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The Economic Loss Rule and Risk Assessment

Timothy R. Hughes, Esq.
Hughes & Associates, P.L.L.C.

Most construction cases are fights that are purely about money rather than personal injuries or property damage. In many states, such claims are called “economic losses” governed by the economic loss rule. Depending on your jurisdiction, the economic loss doctrine can have a critical impact on who can sue you and for what claims.

A. Tort v. Contract

The economic loss rule flows from the distinction between tort and contract. Contract case are relatively easy to understand. Contract claims involves suits over bargained for expectations. When a duty assumed pursuant to contract is breached, a party may sue for breach of contract.

In contrast, tort claims involve breaches of legally imposed duties. One example is a suit involving negligence in driving. A driver acts negligently and causes an accident. The injured party can file a negligence case for personal injuries against the negligent driver. This type of cause of action sounds in tort rather than contract.

B. The Economic Loss Rule: Different State Standards

At its most basic, the economic loss rule provides that a party cannot sue for purely economic losses absent privity of contract. In layperson’s terms, a party cannot sue for contract damages without a contract.

The legal devil is in the details. Different states apply wildly different variations on this rule. For example, Virginia strictly adheres to the economic loss rule. Neighboring Maryland adheres to the rule fairly strictly, but permits an exception where a plaintiff can allege an unreasonable risk of serious personal injury or death. Nearby North Carolina applies the economic loss rule in cases involving product sales yet permits a contractor to directly sue an architect for economic losses without a contract.

C. Practical Impacts of a More Relaxed Standard

There are several critical impacts that flow from applying a more relaxed standard applied to economic loss cases. First, more relaxed standards permit more parties to sue you. This means you have the potential for unexpected claims from unexpected sources on your projects.

Second, contractual limitations on exposure may evaporate. For example, you may have a contractual limitation of liability. A party not in privity may not be bound by those negotiated terms. Waivers of consequential damages may not apply to parties who did not sign on to those terms. States with more relaxed provisions regarding the economic loss rule often disregard contractual limits on liability or damage waivers.

The third major impact is a somewhat unintended consequence. Lawsuits in states with a non-existent or more relaxed economic loss rule tend to be far more ugly and complicated. When a party is limited to only suing the entities with whom it had a contract, the pleadings in the case tend to flow in a streamlined fashion.

In contrast, states with no economic loss rule tend to face litigation with multiple counterclaims, cross-claims, and third-party claims. All of the parties all sue each other. This type of litigation can become a procedural nightmare, particularly in a jury trial.

D. A Recent Analysis of the Economic Loss Rule

A recent case from North Carolina construed the economic loss rule in a health care facility context. Ellis-Don Construction sued the design team on a hospital project. Ellis-Don Const. Inc. v. HKS, Inc. et al., 2004 WL 3094819 (M.D.N.C., 12/29/2004). The University of North Carolina Hospitals (“UNC”) hired the contractor to build the facility. UNC hired HKS to design and manage the project. HKS hired SSR for mechanical, electric and fire protection systems. HKS hired CRS for architectural services, including planning and design, construction administration, and inspections.

CRZ had no contract with the contractor. CRZ moved to dismiss the contractor’s claims. The court ruled that in North Carolina, the economic loss rule was limited to products liability cases. The court stated clearly that an architect had the “power of economic life or death” over the contractor and that a contractor could maintain a direct claim for negligence against the architect even without a contract. Id.

The case drew my attention because nearby courts would have clearly reached a different result. Courts in Virginia routinely dismiss contractor attempts to assert claims like this one. Courts in Maryland do the same thing. The case dramatically emphasizes that businesses need to know and understand the laws of every jurisdiction where they do business to properly assess contract risk and exposure.

Conclusion

The economic loss rule varies from state to state and has critical importance to construction litigation. Knowing and understanding its terms where you do business is vital to anticipating risks on your construction projects.

 

Printed with permission from Electrical Contractor

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