Utah Appellate Court: Homeowners’ Claim for Defective Construction Against Geotechnical Engineer Dismissed Due to Lack of Contract and the Economic Loss Rule

Patrick Johnson | Construction Industry Counselor | July 8, 2019

A recent Utah Appellate Court upheld the dismissal of a homeowners’ claims against a geotechnical engineer because the homeowners did not have a contract with the geotechnical engineer and therefore their claims were barred by the economic loss rule. See Hayes v. Intermountain Geoenvironmental Services, Inc., 2019 UT App 112, 2019 WL 2621931.  In Utah, the economic loss rule only allows lawsuits for defective design or construction to be based on a breach of contract.  Such a claim cannot be brought under a general negligence or tort theory where there is no contract.  Many states have a similar, but often not identical, economic loss rule.

In this case, the plaintiff homeowners purchased land from a developer and constructed a home.   The defendant geotechnical engineer prepared a report for the developer  concluding that the parcel of land was stable and suitable for development.  Fourteen months after construction had concluded, cracks were observed in the foundation of the home and the home began to settle rendering it unlivable.  Because the homeowners did not have a contract with the geotechnical engineer, they could not file a breach of contract claim against the geotechnical engineer. As a result, the homeowners tried to bring a claim under a general negligence theory against the geotechnical engineer for their damages.  The trial court and appellate court agreed that the homeowners were barred from asserting a negligence claim due to the economic loss rule. 

This case serves as a reminder that, in many states, recovery of purely economic losses based on theories of tort are generally not recoverable. Developers and parties to a construction project should  document their agreements in writing.  Likewise, a purchaser of a construction project should receive assignments of the developer’s and/or seller’s written contracts with third-parties involved in the development.   

Exceptions to the Economic Loss Rule in North and South Carolina: Yes, an owner MAY be able to sue that subcontractor after all!

Julia Gallagher | Nexsen Pruet | June 10, 2019

In North Carolina, the economic loss rule will not bar recovery on a negligence claim when there is no contract between the parties. In Lord v. Customized Consulting Specialty, Inc., a general contractor contracted with the plaintiff owners to construct a home. The owners subsequently sued the general contractor for alleged defects in the home’s construction. The general contractor named as defendants the subcontractors with whom the general contractor had contracted with to provide the trusses for the home. These subcontractor defendants asserted that the economic loss rule should apply to bar the plaintiffs’ negligence claim against them. The court acknowledged that, “simply stated, the economic loss rule prohibits recovery for purely economic loss in tort, as such claims are instead governed by contract law.” However, the court recognized the economic loss rule is not fair to those plaintiffs who have suffered economic loss or damage from improper construction but “who have no basis for recovery in contract” in the absence of a contract between the parties. Therefore, the court held “that the [subcontractor defendants] had a duty to use reasonable care in performing its promise to provide reliable trusses to [the general contractor] for use in the construction of the [plaintiffs’] residence, and it further held that because there was no contract between the plaintiffs and the subcontractor defendants, the economic loss rule did not apply and therefore did “not operate to bar the plaintiffs’ negligence claims.”

The North Carolina Court of Appeals recently acknowledged in the 2016 case Buffa v. Cygnature Constr. & Dev., Inc., 796 S.E.2d 64 (unpublished) Lord’s holding that the economic loss rule does not bar a negligence claim where there is no contract between parties in a home construction case. However, the court qualified this holding by stating that “where a basis for recovery is available by warranty,” the economic loss rule will apply to prevent recovery for purely economic loss under a negligence claim. In this case, the plaintiffs sustained damage to their home as a result of defective windows. The seller of the windows did not have a contract with the plaintiffs, as the windows were purchased by the subcontractor who installed the windows. These windows were covered by the manufacturer’s express warranty. Because a basis for recovery was available by warranty, the court held that it was appropriate to apply the economic loss rule to bar negligence claims seeking to recover for purely economic loss. 

