Setting the Table
When a member of the building team (owner, architect, engineer, construction manager, general contractor, subcontractor, consultant, manufacturer or supplier) fails to use due care in performing contractually assumed work, it is foreseeable that other project participants will suffer economic harm. If the one who suffers the economic harm does not have a contract with the offender, is there a remedy in the law of negligence?
In the first installment of a longer article excerpted in the Fall 2013 issue of the Construction Lawyer, “Making Sense of the Economic Loss Rule in Construction Cases,” Paul Helligers traces some of the historical twists and turns that form the Gordian knot of negligence law in construction cases, with a particular focus on the economic loss rule (“ELR”). He notes a trend “in favor of a robust ‘private ordering’ approach in construction cases.” He cites approvingly to an article by Sidney R. Barrett Jr., Recovery of Economic Loss in Tort for Construction Defects: A Critical Analysis, 40 S.C. L. Rev. 891 (1989) that seems to want to do away with negligence in this context:
[P]arties involved in a construction project rely on intricate, highly sophisticated contracts to … allocate among them the risk of problems, delays, extra costs, unforeseen site conditions, and defects. Imposition of tort duties that cut across those contractual lines disrupts and frustrates the parties’ contractual allocation of risk.
Picking up on this, Helligers notes, the Washington Supreme Court in Berschauer/Phillips Construction Co. v. Seattle School District No. 1, 881 P.2d 986 (Wash. 1994) said:
We hold parties to their contracts. If tort and contract remedies were allowed to overlap, certainty and predictability in allocating risk would decrease and impede future business activity. The construction industry in particular would suffer, for it is in this industry that we see most clearly the importance of the precise allocation of risk as secured by contract.
Helligers concludes his first installment by extrapolating this line of thinking:
The Wyoming Supreme Court (in Rissler & McMurry Co. v. Sheridan Area Water Supply Jt. Powers Bd, 929 P.3d 1228 (Wyo. 1996)) acknowledged that the contractor did not contract with the engineer but argued that the contractor ‘had the opportunity to allocate the risks associated with the cost of the work’ when it contracted with the project owner. The Colorado Supreme Court (in BRW Inc. v. Dufficiy & Sons 99 P.3d 66 (Colo. 2004)) explained that the multiple parties to large construction projects typically rely on networks of two-party contracts to allocate their risks, duties and remedies. A subcontractor ‘has the opportunity to allocate the risks of following specified design plans when it enters into a contract with a party involved in the network of contracts. The Indiana Supreme Court (in Indianapolis-Marion Cnty. Pub. Library v. Chalierr Clark & Linard, P.C., 929 N.E.2d 722 (Ind. 2010)) adopted this concept in 2010 in denying recovery to project owners suing design professionals with whom they were not in privity.
In other words, the handwriting is on the wall, if you want to recover economic damages from fellow project participants, you had better mind the P’s and Q’s in your contracts and not rely on a privity bypassing cause of action in negligence to bail you out of a bad bargain.
The Appetizer
I am in favor of a duty analysis in negligence that tightens the circumstances under which tort remedies will be allowed in construction cases. See my unsolicited advice to the California Supreme Court here. However, I am not in favor of using the economic loss rule as a categorical limitation on damages to do the job because I think a rule based application of the ELR leads to inconsistent results and arbitrary outcomes.
Salad Course
The bar review version of a negligence cause of action as applied in a construction project is a follows: (1) we have a duty to use reasonable care in all our endeavors so as to avoid injury to others. (2) The care we must exercise is in accordance with our station in life: on a construction project we must act like careful and prudent architects, contractors, construction managers, owners, trade contractors and suppliers. (3) If we fail to follow this standard of care in a way that foreseeably and proximately will harm others, then (4) we must pay. That is the walls of privity are broken down version of negligence we find in McPherson v. Buick Motor Company (personal injury), Glanzer v. Shepard (overpayment for goods because of defective weight certificate) and J’Aire v. Gregory (contractor’s delay causing damage to restaurant operator). The courts routinely apply these elements without difficulty to compensate for personal injury and property damage caused by negligent conduct.
