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Written By: Anne K. McMichael, Esq.

Zupkus & Angell, P.C.

Denver, Colorado

I.             Introduction

In 2000, Colorado joined Illinois and South Carolina in adopting the “economic loss rule,” a rule of law that defines the sometimes blurred lines between tort and contract law. Since 2000, Colorado courts have issued several opinions attempting to clarify this rule and Colorado’s “independent duty” approach to the economic loss rule.  For those attorneys that have the pleasure of litigating construction defect cases in Colorado, the determination of whether an independent duty exists, impacts the types of claims that the property owners can make against general contractors and/or subcontractors that performed work during construction.  This article offers a brief summary of some of these important decisions as they apply to commercial and residential construction defect litigation in Colorado.

II.            The Origins of the Economic Loss Rule

Though the origination of the economic loss rule stems from the field of products liability, the application of the economic loss rule has been expanded to a number of areas as its purpose is to maintain a distinction between contract and tort law.  See Town of Alma v. Azco Const., Inc., 10 P.3d 1256, 1264 (Colo. 2000).  The economic loss rule states that “a party suffering only economic loss from the breach of an express or implied contractual duty may not assert a tort claim for such a breach absent an independent duty of care under tort law.”  Id. at 1258.

Determining whether to remedy economic loss through tort or contract law is not always simple. A court must determine the “source” of the duty allegedly breached rather than the type of damages suffered.  Id. at 1262.  The key question is whether the duty allegedly breached arises from contract and warranty, or from an “independent duty” imposed by tort law.  Id.

Tort obligations generally arise from duties imposed by law regardless of any agreement or contract.  Id. Tort law is designed to protect all citizens from “damages other than physical harm to persons or property.”  Id.  Contract law, on the other hand, is intended to enforce the expectations of the parties to the contract created by promises made between the parties.  Id. at 1262.  Contract law protects the parties to the agreement, allowing them to allocate risks and costs and bargain freely.  Limiting the availability of tort remedies in light of an existing contract holds the parties to the terms of their bargain.  Id.

Since 2000, Colorado Courts’ decisions concerning economic loss claims have continued to evolve.  The below case analysis will assist practitioners in determining the types of economic loss claims that can be made in construction defect cases.

III.           Commercial Construction and the Economic Loss Rule

A. Town of Alma v. Azco Const., Inc. – Contractual Provisions and Duty of Care:

In Town of Alma v. Azco Construction, Inc., 10 P.3d 1256 (Colo. 2000),  plaintiffs (a municipality and individual landowners) contracted with the AZCO Construction, Inc. (“AZCO”) for the installation of a water distribution system.  When the water lines developed leaks, the plaintiffs sued, alleging negligence, breach of contract, and breach of implied warranty.  Id. at 1258.  Plaintiffs sought damages for the cost of repairs and replacement of the water lines that were the subject of the contract.  Id.  According to the Colorado Supreme Court, these types of damages were considered economic loss damages that must be supported by an independent duty of care to be recoverable in a negligence action.  Id. at 1264.  A review of the contractual provisions showed that AZCO expressly assumed the duty to guarantee its quality of workmanship and the materials when it undertook to install the water lines.  Id.  Because the contract specifically assigned ASCO a duty of care, plaintiffs could not claim that AZCO breached any duty outside of its contractual obligations.  See Id.  Thus, as there was no independent duty to support plaintiffs’ negligence claim, the Court ruled that plaintiffs’ claim was barred by the economic loss rule.  Id. at 1265.

Based on this analysis, the Court officially adopted the economic loss rule, holding that a party suffering only economic loss from the breach of an express or implied contractual duty could not assert a tort claim absent an independent duty of care under tort law.  The lesson construction defect litigators should learn from Town of Alma is that if the duties of the general contractor are spelled out in the contract terms, and a separate, independent duty does not exist, the plaintiffs cannot recover for damages in accordance with tort law.  Savvy practitioners should also advise their clients to pay close attention to the exact contractual duties to be spelled out in their construction agreements as a means of limiting their future potential liability.

Another hurdle in applying the economic loss rule that frequently arises in the construction defect context, is the sheer number of parties and additional complexities that arise based on the number of  third-party subcontractors with interrelated contracts.  In the next case discussed below, BRW, Inc. v. Dufficy & Sons, Inc., 99 P.3d 66 (Colo. 2004), the Colorado Supreme Court addressed how the economic loss and independent duty of care rules apply when interrelated contracts are involved.

