It is not an uncommon scenario related to a construction project: a general contractor on a public construction project that is almost complete is analyzing the project financial information and trying to understand why its profit margin has eroded so severely. The onsite personnel point fingers at the slow responses to a multitude of Requests for Information (“RFI”) and claim that the designers are the reason for the issues. They relate countless stories of interruptions in the flow of work while waiting on answers to technical design questions affecting several construction activities and related trades. Over the course of the project, the cumulative effects of the RFIs have seemingly caused a severe deterioration of the general contractor’s bottom line. That is the time when the contractor may call its attorneys with the question “can we sue the designers?” Unfortunately, the only response we can give at this time, particularly in the Pacific Northwest, is “it depends.”
Economic Loss Rule Generally
First, a little bit of background. On a typical construction project, an owner contracts directly with the designers and then separately with the contractor. As a result, the contractor has no contractual relationship with the designers and therefore cannot sue a designer for breach of a contractual obligation. Under this typical scenario, the contractor would have to sue the owner for the breach of a contractual requirement and then the owner would have to either seek indemnification from the designers or cross-claim against the designers for any liability it owed to the contractor. A more logical approach would be to allow the contractor to sue the designer directly for a cause of action arising in tort, such as negligence. The law that commonly applies to this scenario is known as the Economic Loss Rule and generally bars a negligence claim by one party against another for purely economic losses that arise out of a contractual relationship. In the states that have adopted the Economic Loss Rule, parties are restricted to contract claims. The contractual relationship does not need to be direct; the party just needs to be in a line of contractual relationships that allows indirect access to the offending party, such as the scenario described above with the contractor suing the owner and the owner suing the designer.
The Economic Loss Rule is a judicially developed rule that was first articulated in California in 1965. If the Economic Loss Rule applies, a party will be strictly held to contract remedies, regardless of how a plaintiff characterizes them. This means that the party will be confined to a breach of contract claim (that may be passed down the contractual chain) and will not be able to sustain a negligence claim for purely economic losses. “Economic losses” include costs of repair and replacement of defective property that was the subject of the transaction. On the other hand, if the alleged costs are related to damage of personal property or personal injury, then the Economic Loss Rule does not apply. Courts faced with this issue often find it necessary to distinguish between economic loss and physical harm or property damage. This distinction is typically drawn depending on the nature of the defect and manner in which the damage occurred.
In the past, the answer to the contractor’s question of whether it could sue the designer in the Pacific Northwest was not so complicated. For many years, based on Washington and Idaho law, the answer was simply “no.” If the contractor was in the line of contractual relationships with the designers, either directly or indirectly, the contractor could not sue the designers for economic damages resulting from alleged negligence. That is, any claims for economic damages against the designers were restricted to contract claims. Because of several recent court decisions in both of these states relating to the Economic Loss Rule, however, the answer to the question now is much more complicated.
The Economic Loss Rule In Washington
The Economic Loss Rule was thoroughly addressed by the Washington Supreme Court when it analyzed a negligence claim brought by a contractor against a designer in 1994. In Berschauer/Phillips Const. Co. v. Seattle School Dist. No. 1, et al., 881 P.2d 986 (Wash. 1994), the court cited the Economic Loss Rule as its reason for dismissing the contractor’s negligence claims against the designers. The court stated that the Economic Loss Rule results in the maintenance of the “fundamental boundaries of tort and contract law by limiting the recovery of economic loss due to construction delays to the remedies provided in the contract.” The court further stated, in part:
We so hold to ensure that the allocation of risk and the determination of potential future liability is based on what the parties bargained for in the contract. 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 will suffer, for it is in this industry that we see most clearly the importance of the precise allocation of risk as secured by contract.
In other words, the Economic Loss Rule prevents a party from doing an “end run” around the contract in order to pursue a result it otherwise did not bargain for at the time of contracting. For years, the analysis has been as simple as: Is there a contract? If yes, then negligence claims will not be permitted for purely economic damages.
But in recent years, Washington courts have made a move away from the Economic Loss Rule as a bar to negligence claims that arise out of a contractual relationship. In 2010, the Washington Supreme Court released two opinions that adopt an approach that is more reasoned than the yes/no analysis that has been associated with the Economic Loss Rule. In Eastwood v. Horse Harbor Found., Inc., 241 P.3d 1256 (Wash. 2010), the court insisted that the proper analysis should not focus on the type of damage that was suffered (e.g., economic damages versus non-economic damages), but rather on whether some separate duty of care exists outside the parties’ contractual relationship. The Eastwood court went so far as to erase the term “Economic Loss Rule” from the state’s legal lexicon in favor of what is now called the “Independent Duty Doctrine.” Through its adoption of this Doctrine, the court acknowledged that “[i]n some circumstances, a plaintiff’s alleged harm is nothing more than a contractual breach or a difference in the profits, revenue or costs that the plaintiff had expected from a business enterprise.” Yet, the court further stated that “[i]n other circumstances, however, the harm is simultaneously the result of the defendant breaching an independent and concurrent tort duty. Thus, while the harm can be described as an economic loss, it is more than that: it is an injury remediable in tort.”
