Contracting Around the Discovery Rule? Don’t be SOL
In legal practice, all lawyers stress about blowing deadlines. Perhaps the most popular deadline that keeps lawyers up at night is the statute of limitations. The statute of limitations is a legal principle that requires parties to file their legal claims within a specific time. An exception to the statute of limitations is the discovery rule. The discovery rule provides that the statute of limitations for a legal claim does not begin to accrue (or start) until the injured party either (1) discovers their injury or (2) should have discovered their injury through reasonable diligence. In short, the discovery rule is an effective counter to the statute of limitations defense.
Often, attorneys insert specific clauses into a contract that shortens the statute of limitations otherwise provided by law. It is an effective tactic because it further restricts the amount of time the potentially injured party can bring a claim related to that contract. As further discussed below, parties are permitted to shorten the limitations period through a contract, albeit certain requirements must be met. However, what is often overlooked is the issue of how these contractual provisions impact California’s discovery rule. In other words, does including a contractual provision that shortens the statute of limitations eliminate the application of the discovery rule?
This blog article explores the case law on this distinct issue and provides a brief synopsis on the statute of limitations, the delayed discovery rule, and what requirements must be met for a court to uphold a shortened statute of limitations clause in a contract.
The Statute of Limitations
The statute of limitations operates to limit the amount of time an injured party can bring their legal claim in court. An essential point that is regularly overlooked by litigators, law students, and laypersons is that the statute of limitations begins to accrue (or starts running) from the date all elements of the claim are satisfied. (See Grisham v. Philip Morris U.S.A., Inc. (2007) 40 Cal.4th 623, 634; Civ. Proc. § 312.) For most legal claims sounding in tort or contract, the statute of limitations accrues from the date the party suffers its injury, whether it be physical or monetary. (See Naftzger v. American Numismatic Society (1996) 42 Cal.App.4th 421, 428.)
California’s Discovery Rule
The discovery rule modifies the rule that the statute of limitations accrues on the date of injury. In essence, the discovery rule postpones the accrual of the statute of limitations until the plaintiff actually discovers their injury or the cause of their injury, or should have discovered their injury, had they exercised reasonable diligence. (See April Enterprises, Inc. v. KTTV (1983) 147 Cal.App.3d 805, 832.) The discovery rule operates as an equity-based exception as it protects parties who are ‘ignorant’ of their cause of action through no fault of their own and allows these parties to pursue their claims in court. (Id.) To assert the discovery rule, the plaintiff must show: “(1) the time and manner of discovery and (2) the inability to have made earlier discovery despite reasonable diligence.” (Fox v. Ethicon Endo-Surgery, Inc. (2005) 35 Cal.4th 797, 808.)
The discovery rule frequently applies to cases in which a fiduciary relationship exists between the parties and/or it is difficult to detect the breach, such as Fox v. Ethicon Endo-Surgery, Inc.
In Fox, the plaintiff underwent gastric bypass surgery, but suffered complications and required further hospitalization after the surgery. Plaintiff commenced a medical malpractice suit against the performing doctor and the hospital. During the performing doctor’s deposition, it was revealed that the stapler the doctor used to seal the plaintiff’s incisions might have caused the plaintiff’s injuries. Thereafter, the plaintiff filed an amended complaint asserting a product liability action against the manufacturer of the stapler. However, the amended complaint was challenged by the manufacturer because the statute of limitations for a product liability action was one year from the injury date, and the plaintiff filed the amended complaint two years after suffering the injury.
The court found that the plaintiff timely filed her amended complaint asserting the product liability cause of action because, prior to the doctor’s deposition, the plaintiff had no reason to suspect the stapler was the cause of her injuries. The performing doctor’s reports did not mention the stapler malfunction or misfired. During post-surgical care, the performing doctor never stated that the stapler may have caused the plaintiff’s injuries or had caused similar injuries to other patients in the past. Additionally, the doctor’s deposition was taken only a short time after the complaint was filed, which illustrates that the plaintiff was diligently investigating the causes of her injuries. With these facts in mind, the court found that, under the discovery rule, there was no cognizable reason for the plaintiff to suspect the stapler was the ultimate cause of her injury when she filed her first complaint. For these reasons, the court held the statute of limitations for the products liability action began to accrue on the doctor’s deposition date, and the plaintiff timely filed her amended complaint.
