Long Trail Condo.
Assoc. v. Engelberth Construction, Inc., 2012 VT
80.
There are concepts within the law that are the legal
equivalent of St. Elmo’s Fire. They are
unearthly, luminescent without illuminating, and harbingers of difficulty. The Economic Loss Rule is first and foremost
among these Will O’ the Wisps.
The Rule is a court created doctrine that serves a simple
and admirable purpose: bringing order and sense to business relationships and
effectuating the intent of the parties.
It says this: when the primary nature of the parties’ relationship is contractual
and when the damage done is limited to the object/building that was purchased
through the contract, then the recovery will be under the terms of the parties’
contract and not negligence.
Got it? Basically, if
you sign a contract to purchase something, and that something breaks, then you
cannot file a negligence action—no matter what damage the object causes.
The purpose of this rule is best explained through an
example. Say a contractor agrees to
build a metal fire pit for $500, and the parties agree that any damage
associated with the pit shall be no more than the cost of the pit. Then a spark from that fire pit burns down
the surrounding deck and garage. Homeowner
sues in negligence for the cost of the deck and garage as well as pain and
suffering.
The Economic Loss Rule blocks such an action because
otherwise the parties’ agreement to limit damages would be meaningless. Moreover, if the fire pit manufacturer now
has to factor in negligence liability, fire pits are going to get a lot more
expensive. Of course, homeowner can probably
collect the $500 from the fire pit maker, but the fact that the homeowner knew
that the fire pit maker had limited his warranty should have put homeowner on
notice that he needed to supplement his risk protection (i.e., purchased insurance).
The big idea is that contracts allow the parties to allocate
risk, to disclaim and define their specific responsibility through warranty, and
to make clear from the outset what each owes the other. Negligence is designed for different
situations where the parties do not have the benefit of negotiating what duty
is owed to the other. When you crash
your car, it is negligence because chances are you never met the other driver
before, let alone negotiated the terms each owed the other on the open road. Instead, the law imposes a general duty (do
not crash into one another).
But when you have been working with a customer, signed a
series of agreements, and created a price schedule based on the cost of the
product and the potential liability, a claim for negligence starts to look like
a way of going around the whole process.
That is not fair, and the courts have acknowledged this.
Here is the problem that makes the Economic Loss Rule such a
difficult proposition. Trying to define
what is strictly an “economic loss” and the contractual nature of the parties’
relationships gets confusing once you start piling on the layers of parties,
and inevitably the case involves a semi-“innocent” party who is facing a
recovery shortfall due to an accident or incident beyond her control.
Today’s case is the example that proves the rule. Plaintiff is a homeowners’ association. That means that the members are the end
users, the innocents who have purchased condominiums and must live with the
alleged construction defects on which the association bases its lawsuit. Defendant Contractor is a construction
company who performed the work, built the condos and the structures. It should also be clear. Plaintiff and Defendant never entered into a
contract with each other. In fact, Plaintiff
did not exist when Defendant agreed to construct the condos and signed its
original contracts.
That role was filed by a variety of players, none of which
are named in the case but include the developer, the architect, the engineer,
and other subcontractors who may or may not have been working under the
direction of the Defendant who was the General Contractor for the project.
No one necessarily disputes that Plaintiff’s grievances are
real or that the massive repairs were necessary to correct defects in the
building. As the SCOV notes in the
beginning of this opinion, today’s case is just the latest in a series of
lawsuits and negotiations between the multiple parties trying to allocate
responsibility, cost, and payments.
The Association’s theory of the case is fairly
straightforward. Contractor owed a duty
of care to the Association that it breached by negligently constructing the
building. That breach led to defects
that have cost millions of dollars to repair and that if left untreated would
have destroyed the buildings and caused property loss and personal injury.
Contractor’s defense is the Economic Loss Rule, and it is a
winner. The nature of the Association’s
claims are economic losses (damage to the purchased product—in this case the
building) as opposed to either personal injury or collateral property damage (think
falling chimney crushing parked cars).
To apply the Rule, though, the SCOV has to deal with the
fact that the Association and the Contractor lacked privity (meaning that they
never entered a contract with each other).
But the SCOV has little problem extending the Rule to parties that,
while not in privity with each other, are part of a larger series of contractual
relationships where the parties could allocate the risks. Therefore, privity, or lack of it, is not
determinative, and the SCOV instructs that we must look to the larger nature of
the relationship. Here the Association
is simply at the end of a series of contracts, and its rights are primarily
defined by those contracts that allowed them to initiate a lawsuit against the
developer at the beginning of the problems.
The SCOV next takes up the Association’s argument that
Contractor owed them a professional duty that cannot be eliminated or waived
away through contract. This is an exception
to the Economic Loss Rule that says when the seller owes the buyer a higher,
professional duty (think doctor, architect, surveyor or similar licensed
professional), then the Rule does not prevent recovery based on a negligent
breach of this higher duty.
The problem is that the Association is suing a contractor—albeit
one of the largest in the state.
Contractors in Vermont are not licensed, have not been held to higher
standards, and have rarely been defined as “professionals.” So even though this Contractor is a
multi-million dollar business employing professionals and a consistent
workforce, it receives the benefits of Vermont’s lower contractor standard that
has largely been born out through individuals and small businesses that have
lacked training, professional licensure, or even consistent industry
standards.
As a friend once put it, it is easier to catch the wind then
to assign a duty of care to a contractor.
Lawyers have odd senses of humor.
