By Michael C. Loulakis and Lauren P. McLaughlin
For those newer to the complex world of design professional liability, one of the most fundamental tenets of law surrounding architects and engineers is the economic loss rule. This is the rule that disallows owners or contractors from suing design professionals with whom they have no contract for purely monetary damages.
Several times, we have reported on state decisions that limit the ELR and find design professionals liable, despite the rule, where no liability should exist. While we have seen a concerning erosion of this doctrine in the past, the architect-engineer community can take heart (or note) that decisions recently handed down in three states validate and bolster the ELR as a shield for design professionals.
Arizona closes loophole and tightens the ELR
The first case, Cal-Am Properties Inc. v. Edais Engineering Inc., is an important decision where the Supreme Court of Arizona held that design professionals who lack privity of contract with project owners owe no duty to reimburse those owners for purely economic losses. This decision reverses prior Arizona jurisprudence, which held that a design professional’s duty to use the generally accepted standard of care extended to people foreseeably affected by a breach of the design professional’s duty to its client.
In this case, Cal-Am, a developer and owner of recreational vehicle and mobile home parks, leased the Sundance RV Resort in Yuma to construct a new banquet and concert hall on the property. Cal-Am managed the project and hired VB Nickle to design and construct the hall. VB Nickle, in turn, engaged Edais to survey the property and place construction stakes to mark the permitted location of the hall. The staking was done incorrectly. As a result, the hall was constructed 10 ft north of the planned location. Cal-Am was forced to adjust its site plan accordingly, which eliminated eight RV parking spaces planned near the hall.
Cal-Am sued its design-builder’s subcontractor, Edais, for various claims, including negligence. The trial court granted summary judgment for Edais early (before trial) on the negligence claim, finding that since Cal-Am’s damages were purely financial, the ELR applied to its claim. On appeal, the state’s court of appeals held that Edais did not owe a duty to Cal-Am and affirmed the lower court ruling. Next, the Supreme Court of Arizona was asked to ascertain whether the ELR prevented Cal-Am from suing the design-build contractor’s engineering subcontractor.
In its decision, the state Supreme Court threw out the old way of doing business. It rejected the previous “foreseeability” factor in determining whether a duty was owed by a design professional to a third party. Instead, the court held that duties are based on either special relationships or public policy. Special relationships, the court said, are those that include legally recognized common law relationships, such as landowners and those invited onto the landowners’ property, employer-employee relationships, etc. Foreseeability of a potential injury is no longer a test to be exercised in Arizona in determining the design professional’s duty to third parties.
The court expressly held that design professionals do not have special relationships with owners and so do not owe a duty. Cal-Am tried to argue that the statutes and administrative regulations governing qualifications and minimum standards for design professionals must mean that a special relationship exists. The court rejected this argument, noting that any regulations were intended to provide for the physical welfare of others, not their economic welfare. Indeed, the purpose of engineering regulations are to protect individuals from injury who enter the buildings and structures that regulated professionals design and construct. Cal-Am’s status as the lessee (owner) who suffered purely economic injury did not implicate Arizona’s public policy. Rather, if the legislature saw fit to create liability, it needed to do so by putting pen to paper in legislation.
Cal-Am also relied upon the Restatement of Torts, a definitive collection of the law for establishing negligence. Cal-Am argued that Edais should have known that Cal-Am was relying on Edais to do its work properly, such that a duty was owed not to depart from the standard of care. The Supreme Court squarely rejected this argument, noting that “the missing element in this case is reliance.” Cal-Am did not rely on Edais’ defective staking, said the court. Instead, it was VB Nickle who suffered losses due to its reliance on the defective staking. (The opinion does not state whether and to what extent VB Nickle was liable under a breach theory. It did indicate, however, that both the American Council of Engineering Companies of Arizona and the Arizona chapter of the American Institute of Architects weighed in on the matter with the Supreme Court prior to issuing its decision.)
Now in Arizona, foreseeability is no longer a hook, and design professionals will not be liable to third parties (i.e., owners, contractors, or subcontractors) for purely economic damages resulting in negligence.
Texas enforces the ELR despite engineering error
Turning to Texas, an appeals court recently had occasion to weigh in on the same legal question under similar facts. In Gurka v. J.L. Trevino & Associates PLLC, a Texas appellate court ruled that a project owner could not sue an engineer for professional negligence because the engineer was a subcontractor to the construction contractor.
The facts in Gurka involved the construction of a “barndominium” residence/utility building on a property owned by Val and Terri Gurka in Harris County. Because the property was within the 100-year floodplain, Federal Emergency Management Agency and Harris County regulations required the first floor of the residence to be at least 18 in. above the base flood level, making it an elevation of 54.5 ft.