B. BRW, Inc. v. Dufficy & Sons, Inc. – Interrelated Contracts, Contract Provisions, and Duty of Care

Four years after its ruling in Town of Alma, the Colorado Supreme Court applied the economic loss rule in the commercial construction context.  In BRW, Inc. v. Dufficy & Sons, Inc., 99 P.3d 66 (Colo. 2004), the City and County of Denver (“Denver”) contracted with BRW, Inc. (“BRW”), a licensed engineering firm, to provide engineering and design services related to the construction of two steel bridges.  Id. at 68.  Upon completion of these designs, Denver hired a general contractor, who subsequently hired an array of subcontractors to perform the fabrication, painting, and shipment of portions of the structural steel.  Id.  One of these subcontractors entered into a contract with Dufficy & Sons, Inc. (“Dufficy”) to perform this work.  Id.  BRW also hired Professional Service Industries, Inc. (“PSI”) to ensure the general contractor and subcontractors followed BRW’s designs and to inspect construction of the bridges.  Id.

Delays relating to the painting of the bridges resulted in increased costs to Dufficy, leading Dufficy to file suit against BRW and PSI for negligence and negligent misrepresentation relating to the painting specifications.  Id. at 69-70.  The Court determined that the economic loss rule barred Dufficy’s negligence and negligent misrepresentation claims because BRW and PSI’s interrelated contracts covered their duties for the project.  Id. at 74.  In reaching this conclusion, the Court formulated an extensive method for applying the economic loss rule.  Id.  First, the Court applied the holding in Town of Alma to determine whether or not the alleged duties breached arose in the contracts between the parties.  Id.   If a contractual duty does not exist, a Court should apply the facts and contract terms to the factors outlined in Taco Bell v. Lannon, 744 P.2d 43 (1987), to determine whether to impose an independent duty in tort.  Id.  These factors are as follows: (1) foreseeability of the risk of harm; (2) the gravity of the possible harm; and (3) the cost to implement reasonable measures to prevent the harm.  BRW at 74; See also Taco Bell at 49.  The Court also considered three additional factors: (1) whether the relief sought in negligence is the same as the contractual relief; (2) whether there is a recognized common law duty of care in negligence; and (3) whether the negligence duty differs in any way from the contractual duty.  BRW at 74.  The Court explained that if a duty of care is specified in a contract, “it follows that [a] plaintiff has not shown any duty independent of the interrelated contracts and the economic loss rule bars the tort claim and holds the parties to the contracts’ terms.”  Id. 

Based on this analysis, the Court held that BRW and PSI did not owe an independent duty of care to Dufficy because their duties were memorialized in their respective contracts.  Id.  This ruling also allows parties to contract around independent tort duties by incorporating them into the contract.  The lesson construction defect litigators should learn from this ruling is the same lesson taken from Town of Alma—if duties of care are covered by the terms of the contract, the Plaintiffs cannot recover for damages in accordance with tort law.  If a case involves involves multiple parties with interrelated contracts, it may prevent recovery for damages if the contract terms clearly state the duties owed by these parties. 

The Colorado Supreme Court’s decisions in Town of Alma and BRW, Inc. addressed how the economic loss and independent duty rules apply to cases involving commercial property owners.  But how are these rules applied to cases concerning residential homeowners?  In A.C. Excavating v. Yacht Club II Homeowners’ Assoc., the Court answered this question.

C. A.C. Excavating v. Yacht Club II Homeowners’ Ass’n – Residential Construction and an Independent Duty of Care:

In 2005, the Court distinguished its ruling in BRW by declining to apply the economic loss rule in the context of residential construction.   A.C. Excavating v. Yacht Club II Homeowners’ Ass’n, 114 P.3d 862, 864 (Colo. 2005).  In A.C. Excavating, a homeowners’ association (“HOA”) brought claims on behalf of its unit owners for the repair of numerous construction defects.  The HOA asserted contract, warranty, Colorado Consumer Protection Act, and negligence claims against the developer and general contractor – all of which were settled before trial.  Id. at 864.  The HOA also asserted negligence claims against various subcontractors that performed work during construction of the townhomes.  Id.

The trial court granted partial summary judgment to the subcontractors, ruling that the association’s negligence claim was barred by the economic loss rule because the subcontractors’ duties of care arose entirely out of the interrelated contracts between the subcontractors, developer, and general contractor.  Id.  The Colorado Appeals Court reversed, holding that the economic loss rule did not apply because the subcontractors owed an independent duty of care in the construction of single-family residential homes, notwithstanding the existence of similar duties set forth in the contracts.  Id.  The Court agreed with the Appellate Courts’ reasoning that “subcontractors owe homeowners a duty of care, independent of any contractual obligations, to act without negligence in the construction of a home,” and affirmed the Appellate Courts’ ruling.  Id.

