby acknowledged, and in order to induce BANK to make the Loan to Borrower, the Engineer hereby confirms and agrees as follows…
Again, the underlined wording should be deleted.
The same sample agreement also has other problematic wording:
Engineer acknowledges that BANK may be disbursing construction advances from the Loan proceeds to Borrower and/or third parties in reliance on inspections or certifications to be made or supplied by the Engineer to Borrower and/or BANK in connection with construction of the Improvements and, that BANK shall be entitled to rely upon and receive the benefits of the Contract, inspections and certifications as if BANK were a party thereto or was listed as an addressee thereon.
The first section of the underlined text expands the design professional’s potential liability and the second section (“… that BANK shall be entitled ….”) gives rights to the lender that may not have existed in the original contract.
Professional liability insurance generally covers design professionals for issues arising from their negligence, but does not cover contractual breaches that go beyond the negligence standard or arise from other issues. Clients and lenders may not know that the warranties, guarantees, and other contractual commitments they request in a certification aren’t covered by the design professional’s professional liability insurance.
Make sure relevant parties understand the liability issues associated with any problematic language in the certification and explain that the design firm is likely to lack any insurance protection for related claims. This may enable you to negotiate the insertion of appropriate caveats into the certification – such as “to the best of the engineer’s/architect’s knowledge …” – that may help preserve your coverage.
Some AEC insurers suggest defining the term “certify” at the bottom of the certification form and provide sample wording. In addition, consider including contractual language used in the most recent AIA and EJCDC documents. This language defines more clearly the intent of certifications and provides important protections.
By carefully reviewing any certification with your legal counsel and insurance advisor, negotiating the removal of inappropriate clauses and insertion of caveats to minimize potential liability, design firms will be in a better position to address the needs of their clients and lending institutions financing the projects.
Rob Hughes is senior vice president and partner at Ames & Gough. He can be reached at rhughes@amesgough.com.