So lacking a distinct level of professional care, the SCOV
declines to find one for Contractor based upon the specialized contracting
services provided here. In fairness to
Contractor, this is reinforced by the parties’ contracts that made clear that
Contractor made no warranty or promise to the quality of the construction plans—in
other words, it agreed to erect the structure and its systems according to the
building plans—regardless of whether those instructions made sense or made a
sensible structure.
The SCOV finally takes up the question of immanent
harm. The Association had argued that
the threat of immanent harm (falling balconies, water running through the
walls, and other serious defects) required the trial court to make an exception
to the Rule because the damage was more of the nature of an immediate danger to
person and property that negligence is intended to protect, and the mere fact
that no one was hurt is a small benefit that should not prevent the Association’s
action. In other words, these defects were
negligent and the Association should not have to wait until someone is hurt or loses
their car to a falling chimney to bring a personal injury tort claim.
The SCOV rejects this argument in the broadest terms
available. The SCOV takes issue with the
argument as a subversion of both contract and negligence law. As the SCOV notes, negligence law, apart from
any contract issues, still requires an actual injury. You cannot get around this threshold element,
and its absence is fatal to both Plaintiff’s specific claim and its more
general negligence theory. Therefore,
the mere threat of personal injury is not enough to take a case out of the
Economic Loss Rule no matter how serious or immanent the threat might be.
The SCOV is clear.
There is a bright-line. Someone
must be hurt or collateral property damaged before it will even consider such
an argument, and parties will not be able to re-cast an economic loss issue in
such terms without such actual injury.
So Contractor escapes negligence liability—despite the fact
that the Association suffered damages in excess of its contractual remedies and
the fact that the Association never got to negotiate risk of loss with Contractor. As indicated in the dissent, this will strike
some as unfair and leave an “innocent” party without remedy, but as the SCOV
notes, it is the necessary result of keeping the spheres of contract and
negligence separate and preventing the law of tort to subsume the law of
warranty.
As an indication of just how contentious the Economic Loss
Rule can be, the SCOV’s opinion cites to no fewer than five different decisions
over the past 12 years that have addressed different parts of the Rule. No doubt that today’s case is far from the
last time the SCOV will likely take up the issue in the next 12 years either.
This leads to second section of the opinion and a bit of a
dispute within the SCOV.
The second section deals with the implied warranty of
habitability and good workmanship that attaches to every newly built house or
building that. Like you would expect,
this warranty covers latent defects, problems, and similar issues that are not
obvious to the buyer upon taking possession and which are attributable
primarily to the builder.
Sounds like a winner, except we run into another privity
problem. This time, it is the very lack
of privity that proves fatal to Plaintiff’s claim.
The warranty of habitability and good workmanship only
extends to the first purchaser of the building.
In this case, it was the developer who ordered the construction, took
possession, and then re-sold the units to the individuals who took possession
of the common building as the Association.
Because Contractor did not build the structure for the Association, the
Association cannot come back at Contractor with a warranty claim. The Association can only sue developer.
Before too many tears are shed, it is important to know, as
the majority notes, that the Developer has initiated a lawsuit against the
Contractor seeking many of the same damages sought by the Association. Presumably if the Developer is successful,
that award will flow down the line to the Association (unless settlement
agreements to the contrary prevent such).
The SCOV is clear that only by going up and down the lines
of privity (buyer sues seller who sues contractor who presumably sues
subcontractor who then declares bankruptcy) can the Association hope to seek
recovery. Any attempt to run around this
chain will be swatted down under the Economic Loss Rule or the failure of
privity between parties on a warranty claim.
This does not sit well with specially assigned trial court
Judge Kupersmith and Justice Johnson who joins his dissent. For the dissent, which is limited to the
implied warranty portion of the opinion, applying the rule of privity to
prevent the Association from recovering is a meaningless extension of legal
form that is unwarranted and unfair.
The dissent appears to be hunting bigger game than the
present case as it endorses removing the privity rule for any home builder
warranty claim. The idea is that anyone
who ends up owning a defective home should have the right to pursue the
builder, regardless of whether they are the first, second, third, or even
fourth owner. The only limit, argues the
dissent, should be time. And even that should
be governed by a sliding scale of reasonableness.
The idea behind the dissent is this: builders are obligated
to build good houses. We live in an
increasingly mobile society where it should come as a surprise to no one that a
house built today may be sold three or four times in as many years (although
with Vermont’s Land Gains Tax that might not be as reasonable an assumption as
other states). So it should come as no
surprise to a builder if her product is sold at least once before a latent
defect is discovered. Given such
realities, it is unfair and somewhat absurd to force homeowners to sue up the
chain of ownership and require multiple lawsuits for what might be accomplished
in one.
The majority gives the dissent’s proposal short shrift
because the present case represents the middle of a series of lawsuits that if
not stemmed through legal doctrine, such as privity, would threaten to generate
an infinite litigation loop. Moreover,
the dissent’s argument is based upon cases reflecting much simpler facts. As the majority notes, nearly every case
cited by the dissent concerns a single family home, a series of quick sales,
and an independent builder/developer. In
such cases where there is no other source for compensation, the suspension of
the privity rule is more equitable. But
since those facts are not present, the majority declines the dissent’s
invitation to expand the law and sticks with what it knows.
Still, the dissent’s argument is beguiling, and there is
some sense to its reasoning. Expect to
see this portion of the opinion cited in a number of single-home-construction-defect
cases over the coming year. But like the
mythic Will O’ the Wisp, it remains to be seen whether the dissent’s reasoning will
guide plaintiffs to buried legal treasure or merely mislead them from the path
of solid legal argument into the swamps of speculation.
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