However, it may be important to note that the Buffa case concerned an express warranty. A more detailed analysis may be required as to the issue of whether an implied warranty would bar a negligence claim per the economic loss rule, but the general rule in North Carolina is that a contract “is required to assert a claim for breach of an implied warranty involving only economic loss.” Energy Inv’rs Fund, L.P. v. Metric Constructors, Inc., 351 N.C. 331, 338, 525 S.E.2d 441, 446 (2000). Therefore, the economic loss rule will likely bar negligence claims if a court has recognized the existence of an implied warranty, because an implied warranty typically only exists when there is a contract between parties.  

South Carolina law is complicated in that there are a number of uncoordinated opinions touching on the subject. However, similar to the Lord case above, the South Carolina Supreme Court has ruled that the economic loss rule will not bar a negligence action against a builder when a legal duty has been violated, “no matter the type of resulting damage. . . . But the economic loss rule will apply [to bar negligence actions] where duties are created solely by contract.” Kennedy v. Columbia Lumber & Mfg. Co. This case further emphasized that “privity of contract as a defense to an implied warranty action” has been abolished in South Carolina. So, unlike in North Carolina, the existence of an implied warranty is not likely to bar a negligence claim for economic loss in South Carolina where there is no contract between the parties. Further, in Beachwalk Villas Condo. Ass’n, Inc. v. Martin, the holding in Kennedy was expanded to architects in addition to builders, as the court stated that “architects may be held liable to home buyers for negligence in connection with home construction projects and breach of implied warranty where no contractual privity exists between the architect and the home buyer.” However, the South Carolina Supreme Court has since held that the principle set forth in Kennedy is limited to the residential real estate construction context. Sapp v. Ford Motor Co.

In sum, in both North and South Carolina the economic loss rule will not apply in certain instances to bar recovery for purely economic loss in tort, although the justification for such an exception may differ somewhat between the two states. Therefore, if a party seeks to recover for pure economic loss and does not have adequate recourse via typical contract law, it would be wise to explore the various exceptions in North and South Carolina regarding the economic loss rule when bringing a claim.

Colorado Supreme Court Revisits Economic Loss Rule

Justin L. Cohen, David B. Meschke and Jesse D. Sutz | Brownstein hyatt Farber Schreck LLP | May 28, 2019

The Colorado Supreme Court has issued a number of opinions over the last several years clarifying the scope of the economic loss rule. On May 7, 2019, the court revisited the economic loss rule in Bermel v. BlueRadios, Inc., imparting a blow to the strength of the doctrine by ruling that it does not bar civil theft claims under C.R.S. § 18-4-405, and further suggesting that it does not bar intentional tort claims, such as fraud.

The economic loss rule is a judge-made doctrine that enforces the boundary between contract law and tort law. The purpose of the rule is simple: to prevent parties from expanding the scope of their bargained-for remedies under a contract. At its most basic level, the rule applies when two parties have a contract not to do X, one of the parties does X, and the other party sues under tort theories based on that conduct. The rule is designed to honor the age-old notion that parties are encouraged to carefully allocate risks, rights and remedies when negotiating contracts.

The Colorado Supreme Court adopted the economic loss rule in two decisions issued on the same day in 2000—Town of Alma v. Azco Const., Inc. and Grynberg v. Agri Tech, Inc. The court in Town of Alma explained that the rule “is intended to maintain the boundary between contract law and tort law.” 10 P.3d 1256, 1259 (Colo. 2000). “[T]his principle that parties must be able to confidently allocate their risks and costs in a bargaining situation underlies the necessity for the economic loss rule.” Id. at 1261. The court later explained that the economic loss rule comes down to one fundamental question: can the plaintiff show a duty independent of the contract which supports its tort claim? See BRW, Inc. v. Dufficy & Sons, Inc., 99 P.3d 66, 72 (Colo. 2004).