But it soon became clear that more than “foreseeable harm” was required in cases asserting primarily economic harm. With the benefit of hindsight, plaintiffs, and on a clear judicial day, courts can foresee forever. But limitless liability is not socially useful. So courts look for ways to cut off liability. Two primary tools for cutting off liability for foreseeable harm has been, on the one hand, failing to recognize a duty in a particular case, and, on the other hand, by disallowing certain types of damage, e.g. by application of the ELR.
The Main Course
Helligers points to a three fold rationale for the ELR: (1) the Ultrameres problem: indeterminate liability that is grossly disproportionate to fault (because economic losses ripple out to customers of customers of customers ad infinitum); (2) the Palsgraf problem: the potential of over deterrence that can make economic processes inefficient if actors are exposed to liability socially harmful in its potential scope and uncertainty;” and (3) the Berschaouer/Phillips Construction problem: whether parties in the plaintiff’s position can reasonably be expected to protect themselves through their contracts, or otherwise.
Helligers points out that the six Biakanja v. Irving factors (CA Supreme Court 1958) have dominated the landscape for determining whether a duty exists. The Biakanja 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.
Helligers contends that this test is too foreseeability centric, and it certainly is in the way some courts have applied the test. It’s worth noting that in the construction context, the first four factors are of course always present, almost by definition. It’s only the moral blameworthiness, and the wider social need for a negligence cause of action in order to prevent future harm (as opposed to leaving the parties to the contract remedies they have all agreed on), that can swing the decision one way or the other. That’s where the action should be. Some courts, however, including the California Supreme Court in J’Aire v. Gregory, have completely glossed over these last two factors and basically concluded that foreseeability is sufficient. But that is not necessarily a problem of the formula; I would say it’s a problem of application.
Dessert
Why Not Rely on the ELR instead of Duty? In almost all construction cases, when some project members are harmed, there should not be the need to interject a tort remedy. It’s perfectly foreseeable that some project participants might fall short in their performance, and parties are able to guard against this in their contracts. Resolving problems entirely through a chain of contractual privity works just fine.
The problem with relying on the ELR to do the job is that there is no good reason to distinguish between harm to property and economic harm. When a retaining wall falls down during construction and has to be rebuilt—it’s just money. Why should there be a distinction drawn between this cost of reconstructing a retaining wall and pure economic damages that don’t involve damage to property. If a tort remedy, is appropriate under whatever test is adopted, there is no reason to arbitrarily exclude one type of damage.
Cognac
In California, outside the products liability context, courts have mostly granted relief, or denied relief based on the duty analysis. Contrary to Helligers, Calfornia has not “switched” on this. The cases continue to come out on both sides: some following the foreseeability heavy analysis of J’Aire, and others trimming back on where they find a special relationship. As noted by Helligers, this inconsistency is typical of the country as a whole.
I’m rooting for the trend towards the private ordering of relationships among project participants. I'm in favor of limiting the ELR to a limitation of damages in strict products liability, where it started--although this does not seem to be happening. The trend to let project participants orchestrate their remedies through their contracts, and not recognizing tort duties for economic losses would result in the law being clearer and more rational, and predictable.
Then there is the insurance issue. Doing away with negligence for economic damages on construction projects, if it's done along the "is there a duty" test should properly extend to construction defect cases, even cases involving property damage, as well as purely economic cases. If carried through, this would upset the apple cart on insurance. Resolution of a typical large construction claims dispute relies heavily on insurance for defense and resolution of disputes. If we take negligence out of the equation, does insurance coverage go away?
There is a quiet revolution in insurance for construction under foot already, of course, with the movement to OCIP’s, CCIP’s, legislative abolishment of many traditional forms of indemnity, and the trend to design-build and integrated project delivery. Restricting negligence causes of action among project participants would surely accelerate these changes.
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