General Publications February 2015

“The Economic Loss Doctrine – And Design Professional’s Liability in California,” Hill International Construction Advisory Report, February 2015.

Extracted from Hill International and to appear in the February newsletter.

    Historically in California and several other states, absent property damage or personal injury, a party not in privity of contract with an architect[1] is not entitled to sue that architect for defective design. However, in Beacon Residential Community Association v. Skidmore, Owings & Merrill, LLP, California Supreme Court Case No. S208173 (July 3, 2014) notwithstanding the economic loss doctrine (ELD), the California Supreme Court found that a condominium association could sue an architect, with whom it did not have any contractual relationship, on the grounds that the architect owed the association a duty of care to produce a defect-free design.

    The California Supreme Court’s decision is at odds with case law of several other jurisdictions applying the ELD to preclude a third party from asserting a tort claim against an architect for defective design absent property damage or personal injury. While the Beacon case arguably may be limited to the facts presented --defect claims associated with the construction of a residential project -- the critical issue for construction participants in California is whether Beacon will be interpreted to establish the design professional’s duty of care to others, including non-residential project owners, contractors, subcontractors and suppliers who are not in privity of contract with the design professional. Additionally, there is also the question of whether the duty is owed only by the architect or engineer of record or will extend to lower tier design consultants or even to design/build trade contractors.

    This discussion will provide an overview of the ELD and how other jurisdictions apply that doctrine to preclude third party claims against design professionals and contrast those decisions with the ruling in Beacon.

The Economic Loss Doctrine

    The ELD has been the subject of a great deal of attention since its origins in the 1960’s. Generally, the doctrine holds that a plaintiff cannot sue in tort for a defective product that causes pure economic loss (inadequate value, costs of repair and replacement of the defective product, or loss of profits, etc.) and it is restricted to seeking relief for such damages under a breach of contract theory. That is, a party to a contract cannot sue in tort for a product’s failure to meet contractual expectations where it is seeking damages for the cost of repair of the project. Additionally, a third party not in privity of contract with a party responsible for a defective product cannot sue that party for economic loss damages absent the existence of a duty of care. All but five states in the United States apply the rule to preclude actions in tort when a product failure or defect causes only damage to itself, but does not cause personal injury or property damage to other property.    

    In the majority of states, economic loss damages are interpreted to include the cost to repair the entire project, including damages caused to other parts of the project resulting from the defective component.[2] In the construction context, this doctrine has traditionally been applied to preclude property owners, contractors or subcontractors from suing a design professional in tort for defective design.

The Majority Rule

    The majority of jurisdictions apply the ELD to preclude third party lawsuits against design professionals. For example, in Lincoln Park West Condominium Association v. Mann, Gin Ebel & Frazier, 136 Ill.2d 302 (1990), the Illinois Supreme Court upheld dismissal of claims by a condominium association against the project’s architect which had “developed plans and design specifications for the work and certified the final completion of the project.” The claimed defects included defective doors, windows and roofing and inadequate heating and cooling systems. The Court ultimately rejected the homeowner’s association’s claims on the grounds that the “gravamen” of their claim was “dissatisfaction with the way the building was designed and constructed and the failure to meet the unit owner’s expectations. These were “economic losses” relating to quality rather than safety of the building and since the architect’s responsibility originated in contract with the original owner, its duties should be measured accordingly.

    Although involving third party claims against a subcontractor as opposed to an architect[3], a similar result was reached by the Hawaii Supreme Court in Association of Apartment Owners of Newtown Meadows v. Venture 15, Inc., 115 Haw. 232 (2007). In that case, the association complained of a number of construction related defects including substantial settlement of the building. The association sued, among others, the masonry subcontractor and sought recovery of the cost to repair the damages caused to by the building’s settlement.

    The basis for the Court’s decision was that tort remedies are intended to provide protection against personal injury or separate property damage but where a party’s claims relate to loss of its bargain resulting from deterioration of the project or a failure to meet some standard of quality, the appropriate claim is one in contract. It noted that opening up a contractor to tort liability for economic loss outside of the obligations set forth in its contract would substantial harm to the construction industry as “the fees charged by contractors are founded on their expected liability exposure as bargained and provided for in the contract.”