The Eastwood decision was issued around the same time that the Washington Supreme Court published a similar opinion on a case in which the plaintiffs were seeking tort damages in addition to contractual remedies. In Affiliated FM Ins. Co. v. LTK Consulting Services, Inc., 243 P.3d 521 (Wash. 2010), the court addressed whether an engineering company under a monorail maintenance agreement with the city of Seattle could be liable in negligence to the company that operates the daily monorail service for a fire that caused millions of dollars in losses. In applying the Independent Duty Doctrine, the Affiliated FM court held that since monorail trains carry thousands of people every year in Seattle, the engineering firm assumes a tort law duty of reasonable care that is independent of its contractual obligations because of the safety concerns involved. This duty was in addition to any contractual relationship the engineering company had with the city of Seattle, and therefore, the monorail concessionaire could maintain its tort claim against the engineer.
The rise of the Independent Duty Doctrine and its role of replacing the Economic Loss Rule in Washington were further bolstered in late 2013 when the Washington Supreme Court ruled that an engineer had duties independent of its contract with certain landowners. In Donatelli v. D.R. Strong Consulting Engineers, Inc., 312 P.3d 620 (Wash. 2013), the court determined that: 1) design professionals owe duties to their clients and the public to act with reasonable care, which can sometimes give rise to a tort duty independent of the contract; and 2) a duty to avoid negligent misrepresentation might arise independently of a contract where one party, through misrepresentations, induces another party to enter into a contractual relationship. This second duty is necessarily independent of the contract because it occurs before the parties execute a contract. A Justice who had concurred in the Berschauer Phillips opinion (discussed above) dissented in the Donatelli decision. In so doing, he noted that although the majority states that its opinion does not overturn the Berschauer Phillips holding, the facts are virtually the same, while the outcome is strikingly different. Consequently, the question becomes very factually intensive for future courts that must address similar issues and the outcome may be impossible to predict given the current state of the law in Washington.
The Economic Loss Rule In Idaho
Similarly, Idaho’s Supreme Court, a long-time subscriber to the Economic Loss Rule, published an opinion in 2010 in which it allowed a party to maintain a tort action despite an underlying contractual relationship. In Brian and Christie, Inc. v. Leishman Elec., Inc., 244 P.3d 166 (Idaho 2010), the plaintiff alleged a cause of action for the negligent performance of electrical work. The faulty electrical work caused a costly fire in the restaurant in which the defendant had installed an electric sign. In holding that the Economic Loss Rule did not bar recovery of the type of damages the plaintiff was seeking, the court stated that in circumstances involving the rendition of personal services, the actor has a duty to perform the services in a workman-like manner. This statement may have opened a door for the courts to assess whether there is an independent duty that arises outside a parties’ contract that would render the Economic Loss Rule inapplicable to bar recovery for damages under a tort theory.
As a result of the recent decisions in both Washington and Idaho, it is currently very difficult to predict how courts will handle a negligence claim brought by a contractor against a design professional. The court will be required to perform a factually intensive analysis to determine if the designer breached a contractual duty or a duty that arose outside the contract. The issue of whether there is a direct or indirect contractual relationship is one distinguishing factor between Berschauer Phillips and Donatelli in that the contractor in Berschauer Phillips was not in contractual privity with the designer, but the plaintiff in Donatelli was in direct contractual privity.
Why is the issue of whether the designer can be sued in contract or in tort important? There may be strategic reasons, such as avoiding contractual notice provisions or contractual liability limits. For example, if the contractor arguably did not adhere to a contract’s strict notification provisions, it may be able to seek damages in tort to avoid the contractual notice provisions in their entirety. Similarly, if the contract has a limitation on the amount of daily field office overhead or other damages a contractor may receive for excusable delays (such as the architect taking an unreasonable amount of time to respond to RFIs or return submittals), then the contractor may be able to bring a negligence claim based on the architect’s independent duty to not engage in conduct that is in “wanton disregard of the rights of others,” pursuant to Washington Administrative Code § 308-12-330(5)(c).
While these theories have not been thoroughly tested yet, by all appearances courts in Washington and Idaho are clearing the way for negligence claims to be brought against design professionals. Contractors and design profes-sionals need to be aware of the developments in these jurisdictions as the courts wrestle with these issues in the future.