Construction Claims – No Contract, No Claims?

Andrew Atkins, Peter Marino and Patrick Wilson | Smith Anderson

The North Carolina Supreme Court recently issued a decision in Crescent University City Venture, LLC v. Trussway Manufacturing, Inc.[1] The case decided the question of whether a commercial developer-owner can bring a negligence claim directly against a supplier of defective building material where no direct contract existed between the owner and supplier. The Supreme Court held that the owner could not maintain such a claim and reaffirmed that the “economic loss rule” applied. The economic loss rule provides that, when a duty to perform arises from a contract, no negligence claims can be brought for failing to perform that duty. Instead, only contract claims can be brought.

In the construction context, there are frequently multiple layers of contracts, from the owner’s agreement with the general contractor to multiple tiers of subcontractor and supplier agreements. Under North Carolina law, and as recently clarified in the Crescent case, in the event a subcontractor fails to perform or if a supplier provides a defective product, absent a specific warranty provided by the party at issue, the owner must pursue a contract claim against the party with which it has a contract (i.e., the general contractor). No matter the nature or amount of damage, the owner is precluded from bringing negligence-based claims directly against the offending subcontractor or supplier. This can be problematic in the event that a general contractor goes out of business, especially in the case where an owner did not require a performance bond(s) on the project covering such circumstances. The economic loss rule applies to and poses similar risks and limitations on a general contractor’s claims against lower tier subcontractors and suppliers with whom the general contractor has not contracted directly.

There is a wrinkle. North Carolina courts recognize a limited number of exceptions to the economic loss rule. One such limited exception involves residential home construction. The North Carolina Supreme Court has long held that subsequent residential home buyers can maintain negligence claims directly against home builders, despite the fact that the obligation to build the home arose from a contract to which the subsequent purchaser was not a party. The North Carolina courts have justified this exception by applying equitable principles, noting that residential home buyers expend considerable personal resources to buy a home, subsequent buyers have no input or oversight over the original construction of the home and otherwise would have no recourse against the builder in the event that a latent construction defect is discovered.[2] 

One unresolved issue in North Carolina is whether subsequent owners of commercial properties can benefit from the same exception that has been recognized in the residential context. While the Court in its recent Crescent decision stated it was not inclined to extend the exception to the commercial development and construction context, the issue was not squarely before the Court. Indeed, the commercial owner in the Crescent case was the original owner and had a contract with the general contractor. Because this specific portion of the case is dicta, or non-essential to the Court’s ruling, lower courts are not bound to follow it. With this in mind, there may still be an opening in a North Carolina case to argue that the “subsequent owner” exception to the economic loss rule should be extended to disputes involving commercial construction projects.

The Supreme Court’s recent decision in Crescent is a reminder to project owners, general contractors and all project participants to diligently ensure their “downstream” contracts, insurance, warranties and bonding requirements adequately protect them in the event of the default or dissolution of other project participants. As always, a thorough vetting of key contractors, subcontractors and suppliers goes a long way to effectively manage risk.

[1] Crescent Univ. City Venture, LLC v. Trussway Mfg., Inc., No. 407A19, 2020 WL 7415061, at *1 (N.C. Dec. 18, 2020).

[2] A six-year repose period applies to bar claims brought more than six years after substantial completion of the home.

Yet Another Reminder that Tort and Contract Don’t Mix

Christopher G. Hill | Construction Law Musings

I have stated on numerous occasions here at Musings that in Virginia, contract claims and tort claims (read fraud) don’t mix.  A recent case from the Federal District Court for the Eastern District of Virginia presents another example of this principle.  In Itility LLC v. The Staffing Resource Group, Judge Ellis of the Alexandria Division, considered ITility’s claims of fraud and breach of contract against SRG and one of its officers based upon SRG’s alleged violation of its duties under a teaming agreement.  The claim by ITility was that TSRG provided false and misleading resumes and thus damaged ITility.  SRG filed a Motion to Dismiss and the Court was therefore required to resolve the following issues: (1) whether plaintiff’s fraud claim is barred by Virginia’s “source of duty” rule; (2) whether plaintiff’s claim for tortious interference with a business expectancy is barred by SRG’s participation in the business expectancy, and (3) whether the teaming agreement between the parties bars plaintiff’s claims for consequential and punitive damages.

Unsurprisingly, the Court determined for the defendant, SRG on all three points.  On the question of whether a fraud count could be sustained by ITility, the Court rejected ITility’s argument that the Teaming Agreement didn’t require SRG to provide any representations or warranties regarding its performance under the Teaming Agreement and therefore the fraud claim was outside of the contract.  The Court further fleshed out its ruling on this point as follows:

The question raised by a source of duty analysis is not whether the contract obligated the defendant to certify its performance or not to commit fraud. Rather, the source of duty rule asks whether the alleged tort is based on the defendant’s performance of a contractual duty. Here, SRG had a contractual duty to provide resumes and certifications, and failed in that duty. Therefore, plaintiff’s sole remedy is contract.

The Court then went on to reject the tortious interference and punitive damages claims because SRG was not a third party that could interfere with the contract and punitive damages are not available in contract respectively.

This case continues the long legal history in Virginia that with few exceptions, where a contract exists fraud will not be an available cause of action.  As always, be sure to consult with an experienced Virginia construction attorney to determine if your case may meet one of these exceptions.