Bermel v. BlueRadios, Inc.

The Colorado Supreme Court granted certiorari in Bermel to resolve the narrow question of whether the economic loss rule bars civil theft claims asserted under C.R.S. § 18-4-405. 2019 CO 31, at ¶ 1 (2019). C.R.S. § 18-4-405 provides that the rightful owner of stolen property may recover that property from the taker, as well as reasonable attorneys’ fees and the larger amount between treble damages and $200.00. Despite granting certiorari on the narrow issue regarding the interplay between claims asserted under both the civil theft statute and contract, the court’s opinion extends beyond the bounds of that issue.

The question as to whether the economic loss rule operates to bar civil theft claims was before the court because the Colorado Court of Appeals had arrived at different answers in separate opinions. In Rhino Fund, LLLP v. Hutchins, the Colorado Court of Appeals ruled that the economic loss rule did not bar an investor’s civil theft claim against a fund owner for diverting funds for his own benefit. 215 P.3d 1186, 1190 (Colo. App. 2008). One year later, in Makoto USA, Inc. v. Russell, a different division of the Court of Appeals held that the economic loss rule prevented civil theft claims premised on returning funds paid out pursuant to a contract. 250 P.3d 625 (Colo. App. 2009).

The facts of Bermel were straightforward. Mr. Bermel contracted with BlueRadios, Inc. (“BlueRadios”) to provide engineering services. 2019 CO 31, at ¶ 4. Anticipating that he would soon be fired and potentially be involved in litigation, Bermel forwarded thousands of emails containing proprietary information to his personal email. Id. at ¶ 7. Bermel’s contract with BlueRadios, however, prohibited Bermel from “remov[ing] any Company materials [including Proprietary Information] from the business premises of [BlueRadios][.]” Id. at ¶ 6. After Bermel filed a wage claim against BlueRadios, the company asserted counterclaims against Bermel for breach of contract and civil theft. Id. at ¶¶ 8–9. The trial court found in favor of BlueRadios on both its breach of contract and civil theft counterclaims. Id. at ¶ 11. The Court of Appeals affirmed on the grounds that it considered Rhino Fund more persuasive than Makoto. Id. at ¶ 12.

A preliminary issue in Bermel involved whether civil theft—a statutory right of action—is a tort. But the court determined it was unnecessary to opine on this issue in resolving the case. Id. at ¶ 34. Instead, the court, in an opinion authored by Justice Márquez, reasoned that the economic loss rule does not bar civil theft claims because a judge-made doctrine cannot override a legislatively created right of action; thus, the decision was premised on broader separation of powers principles. Id. at ¶¶ 39–41. As a result, the court overruled Makoto. Id.at ¶ 43.

Justice Gabriel, joined by Justice Hart, dissented. The dissent took the position that a private cause of action under the civil theft statute is a tort, meaning that if the tort duty overlaps with the contractual duty, the economic loss rule bars the civil theft claim. Id. at ¶ 63. The dissent believed this was the case here because to establish that a civil theft occurred, BlueRadios first had to establish Bermel breached the contract by taking proprietary information. Id. at ¶ 65. Because the claims were “inextricably intertwined,” the dissent believed under the facts of this case, the claim was barred. Id. at ¶¶ 65–67.

An Intentional Tort Distinction?

Although the Bermel decision provided much needed clarity on the applicability of the economic loss rule in the context of civil theft claims, the court nevertheless opened the door to more uncertainty. In providing background on the economic loss rule, the court twice explained that its previous opinions had applied the rule to only bar common law tort claims for negligence or negligent misrepresentation. Id. at ¶¶ 15, 21.

Then, in a footnote, the court expounded that “the economic loss rule generally should not be available to shield intentional tortfeasors from liability for misconduct that happens also to breach a contractual obligation.” Id. at ¶ 20, n.6. This statement, arguably in dicta, suggests that the economic loss rule can only bar unintentional tort claims, such as negligence, as opposed to intentional tort claims, such as fraud, even though the Colorado Court of Appeals has applied the rule to both types of tort claims. At a minimum, the court’s footnote opens the door for future litigation on this issue.

