A majority of states, including Indiana, follow the Economic Loss Doctrine. In those states that apply the doctrine -- if a party claiming damage from defective workmanship does not have a contractual relationship with the contractor that performed the work, that party is unable to recover economic damages from the contractor to cure the negligent workmanship if the workmanship has not yet caused death or physical injury to any person and does not pose a "threat of imminent harm" to any person or tangible thing other than the constructed building itself - i.e., the defective construction merely creates a dangerous condition that could cause a future catastrophe to the constructed building. The recent opinion by the Vermont Supreme Court in Long Trail House Condo. Ass'n v. Engelberth Constr., Inc., 2012 VT 80 (Vt. 2012), illustrates this concept.
Engelberth entered into a standard AIA form agreement between owner and contractor with modified A201 General Conditions. After the project was completed, the Long Trail House Condominium Association (the "Condo Association") was incorporated. The condo owners experienced minor problems at first, such as water leakage. Later, structural engineers found significant further damage would likely lead to personal property loss and personal injury if the faulty workmanship that caused the leaks was not fixed. The engineer identified several construction defects. For example, the engineer opined that severe water damage to the balconies could result in their collapse within a year.
In 2007, the project owner and the Condo Association entered into a Settlement Agreement and Release of Claims obligating the project owner to pay the Condo Association more than $7 million to resolve the design and construction defect claims. The agreement also required the project owner to pursue a claim against Engelberth to recover the settlement money. Fairly early in the litigation process between the project ownenr and Engelberth, the Condo Association hired contractors to fix the defective workmanship. The remediation work cost $1.5 million more than the settlement agreement. As a result, the Condo Association decided to bring their own litigation claims against Engelberth alleging that Engelberth was negligent in constructing the project and breached express and implied warranties by failing to construct and repair the project in a good workmanlike manner free of defects. The defects alleged by the Condo Association mirrored those in the project owner's lawsuit and included additional defects in the buildings' HVAC and electrical systems. The trial court concluded that the Condo Association's negligence and warranty claims against Engelberth were barred by the Economic Loss Rule and granted Engelberth's motion for summary judgment dismissing the Condo Association's claims.
The Vermont Supreme Court affirmed the trial court's ruling. The Court concluded that the Condo Association only suffered economic harm and therefore was not entitled to pursue its negligence claim agaist Engelberth. The Court reasoned that to allow the Condo Association "to recover damages for this harm based on a theory that the building defects 'could have' caused an accident would subvert the actual injury requirement and provide an end run around the Economic Loss Rule." Furthermore, the Condo Association did recover damages from the project owner which allowed it to "fix the defects it apparently considered most dangerous."
With respect to the warranty claims, the Vermont Supreme Court acknowledged there is an "increasing trend" among state courts to recognize a cause of action by a subsequent home purchaser against a builder/vendor for breach of the implied warranties of workmanship and habilitability where the innocent purchaser is often left without any meaningful legal or financial recourse. Here, however, the Court was not convinced that the factual circumstances merited the Condo Association's warranty claims against Engelberth. The Condo Association had previously entered into a significant settlement agreement with the project owner. The Court concluded that the Condo Association's warranty remedy lies
with the entity that sold it the condominium units and implicitly warranted through the sale that the units were built in a good and workmanlike manner and that they were suitable for association.
LESSONS LEARNED: If you enter into a settlement agreement that agrees to release all claims against the party you have a contract with prior to obtaining complete estimates to repair construction defects, you might not have enough money to pay for the repairs and you might not have the right to pursue direct claims against the parties responsible for the defects unless you have the right to enforce contractual claims agaist those parties. The party responsible for the defective workmanship typically has a right to cure before repairs are made. Sometimes, the other party does not agree that the construction is defective or that the scope of the contemplated repairs is necessary. I generally favor approaching these situations in a manner that reduces the scope of every party's total risk of exposure and, where possible, I often recommend the use of an interim agreement that allows time sensitive repairs to proceed with all parties reserving all rights and claims to the extent the situation is not fully resolved and future litigation or arbitration is necessary. This often requires a collaborative process.
Categories: Economic Loss Doctrine