    The Virginia Supreme Court in Blake Construction Co. Inc. v. Milton M. Alley, 233 Va. 31 (1987) similarly rejected a contractor’s attempt to assert a negligence claim for economic damages against the project architect, with whom it had no contractual relationship. The contractor claimed that the architect owed it a duty of care to provide defect-free plans and specifications and to properly certify to the owner that the work was performed in compliance with the plans and specifications. The Court rejected the existence of such a duty noting that “the architect’s duties both to the owner and the contractor arise from and are governed by the contracts related to the construction project.” Because there was no contract between these two parties, the Court refused to find that the architect owed any “common law” duty to prevent the contractor from suffering economic loss damages.

The Economic Loss Rule And Design Professionals’ Liability in California

    Prior to the decision in Beacon, the California Supreme Court endorsed the economic loss doctrine in Aas v. Superior Court, 24 Cal. App. 4th 627 (2000). In that case, the Court found that a condominium association and individual homeowners could not sue the developer’s contractors and subcontractors for work alleged to violate applicable building codes because the defective work had not caused property damage. Because the damages constituted economic loss damages and the homeowner’s had not contracted with the contractors or subcontractors, the Court found that those third parties could not be sued in negligence.

    That decision was abrogated with respect to its application to “new” residential construction with the passage of California’s Right to Repair law (Civil Code § 895 et. seq) in 2003. The Right to Repair law allows residential home owners to sue developers, contractors, and design professionals for violations of certain specified construction standards relating to “new” construction, even in the absence of contractual privity and even where the homeowner is only seeking to recover economic loss damages.[4]

    Prior to Aas, the leading California case cited by design professionals to counter the argument that they owed a duty of care to owners or contractors was Weseloh Family Limited Partnership v. K.L. Wessel Construction Co., 125 Cal. App. 4th 152 (2004). In that case, a retaining wall failed and the property owner and the general contractor sued the wall subcontractor’s engineer – which provided design calculations -- for negligence claiming that the wall design was defective. The lower court dismissed the negligence claims and the claimants appealed.

    Although the economic loss doctrine did not come into play because there was resulting property damage, the Court of Appeal focused on whether a duty of care was owed by the subcontractor’s engineer to the owner, general contractor. The Court applied the test announced in Biakanja v. Irving, 49 Cal. 247, 650 (1958) to determine whether a duty of care existed. That test requires a balancing of several factors:

(1) The extent to which the transaction was intended to affect the plaintiff, (2) the foreseeability of harm to the plaintiff, (3) the degree of certainty that the plaintiff suffered injury, (4) the closeness of the connection between the defendant’s conduct and the injury suffered, (5) the moral blame attached to the defendant’s conduct, and (6) the policy of preventing future harm.

    In weighing those factors, the Weseloh court noted that 1) the engineer worked for the wall subcontractor and performed calculations that were primarily intended to benefit the subcontractor, not the other parties, 2) plaintiffs failed to establish the extent to which the design (as opposed to the construction) caused the failure, 3) plaintiffs failed to present evidence that imposition of a duty of care would result in better engineering, 4) because the engineer was not involved in the construction, it did not have “complete control” over the creation of the wall and 5) there was no policy reason to attach greater blame to the engineer than to the plaintiffs for the failure. Therefore, the Court held that no duty of care existed. 

    Beacon comes a decade after Weseloh. In Beacon, a homeowner’s association (HOA) filed suit alleging a number of claims including a claim of negligence against the project architect. After completion, the building was initially utilized for rentals but after two years was converted to condominiums.[5] The Association, formed after the condo conversion, claimed that there were a number of defects with the units including water intrusion, structural cracks, “solar heat gain” caused by substandard windows and an inadequate ventilation system. Interestingly, during the design, the Owner directed the architect to perform value engineering and as a result changes were made in the ventilation system and lower cost windows were substituted for the windows originally specified. In addition to developing the plans and specifications, the architect also performed construction administration services throughout construction of the project.

    The Supreme Court similarly applied the Biakanja factors to determine whether project architect owed the condo association a duty of care to produce a defect-free design in the absence of privity of contract. It found that notwithstanding the lack of privity, the architect owed the Association a duty of care. In reaching this conclusion, it pointed to several factors. First, it noted that the architect had the “primary role in the design” and consequently there was a close connection between the architect’s conduct and the plaintiff’s injury. It identified the fact that the architect provides professional services and therefore has a “unique role” on the Project. Additionally it noted that the architect was involved in the project from start to finish and that it had earned a fee in excess of $5 Million.