The Fox case demonstrates when it is difficult for the plaintiff to detect the cause of the injury. In these rare situations, the plaintiff has suffered an injury but cannot determine the ultimate cause of the injury. As illustrated above, if the plaintiff was diligent in their investigation, the court will likely apply the discovery rule. The next phase of this article discusses the requirements that must be met for a court to uphold a contractual clause that shortens the statute of limitations.
Shortening the Statute of Limitations Through Contract
Through contract negotiations, attorneys strive to limit their client’s potential liability, among other things. An easy way to achieve this goal is to insert a provision in the contract that shortens the statute of limitations provided by statute. This tactic further restricts the amount of time the potentially injured party can bring a legal claim related to the contract. California courts have upheld this practice by hanging their hat on freedom of contract principles, holding that contractual “parties [have] substantial freedom to modify the length of the statute of limitations.” (Hambrecht & Quist Venture Partners v. American Medical Internat., Inc. (1995) 38 Cal.App.4th 1532, 1548.) The only caveat to this broad rule is that the limitation must be ‘reasonable.’ (See Moreno v. Sanchez (2003) 106 Cal.App.4th 1415, 1430.) A provision shortening the statute of limitations is reasonable “if it provides sufficient time to effectively pursue a judicial remedy.” (Id.)
The common theme in California is that the shortened limitations period is reasonable if the legal claim is obvious to the plaintiff. In other words, the plaintiff learns of their legal claim immediately after the wrongful event occurred.
For instance, in Capehart v. Heady (1962) 206 Cal.App.2d 386, a lease agreement shortened the statute of limitations for a breach of contract claim from four years to three months. The plaintiff sued for breach of written lease seven months after the alleged breach, which was then challenged by the landlord as being untimely. The plaintiff argued that the costs he incurred in relocating his business prevented him from bringing this lawsuit within the shortened limitation period. The court sided with the landlord, holding that such costs were natural and expected business expenses, and the tenant should have considered these potential expenses when negotiating the lease and agreeing to the shortened limitation period.
Similarly, in Tebbets v. Fidelity and Casualty Co. (1909) 155 Cal. 137, the life insurance policy stipulated that any action to recover under the policy had to be brought within six months from the date of death. The aggrieved party did not file the claim until after the limitation period expired. The court found that the shortened limitation period was reasonable because, akin to Capehart, the triggering event was evident because it was the death date, and plaintiffs should have asserted their claim within the limitation period provided in the policy.
The underlying denominator in these cases is that the breach was straight-forward and readily apparent. The breach was not hard to detect and was not done in secret. Instead, the breach had a ‘triggering event,’ which helped the court find the limitations period ‘reasonable.’ This leads to the discussion of the discovery rule and whether it is effectively terminated in contracts where the limitations period is shortened.
The Discovery Rule & Contracts That Limit the Statute of Limitations
The discovery rule and contracts that limit the statute of limitations are in direct competition with each other. The discovery rule allows parties to pursue their legal claims after the statute of limitations would have otherwise expired. On the other hand, parties that mutually agree to a shortened limitation period know precisely when they must bring their legal claims related to that contract. The holdings in Moreno and Brisbane Lodging, L.P. are perhaps the two leading cases that split this hair on when the discovery rule applies to cases in which the parties have mutually agreed to a shortened limitation period.
In Moreno v. Sanchez (2003) 106 Cal.App.4th 1415, the plaintiff home-buyers sued the defendant home inspector after discovering the inspector did not disclose defects in the property. The contract between the plaintiffs and the inspector limited the statute of limitations to one year from the inspection date. The plaintiffs filed suit against the inspector approximately 14 months after the inspector completed his inspection. The issue on appeal was whether the contract eliminated the discovery rule.
In a 2-1 decision, the court held that eliminating the discovery rule in contracts entered into between laypersons and professionals in which the contract shortened the statute of limitations period violated California’s public policy. In reaching this broad conclusion, the court emphasized that the discovery rule is founded on crucial public policy considerations and is appropriate in instances where a fiduciary relationship exists. (Id. at 1429.) As touched on above, the court reasoned that in the context of fiduciary relationships, the fiduciary’s breach of the agreement and/or the injury caused is difficult to discover.
