To Claim Damages For Repair Costs Or Not? Beware The Economic Waste Doctrine

J. Curtis Greene | Barnes & Thornburg | October 22, 2019

When claiming damages for construction defects, the doctrine of economic waste is often forgotten or ignored, even among sophisticated parties and counsel, potentially at great cost. Unwary parties to a dispute typically jump to – and focus significant time, money and energy on – seeking damages equal to the cost to repair or replace, without considering what the applicable state law says about economic waste.

In most states, the measure of damages for a construction defect claim center on the cost to repair or replace the defective work, unless the repair cost is clearly disproportionate to the subject property’s probable loss in value because of the construction defect. Put differently, using the repair cost as a measure of damages is “unfair” when such costs are imprudent and unreasonable in light of the property’s probable change in market value if the repair is made.

That’s where the economic waste doctrine comes into play. In such cases, the measure of damages becomes the difference between the fair market value of the property with the defect and without the defect, and the complaining party is not permitted to recover the cost to repair.

Rooted in equity and justice, the economic waste doctrine centers on the idea that, although damages measured by the reduction in property value may not be sufficient to place the injured party in the same position they would have been in if the contract had been properly performed, their financial outcome will be substantially similar.

Take for example a situation where a contractor installed several hundred square feet of expensive ceramic tile in a commercial building, just the wrong color. Or, they installed the wrong brand of windows throughout the building, but with similar performance specifications. Or, they installed a roof with defective discoloration on the backside of a house. It is likely that repairs in any one of these circumstances could result in unreasonable economic waste. Contractors that overlook the economic waste doctrine could find themselves paying substantially more in repair or replacement damages than they may have been required to pay under the law. And, if the complaining party is not prepared to present evidence of the required alternative measure of damages in this situation, it may not be entitled to recover damages at trial.

Jurisdictions differ in how they apply the economic loss doctrine, but here are some considerations that may tip the scale:

  • What would be the probable change in market value of the property if the repair is made? And, to what extent would the cost to repair or replace exceed any decrease in value caused by the defect?
  • Does the claimed defect provide similar general quality and appearance to that which the owner contracted for?
  • Would making the repair require substantial destruction, significant dismantling, or unreasonable expense?
  • To what extent does the defect relate to an aesthetic aspect of the property? Is the defect related to a personal customization? Is it offensive to aesthetic sensibilities?
  • What is the property used for and what is the effect of the defect on such use? Is the property a home, a commercial place of business with customer traffic, or a secluded warehouse or storage facility?
  • Would the damages awarded equitably place the claimant in the position it would have been in had the contract been performed properly?
  • What was the overall condition and age of the property prior to the repairs?
  • Was the contractor’s breach intentional or willful?
  • Is a safety or a health concern involved?

While this list not all-inclusive, it demonstrates that not all damages cases are the same. In most instances, the cost to replace or repair will carry the day, but in some cases the economic waste doctrine may apply. For the alert contractor, invoking the doctrine can substantially impact the ultimate resolution.

Nevada Legislative Update: August 2019

Edward Garcia and Brittany Walker | Holland & Hart | August 30, 2019

CONSTRUCTION

AB 421 amends the laws governing residential construction defects. Key changes include extending the statute of repose from six to ten years and no longer requiring an expert to be present at an inspection concerning an alleged construction defect. Proponents of this legislation stated that it will protect Nevada’s homebuyers and encourage homebuilders to build to a higher standard. Opponents of this legislation stated that it will increase costs to new homebuyers and exacerbate the affordable housing issues facing Nevada.

AB 440 requires contractors who build new, single family residences to provide a disclosure of the purchaser’s rights and a one-year warranty from punch list completion that guarantees all home systems, workmanship, materials, plumbing, electrical and mechanical systems, appliances installed by the contractor, fixtures, equipment, and structural components.

SB 397 authorizes a licensed contractor to perform work in other license classifications which he or she does not have a license for when: (1) the value of the work is less than $1,000 and does not require a permit; and (2) the work is not of a type performed by a plumbing, electrical, refrigeration, or air-conditioning contractor. Essentially, this bill provides a handyman exception for contractors to perform work outside the scope of their license, which will help consumers by allowing a contractor to complete a small project which he or she does not typically perform.

Ohio Supreme Court: All Claims for Defective Construction or Design Must Be Brought Within 10 Years of Substantial Completion

Peter Hahn | Benesch | July 19, 2019

The Ohio Supreme Court has ruled any lawsuit for defective and unsafe conditions arising from the design or construction of an improvement to real property must be brought within 10 years of substantial completion of the project—regardless of whether the lawsuit arises out of a breach of contract or a tort.