Implications

The most obvious implication of the Bermel decision is that plaintiffs are incentivized to plead claims for civil theft in conjunction with their breach of contract claims, particularly since the civil theft statute allows a plaintiff to seek treble damages and attorneys’ fees that might not otherwise be available under the parties’ contract. Plaintiffs now understand that defendants can no longer use the economic loss rule to dismiss such claims.

Beyond Bermel’s limited holding, the court’s footnote suggests that the economic loss rule should not bar claims for intentionally tortious conduct, creating uncertainty for both plaintiffs and defendants. While the key question under the economic loss rule used to be whether the plaintiff has alleged a duty independent from the contract sounding in tort, there now may be a preliminary question as to whether the plaintiff’s claims are for negligence or intentional torts.

The fallout from the Bermel decision will most certainly be litigated in the coming years, and there may be additional unforeseen implications. But what is clear is that Bermel weakens the reach of the economic loss rule.

The Economic Loss Rule and Why It Matters in Construction Litigation

William S. Durr | Ward and Smith | March 20, 2019

In its broadest sense, the “economic loss rule” prohibits recovery in tort for purely economic loss incurred under contract law. 

The Merriam-Webster Dictionary online defines tort as “a wrongful act other than breach of contract for which relief may be obtained in the form of damages or an injunction.”  Negligence, the most common tort claim, is the failure to exercise the care that a reasonably prudent person would exercise in similar circumstances.  Thus, where a contract exists governing the subject matter of the dispute, claims between the parties must be based on the contract terms, and a tort-based claim between the parties will typically be barred.

The rationale for the economic loss rule is that where a contract exists, the parties have freely negotiated to include or exclude terms governing the parties’ respective rights, obligations, and remedies.  If a party to that contract could extend its remedies beyond those set forth in the contract, this would effectively allow the party to obtain something more than (or inconsistent with) what they bargained for in the contract.  This is especially true in the products liability context, where the economic loss rule first arose.

In 1978, some twelve years prior to the express adoption of the economic loss rule, the North Carolina Supreme Court addressed the essential elements of the rule (without referring to it by name in the decision) in a dispute between an owner and general contractor.  The case, North Carolina State Ports Authority v. Lloyd A. Fry Roofing Co., et al., 294 N.C. 73, 240 S.E.2d 345 (1978), involved a claim for damages arising from leaking roofs.  The owner, the North Carolina State Ports Authority, asserted two claims against the general contractor, as well as other project participants.  One claim was for breach of the construction contract, the other for negligence in constructing and installing the roofs.  The Court found that a tort claim is unavailable “against a promisor for his simple failure to perform his contract, even though such failure was due to negligence or skill.”

The North Carolina Court of Appeals expressly adopted the economic loss rule in a 1990 products liability case, Chicopee v. Sims Metal Works, 98 N.C. App. 423, 391 S.E.2d 211 (1990).  Since Chicopee, case law has intertwined the concepts set forth in Ports Authority and Chicopee and extended the economic loss rule to a number of other substantive areas.

There are exceptions to the economic loss rule.  Ports Authority identifies the following exceptions:

  1. The promisor’s negligent act or omission in the performance of the contract caused injury to the person or property of someone other than the promisee.  By way of example, if a crane falls over and injures a third party who had no connection to the promisee, a claim for negligence brought by the third party against the crane supplier would not be barred by the economic loss rule, as there was not a contract between the crane supplier and the third party.
  2. The promisor’s negligent, or willful, act or omission in the performance of his contract, caused injury to property of the promisee other than the property which was the subject of the contract, or personal injury to the promisee.  Thus, if a crane fell over and damaged the utility lines of the building and the contract with the crane supplier did not involve work on the utility lines, a claim for negligence against the crane supplier for damage to the utility lines would not be barred by the economic loss rule.  This makes sense as the contract with the crane supplier did not include or govern the utility lines and, therefore, there was not a contract that applied to the specific subject matter of the dispute (the utility lines that were damaged).
  3. The promisor’s negligent, or willful, act or omission in the performance of his contract, caused loss of or damage to the promisee’s property, which was the subject of the contract, and the promisor had a legal duty, as a matter of public policy, to use care in the safeguarding of the property from harm, as in the case of a common carrier, an innkeeper or other bailee. 
  4. The injury caused by the promisor to the promisee was a willful act.  

In applying and, in many cases, expanding these exceptions, the relevant inquiry under North Carolina law is whether the injured party has a basis for recovery in contract or warranty.  If there is a basis for recovery under a contract or warranty provision, then the Court will generally recognize and apply the economic loss rule, provided that there is not an independent legal duty which is identifiable and distinct from the contractual duty.  See, Bradley Woodcraft, Inc. v. Bodden, 795 S.E.2d 253, 258-59 (2016).  By way of example, an architect is held to a professional standard of care.  While this professional standard of care may be referred to in the contract between owner and architect, the duty to adhere to a professional standard of care is an independent legal standard and the owners’ tort claims against the architect are not barred by the economic loss rule. Put simply, the architect cannot contract away its obligations to perform at a minimum professional standard of care.    

In Bradley Woodcraft, the homeowner entered into a contract with the general contractor to undertake some interior finish work and kitchen remodeling.  The homeowner became dissatisfied with the contractor’s work.  After meeting with the contractor the homeowner paid the contractor an additional sum, using two credit card transactions.  The homeowner testified that payment was made with the understanding that the contractor would complete the project.  The contractor took the funds but never returned to the job.  The homeowner disputed the two credit card charges, which were reversed by the credit card company.  The contractor sued the homeowner for breach of implied and express contract, and the homeowner counterclaimed, alleging among other claims, breach of contract and fraud.  The homeowner argued that their fraud claim should survive the economic loss rule defense.  The Court agreed, “…while claims for negligence are barred by the economic loss rule where a valid contract exists between the litigants, claims for fraud are not so barred…”  Bradley Woodcraft at 259.  Bradley Woodcraft seems to suggest that a tort claim, other than negligence, will survive in an otherwise clear contractual dispute and not be subject to the economic loss rule. 

Fortunately, a 2018 federal case rejected the broad statement that the economic loss rule barred only negligence claims and distinguished Bradley Woodcraft by stating that the proper inquiry is whether there is an independent legal duty, which is identifiable and distinct from the contractual duty.  Legacy Data Access, Inc. v. Cadrillion, LLC, 889 F.3d 158, 166 (4th Cir. 2018).      

An earlier construction case, Lord v. Customized Consulting Specialty, Inc., 182 N.C. App. 635, 643 S.E.2d 28 (2007), allowed the owners of a home to pursue a tort claim against a subcontractor, holding the economic loss rule did not bar claims of negligence given the particular facts of the case.  In this case, the homeowners (Lords) discovered the trusses used to construct their home were defective.  The Lords sued their contractor (Customized Consulting Specialty, Inc.) and the subcontractor who designed the trusses.  The claims against the subcontractor included a negligence claim.  The subcontractor argued the economic loss rule applied to bar the homeowners’ negligence claim, relying on the holdings from several cases involving damage resulting from the use of synthetic stucco, some decided in Federal Court. The North Carolina Court of Appeals rejected the subcontractor’s arguments.  The Court found that no contract existed between the subcontractor and the homeowners, that the economic loss rule did not apply and that the economic loss rule did not operate to bar the homeowners’ negligence claim.     

In summary, while the economic loss rule does not provide an absolute defense to all tort claims, it must certainly be considered in litigation that involves claims sounding in both contract and tort. 

