by Robert K. Cox, Senior Partner

In the Summer 2006 issue of the WTHF newsletter, associate, Sheila Upadhyay addressed a case in which a surety was permitted to recover damages in tort under West Virginia law against a design professional.  In the past, as discussed in the article, sureties had faced legal hurdles, and the courts in many jurisdictions had routinely denied sureties recovery from design professionals because of a lack of contract privity.  In the West Virginia case, however, the court concluded that because the design professional had a special relationship with the surety, it owed the surety a duty of care.  If the design professional breached that duty, then it could be liable in tort to the surety.  The court thus opened a door in West Virginia for once barred surety claims; and in so doing, joined a growing number of similar rulings from other states.

As also noted in that prior article, Mississippi was one of those other states now allowing a surety to sue a design professional directly in tort for negligence in the performance of its duties.  In January 2007, the United States Court of Appeals for the Fifth Circuit, relying on Mississippi law, further expounded on a surety’s right to recovery against a design professional not in contractual privity with that claimant surety.  In Lyndon Properties Insurance Co. v. Duke Levy and Associates, LLC, 2007 WL 10726 (C.A.5 Miss.), the federal appellate court addressed a surety’s rights of recovery against the design professional: (1) under the doctrine of equitable subrogation, and (2) in tort in the face of an exculpatory clause between the project owner and project engineer disclaiming the engineer’s liability to anyone but the owner, and the economic loss rule.  The appellate court’s ruling was not a final decision, but rather was a reversal of a lower court’s ruling against the surety.  Importantly, however, the appellate court remanded the case to the lower court for further proceedings “not inconsistent” with the appellate court’s opinion.

Some Factual Background

Lyndon Properties Insurance Co. was the surety on behalf of the general contractor constructing a sewage collection system in Hancock County, Mississippi for the owner, Hancock County Water and Sewer District.  The District had a separate contract with Duke Levy and Associates, LLC to serve as the engineer of record for the project.  The project did not go as planned and the District, as owner, terminated the general contractor.  The court noted that as of the date of termination, the engineer of record had been paid $266,822 in inspection fees and $71,250 in contract administration fees.  The surety, Lyndon, funded the completion of the project paying a completion contractor to bring the project to substantial completion.

According to the surety, it spent some $900,000 to fix and test work of the defaulted contractor that the project engineer had inspected and approved before termination.  The surety filed suit against the project engineer to recover its damages resulting from the engineer’s allegedly negligent inspection and approval of the defaulted contractor’s work.

The trial court granted summary judgment in favor of the project engineer on all counts.  The appellate court reversed the judgment and remanded with the following discussion of the surety’s rights against the project engineer.

Equitable Subrogation and the Surety

The appellate court first addressed the surety’s rights of recovery against the project engineer under the doctrine of equitable subrogation.  The court described the doctrine of equitable subrogation to be a doctrine by which a surety is permitted to stand in the shoes of the party (here, the District as project owner) that benefited from the surety’s performance of the surety’s obligation in order to prevent unjust enrichment on the part of the wrongdoer who caused the surety’s expense.

The project engineer argued that the surety could not prove a loss by the District, apparently on the basis that the surety had paid the cost of completion, not the District; therefore, the engineer contended there was no loss on the part of the project owner.  The appellate court quickly dismissed the engineer’s argument, writing:

This argument ignores the very principle behind the doctrine of equitable subrogation.  By definition, the party into whose shoes the surety steps has not suffered a loss because the surety protected it from that loss.  [The Engineer] cannot claim that the District suffered no loss simply because [the Surety], rather than the District, paid the costs of [the Engineer’s] alleged negligence.

The Exculpatory Clause and the Surety

The construction contract between the District and its original contractor included an exculpatory clause as follows:

Neither ENGINEER’S authority to act under [the] Contract Documents nor any decision made by the ENGINEER in good faith either to exercise or not exercise such authority shall give rise to any duty or responsibility of ENGINEER to CONTRACTOR, any Subcontractor, any Supplier, or any other person or organization performing any of the Work, or to any Surety for any of them.

(emphasis added).  The engineer contended this clause saved it from liability to anyone but the District.  The appellate court refined the engineer’s argument to be that the engineer had disclaimed, by contract, potential liability to a surety standing in the shoes of the District.

The appellate court rejected the engineer’s argument, noting the close scrutiny that courts give to clauses exculpating a party from its own negligence, particularly when the project implicates the public interest, as with this project.  The appellate court found the clause not sufficiently clear to act as a limitation of liability under Mississippi law, and further that the District could not bargain away the engineer’s potential duty to a surety that would step into the District’s shoes under the doctrine of equitable subrogation.

The Economic Loss Rule and the Surety

The economic loss rule started in product liability cases.  At the outset, the “rule” restricted recovery in products liability litigation to damages for physical harm, thereby excluding recovery for purely economic damages.  Many states expanded the “rule” to preclude negligence actions for economic damages between parties not in contractual privity.  Virginia is one such jurisdiction that continues to recognize the economic loss rule as a valid defense to a contractor’s or surety’s lawsuits asserting negligence against a design professional.

In Lyndon, however, the federal appellate court found no Mississippi case law applying the “rule” outside the realm of products liability.  The appellate court wrote: “[W]e therefore decline to apply the economic loss doctrine to this tort case involving a duty [the engineer’s] shaped by contract.”

Conclusion

As of now, the impact of Lyndon is limited to Mississippi law.  Nevertheless, the appellate court’s opinion recognizes the interplay that exists among the design professional, the contractor and its surety in the design professional’s performance of its construction administration services, whether the services be in inspection of the contractor’s work to approval of the contractor’s pay applications.  The wall of insulation once protecting design professionals from responsibility for negligent performance of their design or construction administration activities continues to dissipate.


The information or opinion provided in this article is the author's own and not necessarily that of Watt, Tieder, Hoffar & Fitzgerald, LLP. The author is solely responsible for the information and opinion that he or she has provided. The information contained herein does not replace seeking specific legal counsel to directly address individual client needs.

Watt, Tieder, Hoffar & Fitzgerald is one of the largest construction law firms in the world, with a practice that encompasses all aspects of construction contracting, claims and disputes resolution, and transactional legal services. WTHF principally represents large general contractors, design firms, and sureties throughout the country and internationally.