The owners entered into a contract with AGVR Construction for the design and construction of the building. It was agreed that AGVR would hire subcontractors and be responsible for their work. AGVR also agreed to obtain all permits needed for the project. AGVR entered into a subcontract with J.L. Trevino & Associates PLLC, a licensed professional engineering firm. Trevino agreed to provide drawings and specifications, foundation plans, and the elevation certificates required by the county. The owners were not a party to the subcontract and had no communication with the engineering firm throughout the project.
Trevino submitted a certificate to the county stating that the first floor of the building would be at an elevation of 54.5 ft, and the county issued a building permit. When construction was complete, Trevino certified that the finished elevation of the first floor was 53.17 ft. The building failed final inspection, and worse, the owners could not obtain a permanent electrical connection or flood insurance. Hurricane Harvey hit, and the building flooded.
The owners sued AGVR for breach and Trevino for professional negligence. The engineer moved for summary judgment, arguing that it had no contract with the owners. Its only obligation, according to Trevino, was to AGVR. The trial court agreed that the negligence claim was barred by the ELR, absent a claim for personal injury or property damage unrelated to the contract. The owners appealed. On appeal, the Court of Appeals for the 1st District of Texas endorsed the ELR and stated the only exception occurs when personal injury or property damage (unrelated to the contract) is alleged. Here the owners could recover only the losses associated with damage to their house from Hurricane Harvey.
Due to the lack of privity, the project owner’s professional negligence claim against the engineer for all other losses to the barndominium were barred.
Tennessee extends application of the ELR to certain construction disputes
Also this year, the Tennessee Court of Appeals issued an opinion extending application of the ELR to certain construction claims. In Commercial Painting Co. Inc. v. Weitz Co. LLC, Weitz acted as the general contractor for the construction of a retirement community. Weitz subcontracted with CPC to install drywall at the project.
When the parties entered into the subcontract, the project was already 6-8 months behind schedule. CPC claimed that Weitz misled it about the extent of the delay and scope of work and that Weitz began compressing the schedule and supplementing CPC’s work to make up time. Weitz also obtained a six-month extension from the owner but told CPC it had received only a four-month extension. At trial, CPC’s claims included breach of contract and fraud related to the schedule and scope of work representations. A jury awarded CPC more than $1.7 million in compensatory damages on both claims and $3.9 million in punitive damages on the fraud claim. Weitz appealed, asserting that the ELR prevented CPC from maintaining its fraud claim and from recovering punitive damages, which are generally unavailable for breach of contract.
The court began its analysis by exploring the history of the ELR around the country and in Tennessee. Although the doctrine is applied in various ways, the court focused on applying the ELR between parties to a contract where one of them seeks a remedy in tort. “In general, tort offers a broader array of damages than contract. The economic loss doctrine precludes parties under certain circumstances from eschewing the more limited contract remedies and seeking tort remedies.” Despite this general rule, many states have adopted exceptions to the ELR where a party alleges fraud in connection with forming the contract.
Tennessee had previously adopted the ELR and limited fraud exception but only in cases involving defective products. In 2021, the Tennessee Supreme Court held that “the economic loss doctrine applies only if the misrepresentation by the dishonest party concerns the quality or character of the goods sold.” Based on this holding, CPC argued that the economic loss doctrine and limited fraud exception applied only to cases involving product liability or the sale of goods. Weitz took a broader view. After analyzing prior decisions from Tennessee and other states, the court of appeals agreed with Weitz, noting that most states have not limited the ELR to products liability. Thus, the court explicitly extended the ELR and the limited fraud exception to contracts other than those involving only the sale of goods, including construction contracts. Therefore, the court reversed the $3.9 million punitive damage award but upheld the award of $1.7 million in compensatory damages on CPC’s breach of contract claim.
The case is now on appeal to the Tennessee Supreme Court.
It has been said that “one of the least-well-known and largely misunderstood rules in civil litigation is the economic loss rule.” Not so for our readers. Design professionals should know whether the ELR applies in the jurisdiction in which they practice. While the ELR does not provide an absolute defense to all tort claims, time and again it provides architects and engineers with an easy out of messy multiparty litigation.
Bear in mind, the protection of the ELR begins with the contract itself. Creating, maintaining, and properly executing well-drafted contracts is a foundational requirement to controlling and allocating risk for your company. Additionally, in their contract negotiations, architects and engineers could consider requiring owners to include in their prime contracts (and all downstream subcontracts) provisions limiting any potential claims against design professionals to property damage or personal injury only, not business losses.
For the design professional community, it is a positive sign that at least three state courts have strengthened and bolstered the ELR.