In a victory for Benesch’s Appellate Practice Group, the Court’s decision in New Riegel Local School District Board of Education, et al. v. The Buehrer Group Architecture & Engineering, Inc., et al. [1] interprets Ohio’s Statute of Repose, [2] which generally requires certain construction defect claims to be brought within 10 years of the date of substantial completion. At issue in the case was whether that statute applies only to tort claims (such as claims that the general contractor or architect negligently performed its work by failing to comply with the applicable standard of care), or also to breach of contract claims. In holding that the Statute of Repose applies to both types of claims, the Supreme Court reversed its own 1986 holding that the statute applied only to tort claims. 

In the New Riegel case, the New Riegel Local School District filed a lawsuit against its architect, general contractor, roofing subcontractor, and a surety for damages arising out of condensation, moisture intrusion, and other deficiencies allegedly resulting from improper design and construction. The lawsuit was filed more than 10 years after substantial completion. At the time the lawsuit was filed, the statute of limitations for a breach of contract action was 15 years and the school district’s lawsuit was filed within that time period. (The statute of limitations for breach of contract claims has since been amended to 8 years.)  But because the school district’s claims were for breach of contract, it argued that the Statute of Repose did not apply and that its claims were not time-barred.

Benesch represented the surety, Ohio Farmers Insurance, at oral argument before the Supreme Court. Tracing the history of the Statute of Repose, the Court first determined that the legislature materially amended that statute after the Supreme Court’s original 1986 decision limiting the application of the statute to tort claims. That earlier decision, therefore, did not apply to the current version of the Statute of Repose, giving the Court an opportunity for a fresh look at whether the legislature intended for the statute to apply to tort claims only or to both tort and contract claims.  The Court held that the new statute’s language made it clear that the legislature intended for the statute to apply to both types of claims.  The Court then sent the case back to the lower courts to determine whether, in view of the Supreme Court’s new interpretation of the Statute of Repose, New Riegel’s lawsuit should proceed or be dismissed.

As a result of this decision, parties to a construction project should assume that claims for defective and unsafe conditions arising from the design or construction of an improvement to real estate will expire 10 years after substantial completion, subject to certain exceptions in the statute (including, for example, claims discovered within two years of the expiration of the 10-year period).  It no longer matters whether those claims arise out of a breach of the parties’ contract or the neglect of a duty under tort law.

A Milestone Construction-Defect Case at New Hampshire Supreme Court

Boston Real Estate Times | August 16, 2019

Morrison Mahoney LLP, one of the northeast region’s leading litigation firms, announced that William A. Staar, a Partner in the firm’s Construction Litigation Practice, prevailed in a case before the New Hampshire Supreme Court (NHSC) on behalf of landscape architect, Wagner Hodgson, Inc.

At issue was whether New Hampshire’s eight-year statute of repose, which protects building professionals from direct claims, also protects those professionals from contribution and indemnity claims. Staar argued that the statute does offer that additional protection. The NHSC agreed, and this landmark decision will provide additional protection for building professionals operating within the state of New Hampshire.

Background

John C. Rankin & A. v. South Street Downtown Holdings, Inc.

South Street Downtown Holdings, Inc. v. Truexcullins and Partners Architects, et al.

The plaintiff is an older man who allegedly fell on a short set of exterior stairs and ramp that are part of a commercial property in Hanover, New Hampshire.  As a result, he purportedly suffered severe facial injuries.  The plaintiff sued the property owner, i.e., South Street, arguing that a defective design plagued the stairs and ramp and that such design caused him to fall.  South Street filed contribution and indemnity claims against several building professionals, including Wagner Hodgson, Inc., that allegedly designed and/or constructed the stairs and ramp approximately a decade before the subject accident.

Legal Argument

The Morrison Mahoney legal team, including Staar and firm associate Nicholas D. Meunier, moved to dismiss, arguing the following:

  1. A New Hampshire statute of repose, i.e., RSA 508:4-b (1990), bars all claims against building professionals “arising out of” allegedly defective construction that are over eight years post the date of substantial completion of a project, and
  2. South Street brought its third-party claims against Wagner Hodgson 8.5 years after the Town of Hanover issued a certificate of substantial completion.

South Street conceded that the third-party claims were late, but argued that the statute of repose (1) only barred direct claims against building professionals and (2) did not bar indemnity nor contribution claims.  It principally relied on the fact that the pre-1990 version of the statute did specifically bar indemnity and contribution claims and that the current version of the statute does not.  The trial court did not rule on the motion and, instead, passed the issue to the NHSC.

