by Justin L. Watkins, Associate

In today’s trying economic times, courts are saddled with hearing countless claims between and amongst contractors and design professionals; including many claims that historically would not have been made.  Traditionally, contractors and designers suffering losses on a project through no fault of their own would make claims based on contract – typically against the owner.  However, today many owners are bankrupt or are single-purpose entities with no assets and no equity in their properties.  As a result, contractors and design professionals alike have looked beyond their contracts for ways to recover their losses.  In so doing, many are making tort claims, based on negligence theories of liability, against other contractors, designers or engineers with whom they have no contractual relationship.

The Mountain West Region is a hotbed for negligence claims in construction disputes, due to its recent construction booms and subsequent plummeting property values.  To combat these claims, contractors and design professionals are utilizing a legal defense that bars negligence claims by parties that have not suffered physical injury or property damage: the economic loss doctrine.

The economic loss doctrine is a judicially created rule that is designed to denote a fundamental boundary between contract law, which protects the expectancy interests of contracting parties, and tort law, which protects against physical harms to people and property by imposing a duty of reasonable care.

In those states recognizing the defense, courts have used the economic loss doctrine to bar unintentional tort actions (e.g., negligence claims) in which the plaintiff seeks to recover “purely economic losses,” i.e., damages not resulting from injuries to persons or “other property.” In the construction context “other property” has been defined as property other than which was originally constructed.  See Hughes Custom Building, L.L.C. v. Davey, 221 Ariz. 527, 212 P.3d 865 (App. 2009).  This can mean that a general contractor not in contract with the design professional may be precluded from pursuing a cause of action against an architect/engineer for faulty design; the general contractor’s course of action would be against the project owner who, in turn, may have a contract action against the design professional.

In 2009, Colorado, Nevada, Utah and Arizona each addressed similar applications of the economic loss doctrine to construction claims.  As will be discussed below, the doctrine can have significant effects on claims by and against contractors, owners and design professionals.

Colorado

In Town of Almav . AZCO Const., Inc., 10 P.3d 1256 (Colo. 2000), the Colorado Supreme Court applied the doctrine to bar tort claims against design professionals.  The court analyzed the nature of the relationship between the parties, rather than whether the damage was to person or other property.  The court held that if the relationship was born out of contract, e.g., owner contracted separately with contractor and designer for design and construction of same project, then the economic loss doctrine barred the presentation of tort claims between all the contracting parties – even if the parties involved in the claim never had a direct contract between them.

Later, the Supreme Court reasoned that if a separate independent duty was owed where no contract existed, then a tort claim could be maintained.  AC Excavating v. Yacht Club II HOA, 114 P.3d 862 (Colo. 2005).  AC Excavating held that despite no contract existing between the homeowners and a subcontractor, a negligence claim would be permitted, as a contractor has an independent duty to construct homes free of negligence.

In recent years, Colorado courts have expanded the application of the economic loss doctrine to bar misrepresentation and fraud claims against design professionals - a position that few states have been willing to take.  See BRW, Inc. v. Dufficy & Sons, Inc., 99 P.3d 66 (Colo. 2004) (misrepresentation); see also Hamon Contractors, Inc. v. Carter & Burgess, Inc., 2009 WL 1152160 (Colo. Ct. App. 2009) (fraud).

Nevada

In Nevada, the economic loss doctrine is applied differently depending on whether the project is residential or commercial, due to residential construction defect claims being governed by Chapter 40 of the Nevada Revised Statutes.  As statutory causes of action, Nevada courts have been reluctant to bar claims by residential owners against design professionals or contractors for purely economic damages.  See Olson v. Richard, 120 Nev. 240, 89 P.3d 31.

In 2004, the Nevada Supreme Court displayed this reluctance by overruling prior precedent and holding that a residential property owner could assert negligence claims brought under NRS Chapter 40 when purely economic losses were at stake.  Olson, 120 Nev. 240, 89 P.3d 31 (overruling in part, Calloway v. City of Reno, 116 Nev. 250, 993 P.2d 1259 (2000)).  Thus, residential owners were permitted to file claims against design professionals and contractors despite having no contract with them.

