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Home | Columnists | Legal | Legal - The Economic Loss Rule and construction defect litigation Part 1: What is the Economic Loss Rule?

Legal - The Economic Loss Rule and construction defect litigation Part 1: What is the Economic Loss Rule?

image Varant Yegparian, Schiffer Odom Hicks and Johnson PLLC, Houston, TX

AUSTIN - A. Introduction. Litigation is the last place anyone in the construction industry wants to be in. That is why owners, developers, contractors, and sub-contractors should draft their contracts with an eye toward the possible lawsuit. To that end, a contract’s terms (capping damages, excluding claims, specifying specific types of relief, etc.) represent a careful allocation of the parties’ risk—the “benefit of the bargain.” Parties to a construction contract rely on the negotiated terms to provide a measure of certainty—letting them know what to expect over the course of a construction project.

    The ability to rely on a contract’s terms is especially important in litigation; being able to use a contract’s terms as defenses to a lawsuit can radically alter a person or company’s decision to sue. Therefore, knowing whether a contract’s terms can be used in a lawsuit is essential.
    A legal doctrine known as the “economic loss rule” is especially important in determining whether contractual defenses will be available in a lawsuit. Indeed, the rule provides a useful weapon to those who find themselves in litigation.
    This article is part of a three-part series which will explain what the rule is, how it works in a lawsuit, why it is important to the construction industry, and how some recent court decisions affect the rule.

B.  The Economic Loss Rule

    The economic loss rule is a legal sorting machine: put in information about the parties, the type of damage, and whether there is a contract and it will spit out whether you have a contract or tort claim.
    This sorting might not seem like much,    but drawing a line between contract and tort claims can have significant consequences for a lawsuit. This is because tort damages cannot be recovered in contract – and – contract damages cannot be recovered in tort.

C.  Tort or Contract: What is my claim?
    In a construction defect lawsuit, the plaintiff usually asserts two types of claims: contract and tort. A breach of contract claim is straightforward: a party will claim that it had a contract with the defendant to, for example, to do all electrical subcontracting on the project. If the subcontractor fails to do its job properly, it will be liable or responsible to the plaintiff for breach of contract.
    A tort claim—i.e., one for negligence—is a little more complicated. In the example above, assume again the subcontractor did not properly install the wiring for the project. If a third-party inspector is inspecting the electrical work and gets shocked due to the faulty wiring, he could bring a personal injury suit against the subcontractor. This would be a tort claim. Importantly, the inspector could not bring a breach of contract lawsuit against the subcontractor because there is no contract between the two. The inspector’s contract would be with the project owner, not the electrical subcontractor. Therefore, the inspector’s claims would be limited exclusively to tort—not contract—damages.

D.  The Economic Loss Rule, Again: What does it do?
    Returning to the example above, the inspector could not sue electrical subcontractor for breach of contract because no contract between the two existed (hence, tort damages cannot be recovered in contract). Likewise, the project owner could not sue the subcontractor for negligence because the damage suffered by the owner—improper wiring—is covered entirely by its contract with the subcontractor. This sorting of contract and tort is the key feature of the economic loss rule.

E.  Conclusion
    The legal “sorting” provided by the economic loss rule—its way of separating contract claims from tort claims—is important in litigation. While some might think the difference between a contract and tort claim might is obvious, sometimes it is not. As will be explained in next month’s article, the economic loss rule can be particularly useful for those in the construction industry when there is an issue regarding what type of claim—whether contract or tort—a plaintiff has actually pled.

Varant Yegparian
700 Louisiana Ste. 2650
Houston, Tx 77002  •  Tel: 713.255.4109

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Reesa Doebbler reesa@constructionnews.net