NHSC Ruling

The NHSC found that the current version of the statute bars both indemnity and contribution claims.  Its principal reasons were as follows:

  1. Although the current version of the statute does not explicitly bar indemnity and contribution claims as the prior one did, it contains broader language that does encompass such claims.  Specifically, the current statute bars “all actions” older than eight years against building professionals “to recover damages for . . . economic loss arising out of any deficiency in the creation of an improvement to real property.”  The Court found that a successful claim by the plaintiff against South Street would constitute an “economic loss” that “arose out of” such an alleged deficiency; and
  2. Excepting contribution and indemnity claims from the statute fundamentally would frustrate the central purpose of the statute, i.e., to allow building professionals to be free and clear from lawsuits pertaining to their work on a particular project eight years after the completion of such work.  As made clear by the legislative record for the statute, the goal of the statute was to protect such professionals from all claims arising out of their work.  The genesis of the statute was that, prior to its enactment, many building professionals operating in New Hampshire suffered severe financial strain by having to maintain liability insurance for their work sometimes decades after they had completed such work, including well into retirement.

The case was argued in the chamber of the New Hampshire House of Representatives on Tuesday, June 4, 2019, in celebration of the bicentennial anniversary of the state house, and the Court decision was released on August 6, 2019. The Court videotaped both oral argument and the Q&A, which is available here.

Builder’s Risk Coverage – Construction Defects

Brian Hearst | Construction Executive | June 15, 2019

COVERAGE FOR LOSS ENSUING FROM FAULTY WORKMANSHIP

Part I tackled the standard builder’s risk exclusion that applies to losses arising from faulty materials or workmanship. Traditionally, carriers do not have an appetite for covering a contractor’s failure to perform their work properly. There is one exception, which is coverage is available for ensuing loss – or the resulting damage to other property from faulty workmanship. 

If the excluded cause of loss (i.e., faulty workmanship) causes resultant damage, the builder’s risk policy will cover the damages to the extent the peril of fire is covered. The ensuing loss exception limits the faulty work exclusion to costs directly related to repairing or replacing the faulty work. 

For example, suppose faulty wiring work leads to a fire which damages part of a structure under construction. The faulty workmanship exclusion would apply to the actual faulty wiring work, but if fire is a covered peril under the policy (this is nearly always the case), the policy would respond to the structure’s fire damage.

Coverage for ensuing loss is either stated as an exception to the faulty workmanship exclusion or by limiting the faulty workmanship exclusion language. Working with a broker to assure a properly written ensuing loss provision is critical.

LEG – LONDON ENGINEERING GROUP EXCLUSIONS

The London Engineering Group serves as a consulting body to various insurance and reinsurance companies, as well as various Lloyds syndicates providing, among others, construction insurance. LEG published three variations of defects exclusions, known as LEG 1, LEG 2 and LEG3, with increasing levels of coverage for defective construction. While initially available through London markets, these endorsements, or similar “cost of making good” endorsements are increasingly available from domestic insurers. 

  • LEG 1. Broad Exclusion serves as a baseline endorsement broadly excluding “loss or damage due to defects of material workmanship, design, plan or specification.” This can also serve to exclude ensuing loss, as mentioned above. 
  • LEG 2. Compromise Exclusion provides coverage for costs to remedy ensuing loss to covered property and costs to remedy damage to property supported by defective property. LEG 2 excludes the costs incurred to remedy a defect immediately before the damage occurred. 
  • LEG 3. Narrow Exclusion is most broad by only limiting the exclusion to costs incurred to improve original materials, workmanship, design, plan or specification. Thus, in addition to the cover provided under LEG 2, LEG 3 will respond to the costs to remedy damage to defective property, costs to put right defective “part, portion or item,” and loss, damage or expenses incurred to access defective parts (rip and tear). 

Under both LEG 2 and LEG 3, an ensuing loss exception is no longer necessary. The policy states that the entire loss will be covered less a specified amount. The loss payable is the total amount of the covered loss minus what it would have cost to replace the faulty work prior to the loss (LEG 2) or the cost to improve the original materials, workmanship or design (LEG 3). 

Any claim under LEG 2 or LEG 3 will only respond if the project suffers damage or destruction. Rectification of a known defect, part or system that has not manifested damage is not an insured loss.

LEG – LOSS EXAMPLE

An HVAC unit placed between floors of a partially completed five story building is being commissioned. A fire occurs and causes $3 million in damage to the HVAC unit and parts of the building surrounding the unit. It is determined insufficient electrical wires were installed. To access and replace the fire-damaged HVAC unit, $400,000 of undamaged property will need to be ripped out to replace the damaged unit. Engineers determine the wiring requires an upgrade at an additional cost of $65,000. A $75,000 policy deductible will apply. LEG response:

  • LEG 1 – Loss is not covered;
  • LEG 2 – Pays $3,000,000 damage to covered property less $65,000 the before-loss cost to replace the inadequate wiring less $75,000 deductible. Final Claim Value is: $2,860,000; or
  • LEG 3 – Pays $3,000,000 damage to covered property plus $400,000 rip and tear costs less $75,000 deductible. Final Claim Value is: $3,325,000.

The language in the builder’s risk policy matters. If a construction loss occurs, it can determine the company’s financial future. An insurance broker can help review, construct and understand policies, ensuring critical loss is a covered matter.