    The Court rejected the argument that imposing liability would raise the prospect of creating liability “in an indeterminate amount, for an indeterminate time to an indeterminate class” – which is a factor relied on by other jurisdictions to find that there is no duty of care. It pointed out that the architect knew that the finished product would be sold as condominiums and used as residences and “there was no spectre of vast numbers of suits and limitless financial exposure.” It also found that the HOA was not in a position to protect itself from potential injury because “it is unrealistic to expect homebuyers to hire their own architects to fully investigate the structure and the design.” 

    The Court distinguished the Weseloh decision on several grounds but pointed out that the engineer in that case had a very limited role on the project and that its services (providing engineering calculations) were provided to the contractor which in turn applied its own technical expertise to building the wall that failed.

    What is particularly interesting about the case is that the Court dismissed certain facts that arguably should have supported the opposite conclusion. Specifically, the Court dismissed the fact that the owner’s value engineering effort required the architect to modify the design of the ventilation system and to substitute an inferior window system. This would seem to undermine the Court’s conclusion that the architect had “control” over the design of the project. Additionally, the Court rejected the architect’s reliance on terms in its contract with the developer which expressly provided that there were no third party beneficiaries of the obligations owed by the architect to the owner. Obviously, this language was included in the contract specifically to prevent the kind of claims that were asserted in this case. This contract provision would likely have been relied on by Courts in Hawaii, Illinois and Virginia to find that no duty of care existed.

    In order to attempt to interpret the potential application of the Beacon decision, we look to the Court’s holding in the case:

“we hold that an architect owes a duty of care to future homeowners where the architect is the principal architect on the project – that is, the architect in providing professional design services, is not subordinate to any other design professional – even if the architect does not actually build the project or exercise ultimate control over construction decisions.” (emphasis in original)

One could narrowly read the Beacon decision to establish a design professional’s duty of care to third parties only in the limited circumstances where the case involves residential construction and the design professional is involved in all aspects of the project including the design and follow on construction administration.

    However, the case easily could be interpreted to establish that a design professional also owes a duty of care to general contractors, subcontractors and even suppliers and that the duty exists, not just to residential projects but to all types of construction projects. The application of the Biajanka factors to these other parties and other types of projects would be very similar to the analysis applied by the Beacon court. Moreover, there appears to be no effective way that a principal architect or design professional could contractually limit its liabilities to these third parties, as contract terms limiting liability for value engineering decisions made by the owner would not appear to protect design professionals from liability to third parties.

    In January 2015, the California Court of Appealin State Ready Mix, Inc. v. Moffatt & Nichol, 2015 Cal. App. LEXIS 11 (January 8, 2015), rejected an argument that an owner’s engineer owed a duty of care to the supplier of defective concrete after the engineer reviewed the supplier’s proposed design mix. While the Court found there was no duty of care because the owner’s engineer gratuitously reviewed the design mix, the facts established that defective concrete resulted from the supplier’s failure to follow its own design mix. Additionally, the case did not discuss nor even acknowledge the Beacon decision. Therefore, it provides little if any guidance regarding the application of Beacon..

    The Beacon decision eliminates the economic loss doctrine’s application in California to design professional liability in the residential construction context. The next question is: will a design professional’s duty of care be extended to other parties and to other contexts?


[1] The terms “architect”, “engineer” and “design professional” are used interchangeably throughout this piece as the law discussed herein could apply to any design professional.

[2] The ELD applied in California is narrower than the ELD applied by other jurisdictions. The majority of jurisdictions follow the rule that even if a single component of the work causes damages to other parts of the construction project, the cost to repair the entire project constitutes “economic loss damages. However, in California damages caused by the defective element to other parts of the project are considered “property damage” that is compensable even absent privity of contract. Jiminez v. Superior Court, 59 P.3d 450 (Cal. 2002)

[3] In another case, City Express v. Express Partners et. al, 87 Haw. 466 (1998), the Hawaii Supreme Court rejected a project owner’s negligence claim against its architect relating to alleged defective design of a warehouse. The Court noted that if tort and contract remedies overlapped “certainty and predictability in allocating risk would increase and impede future business activity and that “the fees charged by architects, engineers, contractors, developers . . . are founded on their expected liability exposure as bargained and provided for in the contract.” Therefore the project owner was limited to its contract remedies.

[4] However, in order to bring a claim under that statute, the homeowner is obligated to provide those parties with notice of the defects and an opportunity to cure the alleged defects. Although it is not clear from Beacon, the plaintiffs in that case may have failed to comply with those requirements making it necessary for them to succeed with their common law negligence claim.

[5] This existence of this fact may be reason why the Association sued the architect in negligence as the Right to Repair Act does not apply to condominium conversions.

 

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