Within the world of construction and design related claims, there is a legal doctrine referred to as the “economic loss rule”. 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. Repairs to the project may also be considered economic damages, so long as the repairs do not involve damage to “other property” outside the scope of the project.
Where there is a binding contract, courts regularly interpret and enforce those contracts; the contracts represent the best evidence of the bargained-for agreement between the parties to the project. The contracts typically identify the parties involved, the scope of work covered by the agreement, the price and payment terms, the schedule for the work, and a whole host of other issues related to the expectations and agreements of the parties to the project. Contract claims require analysis of whether a particular party breached the terms of the contract, and whether the non-breaching party has been damaged as a result. Contracts may also have terms related to the types and amounts of recoverable damages, including limitations of liability, specific warranty terms, waivers of certain types of damages, and specific exclusions from the work involved, which can further define and potentially limit the parties’ recovery rights.
Negligence claims, on the other hand, require fact specific investigation and analysis of the nature of the legal duty involved, breach of that duty, damages, and proof that the damages were proximately caused by the breach of duty. Claimants asserting negligence claims often allege that the legal duties and recoverable damages involved are broader or more expansive than what is set forth in the parties’ written contracts. Thus, negligence claims potentially expand a claimant’s rights and remedies (and a defending party’s potential risk and liability), even where such rights and remedies might otherwise be limited or excluded by the terms of a contract.
One justification for courts applying the economic loss rule has been that allowing parties to circumvent their contracts by pursuing a general negligence claim could frustrate the purpose of having a contract in the first place. If parties could avoid contract terms by simply filing a negligence claim, the contracts would essentially become superfluous. As a result, the economic loss rule serves as a guardrail for contracting parties on a construction project, limiting those parties to their contract claims and remedies, and barring negligence claims for purely economic damages. As a corollary to this rule, where parties have no contract relationship—and therefore have no readily available contract rights or remedies to pursue—courts have often found that the economic loss rule does not apply, meaning those parties can proceed with negligence claims.
In 2005, the Indiana Supreme Court confirmed that the economic loss rule applied to construction claims in Gunkel v. Renovations, Inc., 822 N.E.2d 150 (Ind. 2005). In Gunkel, the court addressed a residential construction project involving the installation of a stone façade and alleged defects related to that work. The Indiana Supreme Court found that there was a direct contract relationship between the project owner and the contractor, such that the economic loss rule would bar any negligence claim against the contractor related to defects in the stone façade work itself. However, for damages to “other property” outside the stone façade, the court recognized that the economic loss rule may not apply, meaning the owner may have a viable negligence claim against the contractor for those types of damages.
In 2010, the Indiana Supreme Court again weighed in on the economic loss rule, this time in the context of the design and construction of a public library facility in Indianapolis-Marion County Public Library (IMCPL) v. Charlier Clark & Linard, P.C., 929 N.E.2d 722 (Ind. 2010). Whereas the parties in Gunkel had a direct contractual relationship, 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.
Since 2010, multiple cases have worked their way through trial courts and the Indiana Court of Appeals on application of the economic loss rule, without any significant participation by the Indiana Supreme Court. However, in June 2021, the Indiana Supreme Court signaled that it may be ready to again address the economic loss rule in the construction context when it granted a petition to transfer in a construction case involving a condominium association’s lawsuit against various entities involved in the development and construction of a residential condominium project. The case involved arises from the Indiana Court of Appeals decision in Residences of Ivy Quad Unit Owners Association, Inc. v. Ivy Quad Development, LLC, 164 N.E.3d 142 (Ind. Ct. App. 2021).
In Ivy Quad, the trial court granted a motion to dismiss by several developer and contractor entities, finding that the economic loss rule applied to bar the condo association’s negligence claim. The Court of Appeals reversed the trial court’s decision to dismiss the developer and contractor entities, finding that the dismissal was premature since the exact nature and extent of the contract relationships had not yet been fully explained. As a result, the Court of Appeals remanded the case to the trial court so that the case could proceed to the discovery phase. That portion of the decision itself, however, did not preclude application of the economic loss rule in the future if the discovery confirmed the existence of a “chain of contracts” or even direct contracts that would support application of the economic loss rule. What was noteworthy, though, was the Court of Appeals went on to opine that the economic loss rule may no longer be appropriate in all construction contexts—specifically questioning whether the economic loss rule should continue to apply to residential construction claims, which often involve less sophisticated parties than in the commercial construction arena. Whereas prior case law in Indiana on the economic loss rule did not differentiate between the types of projects involved (e.g., residential vs. commercial), the Court of Appeals opined that such a distinction may be appropriate going forward. The implicit suggestion is that there could potentially be different outcomes depending on the type of project, due to perceived differences in the level of sophistication of contracting parties involved.
The Indiana Supreme Court accepted transfer of the Ivy Quad case and has scheduled oral arguments in September 2020. It is unclear what direction the Supreme Court may take on the economic loss rule in the context of the Ivy Quad litigation. However, there are several possible approaches that the Supreme Court could take:
- The Supreme Court could disagree with the Court of Appeals on all issues, hold that the trial court correctly dismissed the claims based on application of the economic loss rule, and confirm its prior holdings on application of the economic loss rule to all types of construction projects.
- The Supreme Court could agree, in part, with the Court of Appeals that the dismissal was premature, and that further discovery is needed on the nature and extent of the contract relationships at issue; but then also disagree, in part, with the Court of Appeals as to any proposed limitations or qualifications to the economic loss rule, thus confirming its prior holdings on application of the economic loss rule to all types of construction projects.
- The Supreme Court could agree with the Court of Appeals on all issues, hold that the trial court erred in dismissing the negligence claims, and further take the opportunity to clarify, limit, or revisit the economic loss rule as it applies to different types of construction projects or contracting parties.
What the Indiana Supreme Court will do—and what effect, if any, it may have on construction and design claims—remains to be seen. Regardless of the outcome, all participants in design and construction projects are best served to carefully review and negotiate their written contracts for all types of projects, to accurately define the expectations, agreements, obligations, and understandings of the parties. Contracts not only help avoid confusion about each participant’s role in the project, but they also help define and clarify the categories of claims, damages, and remedies that may be involved for any subsequent disputes.
For questions about construction legislation, contact William E. Kelley at firstname.lastname@example.org or your DSV attorney.
***The information contained on this website is for informational purposes and is not intended as formal legal advice and cannot be relied upon as such. No attorney client relationship is established or intended as a result of the information contained on this website.**