Construction Law And Litigation Committee Newsletter

The economic loss rule and the integrated product doctrine are important defenses in construction litigation for developers, architects, contractors, subcontractors, product manufacturers, and suppliers. These legal defenses are recognized by the majority of federal and state courts, and, when properly used, serve two important functions: first, they limit damages to those measures prescribed by the parties' contracts; and second, they preclude certain types of less-predictable tort causes of action. For these reasons, the economic loss rule and the integrated product doctrine are critical insofar as they allow parties to predict and control, to a degree, their potential risks, and thereby contribute to the maintenance of stable construction markets.

This article will explain these rules in broad terms and through examples, and will look at some recent challenges to their viability. Finally, we offer some simple strategies for successfully employing these defenses.

The Economic Loss Rule

Conceptually, the economic loss rule is fairly easy to state: parties are not allowed to turn what should be breach of contract claims into tort claims.

Tort claims typically allow for a wider array of, and potentially much larger, damages. As a result, plaintiffs frequently attempt to state their claims in terms of tort law. This, of course, begs the question: where is the line between tort and contract law? Again, the basic answer is relatively straightforward. Most jurisdictions accept as a matter of common law that you may be subject to tort liability for your actions that result in physical injury to others or to "other property." Stated another way, you have a duty to avoid injuring others or their property. On the other side of the line between tort and contract law, there is no general common law protection against purely economic losses. Therefore, if you agree to do a task but do it poorly, albeit without injuring anyone or their property, then you may be sued for breach of contract for recovery of your "economic losses" but, typically, you are not exposed to tort damages.

The following example is illustrative. If a building's brick façade collapses, injuring the building's owner or damaging her car, then the owner can likely sue the builder in tort. If, on the other hand, the façade collapses but only damages other parts of the building, then the owner will likely be limited to a breach of contract action.

Difficulty in Application

While the general rule can be explained easily, it can be uncommonly difficult to apply. This is due in part to significant differences in how the rule is enforced in different jurisdictions. Examples from two states serve to make this point.

Consider purchasing a home in Virginia. The home is built by a design-build firm and includes a pool. Construction of the pool is subbed out to a specialty contractor who signs a subcontract with the builder but not the purchaser. After the purchase, the pool develops leaks, causing damage to the home's foundation. In Virginia, the owner, generally speaking, cannot successfully pursue a tort claim against the pool contractor because this claim is barred by the economic loss rule. See Sensenbrenner v. Rust, Orling & Neale, Architects, Inc., 374 S.E.2d 55 (Va. 1988). Moreover, the owner does not have a contract with the pool contractor; so, absent a warranty, the owner cannot sue the pool contractor for breach of contract. The only option for the owner in this case is a breach of contract suit against the builder. Your lawsuit options are even more limited if you are the second owner of the home. In this case, absent a warranty from the contractor or subcontractor, your only option would likely be to sue the person from whom you bought the home for breach of contract. Of course, your ability to recover against the seller in this case is typically very limited by the terms of the purchase and sale agreement.

Now, consider a similar home built in North Carolina. North Carolina has created an exception to the economic loss rule that protects downstream home purchasers. As a result, in...