By: Tyler S. Lemen
The Indiana Supreme Court recently considered the application of the economic loss doctrine in the context of residential construction. The Court’s opinion is notable not for what it said but for what it left unsaid. In particular, the Court overturned the Indiana Court of Appeals decision which called into question the application of the economic loss doctrine to residential construction projects or when the parties are not “sophisticated.” The Supreme Court implicitly declined the suggestion from the Court of Appeals that the economic loss doctrine should be revisited in the residential construction field.
For an in depth review of the economic loss doctrine and its history, please refer to William Kelley, Jr.’s article here. In short, the economic loss rule provides that, where alleged damages or losses are purely “economic” in nature, claimants must pursue their available contractual rights rather than pursuing general negligence claims. Damages are “economic” when they do not involve bodily injury or property damage; common types of economic damages include lost profits, business interruption, delays, diminution in value to property, disappointed expectations by the parties, and additional costs and expenses incurred during the project.
In Ivy Quad, the Court weighed in on a dispute between the homeowners association of the Ivy Quad condominium complex (“Ivy Quad”) and several entities involved in the development, design, construction, and sale of the condominium complex to the respective condominium owners. In particular, Ivy Quad claimed a breach of the implied warranty of habitability and negligence which impaired the residents’ use and enjoyment of their units and common area as well as “damage to property other than the building itself.” A group of defendants was granted an early dismissal as they argued the economic loss doctrine barred Ivy Quad’s negligence claim against them.
Considering the trial court’s ruling on appeal, the appellate court disagreed with the trial court and determined the dismissal of Ivy Quad’s claim was premature as the exact nature and extent of the contract relationships between the parties had not yet been fully explained. In short, there was not yet a sufficient factual record from which to determine if the economic loss doctrine applied; therefore, the trial court could not yet base its opinion on the doctrine.
Interestingly, the appellate court went on to discuss the application of the economic loss doctrine and opined that the doctrine may not apply to Ivy Quad’s claims since the condominium owners were not sophisticated parties. The appellate court took issue with applying the doctrine in the residential construction context as such parties were presumed to be less sophisticated than participants in the commercial construction context. The implicit suggestion was there could potentially be different outcomes depending on the type of project due to perceived differences in the sophistication level of the contracting parties.
The appellate court relied upon a prior seminal Indiana Supreme Court decision applying the economic loss doctrine in the construction context. See Indianapolis-Marion County Public Library (IMCPL) v. Charlier Clark & Linard, P.C., 929 N.E.2d 722 (Ind. 2010). The parties in the IMCPL case did not directly contract with each other; instead, as is typical for most construction projects, the parties were connected through a series of contracts between and among the various entities providing different aspects of the labor, materials, design, and work for the project. The project owner had a prime agreement with the project architect and another with the general contractor. The owner was then indirectly connected to the various other design and construction entities through a “chain of contracts” involved on the project. The owner sued numerous parties, including engineers that had no direct contract with the owner, related to allegations of significant design and construction defects in the project’s parking garage.
The Indiana Supreme Court that held that despite the lack of a direct contractual relationship with the engineers, the owner was connected to the engineering firms through the chain of contracts, meaning that the economic loss rule applied to bar its negligence claim. The owner had to pursue its available contract remedies with the entities in direct contractual privity; those entities, in turn, could pursue downstream contract claims against the other entities involved in design and construction of the project.
Considering the IMCPL case, the appellate court noted the Restatement of Torts relied upon by the Indiana Supreme Court had changed in the ten years since the IMCPL opinion. The appellate court specifically noted the following found in a comment to the Restatement:
As for a broader application forbidding tort claims between parties who are only ‘indirectly’ linked by contract, the commentary cautions that while threat of application of the doctrine would put pressure on parties to specify their rights carefully in advance and spare courts the need to decipher them later, ‘that incentive is most likely to be noticed by sophisticated parties negotiating large projects[.]’ ‘Meanwhile, less sophisticated parties would stand a good chance of being tripped up by a broad rule, as when they fail to provide for indemnification in some direction and inadvertently leave a party who has been wronged with no remedy.’
With this in mind, the appellate court stated:
In light of the foregoing, we are persuaded that the reasoning behind and sweeping holding of Indianapolis-Marion County Public Library was meant to apply only to sophisticated parties involved on all sides of large commercial construction projects and not in the typical residential construction context. Our supreme court used the term “major construction project” throughout its opinion, underscoring that the use of the doctrine as a shield by a defendant without contract privity should be limited to such. We do not think our current supreme court would be inclined to apply the economic loss rule to leave plaintiffs remediless in cases where contract privity between the buyer and the majority of the construction professionals is understandably lacking, especially those concerning much smaller residential construction projects. The economic loss doctrine was never meant to operate as a sword to be used by defendants to attack a plaintiff’s tort claim that falls wholly outside of contract law.
Following the appellate court’s opinion, the Indiana Supreme Court accepted transfer thereby vacating the appellate court’s opinion. In the recently issued opinion, the Court made no reference to the sophisticated vs. unsophisticated or residential vs. commercial construction distinction discussed by the appellate court. Rather, the Supreme Court determined Ivy Quad’s damages may not be “purely economic” since it alleged damage to “other property” in the Complaint, and the factual record was not yet sufficient to determine if the economic loss doctrine applied to bar Ivy Quad’s claims. Therefore, the trial court had improperly dismissed Ivy Quad’s claims.
In sum, the Court’s opinion was relatively uneventful, resolving the matter without undertaking a review of the economic loss doctrine. Though, the lack of a discussion was telling of how the Court may rule on this issue in the future. Indeed, since the appellate court had already reversed the trial court on the same grounds ultimately used by the Indiana Supreme Court, there was seemingly no reason for the Supreme Court to hear the case. One possibility is the Supreme Court’s reason for hearing the case was to vacate the appellate court’s reference to a residential construction carveout from the general economic loss doctrine. Another possibility is that the factual record here was still undeveloped, since it involved an early dismissal, and the Court did not believe these sparse facts were sufficient to change the scope of the economic loss doctrine. Regardless of the reason for hearing the case, following the Court’s opinion, the economic loss doctrine can still be applied without regard to the type of construction project or the parties’ alleged level of sophistication.
With that said, the Indiana Supreme Court did take the time to hear oral arguments. Meaning, expectations for an unchanging economic loss doctrine in the future should be tempered. It is possible the Court may still consider the very carveout referenced by the appellate court, but may wait for a different case with a more developed factual record in which to express changes to the doctrine.
For questions about construction litigation, contact Tyler Lemen at firstname.lastname@example.org or your DSV attorney.
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