Making “Special Relationships” less special: Advice to the California Supreme Court for deciding Beacon Residential Community Association v. Skidmore, Owing & Merrill LLP.

In California, the courts are as muddled as anyone about the rationale and extent of the Economic Loss Rule.   In Beacon Residential Community Association v. Skidmore, Owing & Merrill LLP, currently pending in the California Supreme Court, there is an opportunity to fix this—let us hope they will. 

Historically, California courts followed the view that the negligent breach of a contractual duty resulting in economic harm would not give rise to a cause of action in negligence.  Buckley v. Grey (1895) 110 C 339.  Fifty-five years ago, however, the California Supreme Court departed from the historical rule and said that economic damages should be allowed in negligence actions if the parties are in a “special relationship.”   Biakanja v. Irving (1958) 49 Cal. 2d 647.  The court established a six factor balancing test to evaluate whether a relationship is sufficiently “special.”  The six factors are:  (1) the degree to which the transaction was intended to affect the plaintiff, (2) the foreseeability of harm to the plaintiff, (3) the degree of certainty that the plaintiff suffered injury, (4) the closeness of the connection between the defendant’s conduct and the injury suffered, (5) the moral blame attached to the defendant’s conduct, and (6) the policy of preventing future harm. 

In the 60’s, a time of peace, love, and understanding, the courts, in keeping with the times, were liberal in recognizing special relationships.  Thus in Stewart v. Cox (1961) 55 Cal. 2d 857, the Supreme Court found a “special relationship” between a homeowner and a concrete subcontractor who negligently installed a swimming pool.  That same year, the First District Court of Appeals, in M. Miller Co. v. Dames & Moore (1961) 198 CA2d 305, allowed recovery of economic damages in negligence.  The court held that an underground contractor who encountered unstable soil could sue the soils engineer hired by the owner in negligence for the increased cost of performance.  The court cited Biakanja and said: “it was held that the transaction was intended to affect the plaintiff and injury to the plaintiff was foreseeable.”  Also in 1961, in Lucas v. Hamm (1961) 56 Cal.2d 583, the California Supreme Court held that the Biakanja rule would apply to permit a cause of action in negligence by a beneficiary under a will who received less than intended because of attorney error.  In Conner v. Great Western Savings & Loan Association (1968) 69 Cal.2d 850 the Supreme Court allowed a negligence cause of action for economic damages resulting from improperly compacted foundations.   Applying the Biakanja factors, the court found the requisite “Special Relationship” existed to allow homeowners to state a cause of action against the construction lender for the development project.  In Kent v. Bartlett (1975) 49 CA3d 724, the court permitted a negligence action for economic damages to proceed against a land surveyor who incorrectly surveyed the division of a plot of land into two lots.  Finally, in J’Aire v. Gregory (1979) 24 Cal.3d 799 the California Supreme Court allowed a restaurant owner to recover economic damages in negligence from a contractor (lost business from delayed opening of restaurant).  The theory was that the contractor negligently delayed completion of construction, damage was foreseeable, and voila! 

J’Aire was the high water mark of the movement to allow recovery of foreseeable economic damages in negligence by the California Supreme Court.  Since then, the court has retrenched considerably.  In Erlich v. Menezes (1999) 21 Cal.4^th 543 the court made clear that, without more, negligent performance of a construction contract does not justify an award of tort damages. The following year, in Aas v. Superior Court (2000) 24 Cal.4^th 627 the court applied the Biakanja factors and held that economic damages in negligence are not available for the negligent breach of a construction contract where the damage is limited to the defective work itself and the defective construction has not caused damage to other property. 

Some California Courts of Appeal decisions have picked up on the sea-change.   In The Ratcliff Architects v. Vanir Construction (2001) 88 Cal.App.4^th 595, an architect alleged that a construction manager mismanaged a school renovation project, causing the architect to incur additional uncompensated costs.  The court found that the construction manager did not have the requisite “special relationship” to owe a duty of care to the architect.  The construction manager’s service was not intended to benefit the architect; moreover, the “moral blame” and connection to the alleged injury were too remote to justify imposition of a tort duty.  Similarly, in Weseloh Family Ltd. Partnership v. K.L. Wessel Construction Co. (2004) 125 CA4th 152, the court held that an engineer, consultant to a subcontractor who agreed to design-build a retaining wall, did not owe a duty of care to the general contractor or the owner on the project.  In Lake Almanor Assoc. L.P v. Huffman-Broadway Group, Inc. (Cal. App. Ct. 2009) 178 Cal. App. 4th 1194, 1205 the court found no tort duty existed for an environmental consultant to timely produce an environmental impact report.

Other California Court of Appeals decisions have not picked up on the sea-change wrought by Menzes and Aas.  A trio of cases decided in 2004 demonstrates that some appellate courts have a continued commitment to allow economic damages for negligence in construction cases.  First, in Mesa Vista South Townhome Assn. v. California Portland Cement Co. (May, 2004) 118 Cal. App. 4th 308 the court upheld a negligence award in favor of a homeowner against a concrete manufacturer who supplied the wrong concrete mix, resulting in “sub-microscopic” cracking of concrete foundations.  A negligence claim was allowed despite the fact that damage was limited to the defective part, i.e. the concrete foundation.  The Supreme Court declined to review this case but decertified the decision for publication.  Second, in Superior Gunite v. Ralph Mitzel, Inc. (2004) 117 Cal.App.4^th 301 the court upheld a negligence award to a lower tier subcontractor for lost profit resulting from productivity losses caused by a general contractor’s failure to properly manage the project.  The Supreme Court declined to review the case and allowed it to be published.  Third, in Shekter v. Seneca Structural Design (2004) 121 Cal.App.4^th 1055, the court allowed a plaintiff owner to proceed with a cause of action in negligence against a contractor’s design consultants for allegedly failing to follow the standard of care in designing repairs to an elevated deck structure.  “Progressive cracking” of the deck was alleged.  The court held that the owner could recover damages in tort if he could prove that a defective design resulted in appreciable, nonspeculative, present physical damage to the repaired structure.  The Supreme Court denied review and decertified the opinion for publication. 