More importantly, the protection of the economic loss rule begins with the contract itself.  Creating, maintaining, and properly executing well-drafted contracts is a foundational requirement to controlling and allocating risk in the construction industry.  If you give less attention to your contracts than you do other details of a project, you are placing your company at risk, as you may find yourself defending both contract and tort claims.

Illinois Supreme Court Limits Reach of Implied Warranty Claims Against Contractors

Thomas G. Cronin | Gordon Rees Scully Mansukhani | February 25, 2019

In a recent decision, the Illinois Supreme Court held that a purchaser of a newly constructed home could not assert a claim for breach of the implied warranty of habitability against a subcontractor where the subcontractor had no contractual relationship with the purchaser. Sienna Court Condo. Ass’n v. Champion Aluminum Corp., 2018 IL 122022, ¶ 1. The decision overruled Minton v. The Richards Group of Chicago, which held that a purchaser who “has no recourse to the builder-vendor and has sustained loss due to the faulty and latent defect in their new home caused by the subcontractor” could assert a claim of a breach of the warranty of habitability against the subcontractor. 116 Ill. App. 3d 852, 855 (1983).

In Sienna Court Condo. Ass’n, the plaintiff alleged that the condo building had several latent defects which made individual units and common areas unfit for habitation. 2008 IL 122022 at ¶ 3. The Court rejected the plaintiff’s argument that privity should not be a factor in determining whether a claim for a breach of the warranty of habitability can be asserted. Id. at ¶ 19. The Court also rejected the plaintiff’s argument that claims for a breach warranty of habitability should not be governed by contract law but should instead be governed by tort law analogous to application of strict liability. Id.

The Court reasoned that the economic loss rule, as articulated in Moorman Manufacturing Co. v. National Tank Co., 91 Ill. 2d 69, 91 (1982), refuted the plaintiff’s argument that the implied warranty of habitability should be covered by tort law. 2008 IL 122022 at ¶ 20. Under the economic loss rule, a plaintiff “cannot recover for solely economic loss under the tort theories of strict liability, negligence, and innocent misrepresentation.” National Tank Co., 91 Ill. 2d at 91. The Court explained that the rule prevented plaintiffs from turning a contractual claim into a tort claim. 2008 IL 122022 at ¶ 21. The Court further noted that contractual privity is required for a claim of economic loss, and an economic loss claim is not limited to strict liability claims. Id. Because the plaintiff’s claim was solely for an economic loss, it was a contractual claim in nature; therefore, the Court concluded that “the implied warranty of habitability cannot be characterized as a tort.” Id. at ¶ 22.

The Court also rejected the plaintiff’s argument that warranty of habitability should be governed by tort law because it involves a duty imposed by the courts. Id. at ¶ 23. It reasoned that “an implied term in a contract is no less contractual in nature simply because it is implied by the courts . . . .” Id. The Court noted that the warranty of habitability can be waived under Illinois law, but individuals are not able to waive duties imposed upon them by the courts. Id. If the warranty of habitability was a tort claim, it would “raise[] significant practical problems, particularly for subcontractors” given that they “depend upon contract law and contracts with the general contractor to protect and define their risks and economic expectations.” Id. at ¶ 24. Because a subcontractor’s fees, costs, and liability are controlled by his contracts, turning an implied warranty of habitability claim into a tort would make those contracts pointless. Id.

The Court’s decision to overrule Minton rested on three primary reasons: (1) Minton failed to discuss why the economic loss rule did not apply; (2) Minton did not address what effect its holding would have on the contractual relationships of subcontractors and general contractors; and (3) there is “no authority for the idea that a tort duty comes into and out of existence depending on whether another entity is bankrupt.” Id. at ¶ 25. In light of the opinion, a home purchaser’s remedy where there is economic loss is now limited to those parties with whom it has a direct contractual relationship.