Conversely, the Nevada courts bar professional negligence claims against design professionals on commercial projects, i.e., non-residential projects that are not governed by Chapter 40 of the Nevada Revised Statutes.  See Terracon Consultants Western, Inc. v. Mandalay Resort Group, 206 P.3d 81 (2009).  Terracon reasoned that the primary purpose of the economic loss doctrine is “to shield a defendant from unlimited liability for all of the economic consequences of a negligent act, particularly in a commercial or professional setting, and thus to keep the risk of liability reasonably calculable.” Terracon, 206 P.3d at 86 (2009) (quoting Local Joint Exec. Bd. v. Stern, 98 Nev. 409, 411, 651 P.2d 637, 638 (1982)).  Thus, the doctrine would apply in commercial settings in order to protect the steady stream of commerce.

It should be noted, however, that while Terracon was a favorable ruling for design professionals, it was not a complete victory for the construction industry.  The court limited its holding to barring only claims against design professionals whom did not perform any physical construction activities on the commercial project.  The holding implies that commercial contractors may not be protected from tort claims, because they perform physical construction services.

Utah

In 2009, the Utah Supreme Court held that the economic loss doctrine was “particularly applicable to claims of negligent construction based on the construction industry’s use of detailed and comprehensive contracts that form obligations and expectations,” and it accordingly adopted the rule.  Davencourt at Pilgrims Landing Homeowners Ass’n v. Davencourt at Pilgrims Landing, LC, 640 Utah Adv. Rep. 16, ¶ 20 (2009) (quoting American Towers Owners Ass’n v. CCI Mechanical, Inc., 930 P.2d 1182, 1189 (Utah 1996)).  In Davencourt, the court held that outside of a contractual relationship, claims for purely economic losses against contractors and/or developers will be barred.

The court did not address the doctrine’s application to tort claims against design professionals.  However, there is little doubt that the doctrine would bar such claims, as the Utah Legislature codified the economic loss doctrine in 2008.  See Utah Code Section 78B-4-513.

Arizona

In Flagstaff Affordable Hous. Ltd. P’Ship v. Design Alliance, Inc., 221 Ariz. 433, 212 P.3d 125 (App. 2009), Division One of the Arizona Court of Appeals held that the doctrine barred recovery in a negligence action against an architect for defects in design, as opposed to defects in construction.  In Flagstaff, the architect provided the builder with a plan for an apartment complex that failed to comply with federal regulations.  When the builder brought an action for the significant additional costs during construction, the court noted that the architect’s duty “ar[o]se independently of any contract” and therefore, “the purpose of the economic loss doctrine-maintaining a distinction between tort and contract actions-is not implicated.” Id.

Less than a month later, Division Two of the Court of Appeals determined that the economic loss doctrine did not apply to an action against a civil engineering firm, because the plaintiff alleged damage to “other property.” Hughes, 221 Ariz. 527, 212 P.3d 865.  In Hughes, the plaintiff engaged the services of a civil engineering firm to perform various engineering services for the developer on a real estate subdivision.  The builder brought negligence claims against the engineer for damages occurring to the homes that were eventually constructed on the lots.  The court held that the homes were separate property from the land, and therefore the builder’s claims were relating to damage to “other property.” As such, the economic loss doctrine did not apply.

Based on the factual distinction noted in Hughes, Arizona’s rule on the economic loss doctrine appears somewhat antiquated.  The economic loss doctrine does apply to tort claims against design professionals.  However, the court has a broad interpretation of “other property,” and may refuse to apply the doctrine in certain factual situations.

Conclusion

Many contractors, architects and engineers are now looking for work in neighboring states in order to stay afloat.  Throughout the Mountain West, contractors and design professionals face differing levels of exposure for purely economic losses of owners, contractors, architects and engineers, ranging from preclusion of any non-contract claims to the acceptance of tort claims based on the company’s scope of work and the type of project.

Financially speaking, the economic loss doctrine may not always decrease liability.  Rather, the doctrine will affect the types of claims permitted and against whom they may be asserted.  Thus, contractors, architects and engineers in the region are encouraged to reevaluate their standard contracts, as the terms will govern the allowable claims when the doctrine applies.  Likewise, companies should closely analyze the contracts they are presented, as savvy owners, contractors and design professionals may attempt to limit their exposure at the expense of others.

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.