After depublication of Shekter, the First Division of the Court of Appeals reached the same result in Beacon Residential Community Association v. Skidmore, Owing & Merrill LLP et al. (2012) 211 Cal. App. 4th 1301 (“we find nothing in the Biakanja factors that would preclude imposition of liability upon the architects to purchasers of residential construction for alleged negligence in the rendition of professional services.”)

The problem is that, in Aas, the California Supreme Court failed to tackle the problem head on.  The court changed course and clearly implied that J’Aire went too far.  However, the court failed to overrule J’Aire and, instead, finessed its decision with an allusion to the economic loss rule.  The court said:

“The difference between price paid and value received, and deviations from standards of quality that have not resulted in property damage or personal injury, are primarily the domain of contract and warranty law or the law of fraud, rather than of negligence.  In actions for negligence, a manufacturer's liability is limited to damages for physical injuries; no recovery is allowed for economic loss alone. (Seely v. White Motor Co. (1965) 63 Cal. 2d 9, 18.) This general principle, the so-called economic loss rule, is the primary obstacle to plaintiffs' claim.” 

And, of course, this is just so wrong….

Yes, it’s true, “Economic loss” has been defined as “damages for inadequate value, costs of repair and replacement of the defective product or consequent loss of profits -- without any claim of personal injury or damages to other property." See Note, Economic Loss in Products Liability Jurisprudence (1966) 66 Colum.L.Rev. 917, 918.  It’s also true that in California the rule that such damages cannot be recovered in products liability cases derives from a dictum in the case of Seely v. White Motor Company (1965).  In Seely, the Supreme Court affirmed judgment in favor of the purchaser of a defective truck against the manufacturer for lost profits and return of the purchase price.  Recovery was based on an express warranty, i.e. contract.  The court, however, embarked on a general discussion regarding the distinction between warranty law and tort recovery in order to explain its view why recovery would not have been appropriate under a strict liability theory.  The court noted that whereas a manufacturer can be held liable for physical injuries caused by defects in its products, by requiring its goods to match a standard of safety defined in terms of conditions that create unreasonable risks of harm, it cannot be held for the level of performance of its products in the consumer’s business (e.g. lost profits) unless it agrees that the product was designed to meet the consumer’s demands. 

And, yes it’s true, that the Seely court also said that “Even in actions for negligence, a manufacturer’s liability is limited to damages for physical injuries and there is no recovery for economic loss alone.”  But this dictum in Seely that economic damages are not available in California on a negligence cause of action is, of course, not correct.  The Supreme Court allowed the recovery of economic loss in negligence actions in both Biakanja and Stewart v. Cox.  Presumably the court was well aware of those decisions when it decided Seely.  Seely was only thinking of product liability and, in its dicta, it thoughtlessly failed to distinguish between negligence and strict liability.  [There's a reason we shouldn't pay attention to dicta!]

The economic loss rule developed as a categorical limitation of damages in strict liability in the wake of McPherson v. Buick Motor Company.  This makes sense.  Strict liability is imposed on defendants without regard to fault.  It is one thing to hold a manufacturer of a product strictly liable for property damage or personal injury caused by their mass-produced goods; it is another thing entirely to hold them strictly liable for a purchaser’s frustrated expectations of performance of the product.  If a defective tennis racquet causes Serena Williams to lose match point, courts do not, and should not hold the manufacturer liable in strict liability for the lost prize money. 

With negligence, on the other hand, there is not, and should not be a categorical limitation on economic damages.  The question is one of duty.   Damages for breach of a contractual duty cannot be recovered in negligence unless there are some overriding social factors that make the imposition of a legal duty proper.  The Supreme Court has outlined what those factors are in Biakanja.  These are well settled.  It is perfectly reasonable to look at the fact that the damage is nothing more than a frustration of an expectation interest arising from contract, as the Supreme Court did in Aas, to determine that there has not been substantial harm of the type that should be recognized in a negligence cause of action.  But that is not a categorical rule on damages.  That is simply an application of the recognized factors for determining whether there should be a duty. 

The “economic loss” rule should be maintained as a categorical rule for strict liability actions, the Biakanja factors should govern in negligence actions.  

A failure by the Supreme Court to seize the opportunity to formally overrule J’Aire v. Gregory in Beacon Residential Community Association will lead to more bad law.  Take for example, Black & Veatch Corporation v. Modesto Irrigation District (2011) 827 F. Supp. 2d 1130.  There, the poor Federal District Court, confronted by the apparent conflict between J’Aire and Aas, tried to reconcile the two by articulating a rule that economic damage is recoverable for negligent interference with prospective economic advantage, but not available under a defective construction claim.  This is a highly artificial distinction, and thus bad law, because any claim for negligent breach of a construction contract can be pled just as well as a negligent interference with prospective economic advantage.  It is to devolve to sophistry … and, with all due respect to Thrasymachus, where I come from that is a bad thing. 

Let’s hope the Supreme Court gets it right and fixes this.