In reaching its decision, the Court cited the 1983 case Cosmopolitan Homes, Inc. v. Weller,  663 P.2d 1041 (Colo. 1983).  See A.C. Excavating, 865-66.  In Cosmopolitan Homes, the Court permitted subsequent purchasers of a home to bring negligence claims to recover economic losses, after determining that a builder’s obligation “to act without negligence in the construction of a home is independent of contractual allegations such as an implied warranty of habitability.” Cosmopolitan Homes at 1042.  This duty is based on the view that unsophisticated homebuyers cannot adequately protect themselves from economic loss through their contractual dealings with sophisticated construction professionals.  Id. at 1045. The Court held that negligence law “requires that a builder or contractor be held to a standard of reasonable care” with respect to “workmanship, supervision, or design.”  Id. at 1044-45.

The Court’s decision in A.C. Excavating and Cosmopolitan Homes, Inc. recognized that contractors and subcontractors have an independent duty of care to homeowners, separate and distinct from the economic loss duty.  These cases highlight that residential homeowners can, and do, recover damages against contractors and subcontractors via independent duty of care claims.  However, these cases did not establish whether a subsequent titleholder could bring these same claims.  The recent 2013 decision in Mid Valley Real Estate Solutions by the Colorado Court of Appeals examined this issue.

D. Mid Valley Real Estate Solutions V, LLC v. Hepworth-Pawlak Geotechnical, Inc. – Subsequent Titleholders and the Application of the Economic Loss Rule

In Mid Valley Real Estate Solutions V, LLC v. Hepworth-Pawlak Geotechnical, Inc., No. 13CA0519, 2013 WL 3943215 (Colo. Ct. App. Aug. 1, 2013),  a developer (unnamed), entered into a written contract with a geotechnical engineering firm, Hepworth-Pawlak (the defendant), to analyze the soil on which houses would be built for resale.  Id. at *1.  The general contractor then entered into an oral agreement with structural engineers to provide designs for construction.  Id.

After completing construction of the house, the developer was unable to sell the home and defaulted on its construction loan.  Id.  To avoid foreclosure, the developer and the bank entered into an agreement, which included transferring the title of the home to Mid Valley (the plaintiff) for resale.  Id.  Soon after Mid Valley took title of the home, significant structural damage began to appear.  Id. at *2.  Mid Valley sued Hepworth-Pawlak for negligence in failing to identify expansive soils and specify an appropriate foundation.  Id.   After consulting the previous rulings of Cosmopolitan Homes, Inc. and A.C. Excavating, the Appellate Court determined that, allowing Hepworth-Pawlak to avoid liability because Mid Valley was not a traditional homeowner would afford Hepworth-Pawlak a windfall from the fortuity that the latent defects caused damage before Mid Valley could sell the house.   Id. at *4.  Therefore, the independent duty of residential construction professionals can be enforced by any transferee of a home who is in title when the latent defects cause damage to the home.    Id.

The ruling in Mid Valley establishes that the owners’ relationship to the titleholder (Mid Valley in this case) does not prevent it from bringing independent duty claims against the general contractor.  Id.  This ruling also indicates that Colorado Courts are open to broadening the category of who can recover for damages through independent duty claims in construction defect cases. 

IV. Conclusion

Since the 2000 case of Town of Alma, Colorado courts have continued to expand on the application of the economic loss and independent duty of care rules as they are applied to construction defect cases.  Commercial construction owners can bring claims against both general contractors and the subcontractors that performed work on the project due to the interrelated contract terms. However, Colorado courts appear to be standing firm on their ruling that commercial construction plaintiffs cannot recover under the independent duty of care rule.

In cases involving residential homeowners, Colorado courts have determined that general contractors and subcontractors owe an independent duty of care to homeowners.  This independent duty is separate and distinct from the duty outlined in the economic loss rule.  The establishment of the independent duty of care allows residential homeowners and even subsequent titleholders to recover for damages separate to those recoverable under the contract.

How the economic loss rule and the independent duty of care rule can be applied in construction defects cases is likely to continue to evolve in Colorado.  The decisions made by the Colorado Courts Town of Alma, A.C. Excavating, BRW, and Mid Valley illustrate the belief that general contractors and subcontractors cannot, and should not, avoid responsibility for deficient work performed for residential and commercial owners.  However, the question remains that if parties are free to contract, does this not allow parties to contract around the independent tort liability?  This question is just one of many that is likely to be addressed by Colorado courts in the future.  Construction defect litigators should be aware that the application of the above-summarized case law is ever changing and the distinction between contract and tort claims continue to be blurred, at least in Colorado.

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