Armed with this principle, the court held that a fiduciary relationship existed between the plaintiff and the inspector. The inspector, albeit not the ordinary professional, was a tradesman and possessed specialized skills and knowledge to analyze a residence’s structural and component parts. Furthermore, the plaintiffs trusted the inspector to disclose any property defects, so the plaintiffs could decide to purchase the property. For these reasons, the court concluded that the discovery rule equally applied to home inspectors as it did to other professionals, such as doctors, lawyers, and engineers.
The court then concluded that the discovery rule could not be terminated through a contractual provision that shortened the limitations period. Central to the court’s holding was that the discovery rule was a judicially created exception to the statute of limitations enacted by the Legislature. And if the laws enacted by our Legislature had to yield to the judicially made discovery rule, so too did contractual clauses that provided a shortened statute of limitations. Moreover, the court held that the cases that upheld contractually created limitation periods were cases in which the breach or injury was readily apparent to the plaintiff. Those cases, such as the ones touched on above—Tebbets and Capehart—were instances in which the plaintiff knew of their injury exactly when it occurred, and no fiduciary relationship existed between the parties. The court noted that these cases were strikingly different from the one at hand wherein the plaintiffs did not learn of the inspector’s breach until well after his inadequate inspection of the property. For these reasons, the court concluded that the discovery rule applied to cases in which there existed a fiduciary relationship between the parties, regardless of whether the contract stipulated for a shorter limitations period. [1]
Moreno is the first case to decide that shorter limitations periods in contracts do not abrogate the discovery rule in the context of a fiduciary relationship between the parties. However, in Brisbane Lodging, L.P. v. Webcor Builders, Inc. (2013) 216 Cal.App.4th 1249, the court distinguished Moreno and ruled that when there are sophisticated parties, who possess equal bargaining power, the shorter limitation period terminates the discovery rule.
In Brisbane, the developer-plaintiff entered into a contract with the builder-defendant to construct a hotel in San Francisco, California. Through their lawyers, agents, and other representatives, the parties engaged in extensive contract negotiations, evidenced by the numerous revisions made to the contract at issue. As part of the negotiations, the parties mutually agreed that the statute of limitations for any claim related to the project’s construction began to accrue upon completion of the project. The project was completed in July 2000, and the statute of limitations for breach of written contract was (and still is) four years, which meant any claim related to the project had to be filed by or before July 2004. After discovering multiple defects with the project, the plaintiff filed suit in 2008. The plaintiff argued that the contract eliminated the discovery rule and that such provision violated California’s public policy, as articulated in Moreno.
The court disagreed and held that the discovery rule did not apply to the contract at issue. Central to the court’s holding was the sophistication of the parties. Different from Moreno, the parties were professionals and were represented by lawyers and agents who exchanged multiple iterations of the contract and understood the potential consequences of the contractual provisions they agreed to. Additionally, in Moreno, a fiduciary relationship existed between the parties, which was vital to that court holding that the contractual provision did not eliminate the discovery rule. In this case, no fiduciary relationship existed between the parties, and the parties negotiated the contract at arm’s length and on equal footing. [2]
Together, the holdings in Moreno and Brisbane teach us that the discovery rule will likely continue in full force when there is a fiduciary relationship between the parties, regardless of whether the contract stipulates for a shorter limitations period. On the other hand, when the parties are sophisticated and bargain on equal footing, a contractual provision that shortens the limitations period terminates the discovery rule, per the ruling in Brisbane.
In closing, the distinction between Moreno and Brisbane is essential for laypeople and attorneys to understand when they are faced with a contract that shortens the statute of limitation ns period. For attorneys especially, they must be careful not to shorten the limitations period to an extent that it harms their client down the road.
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[1] Reaffirmed in William L. Lyon & Associates, Inc. v. Superior Court (2012) 204 Cal.App.4th 1294, 1310 (finding that the delayed discovery rule applied to a broker-buyer contract that limited the statute of limitations to two years and in which the broker was a dual agent and helped the sellers conceal defects in the property sold to plaintiff-buyers).
[2] The holding in Brisbane was affirmed in Wind Dancer Production Group v. Walt Disney Pictures (2017) 10 Cal.App.5th 56, 73 (holding that the contractually agreed 24 months statute of limitations was not inherently unreasonable because the contracting parties negotiated the agreement with equal bargaining power as they were represented by attorneys and other professionals).
