Very few esoteric legal doctrines have more of a significant impact on the construction industry than the economic loss rule. In a nutshell, the rule stands for the proposition that a party cannot sue another party for purely economic losses, such as lost profits, if no contract between them exists. This is different than saying a party may sue another party for losses occasioned by property damage or bodily injury, in which case, a contract is likely irrelevant.
The impact of the economic loss rule becomes appreciable if you are a design professional facing faulty design allegations from a contractor that lost profits stemming from such allegations. If the design professional solely contracted with the owner, then the contractor will have a difficult time making a direct claim against the design professional.
This was the rule in Washington state until a decision by the Washington State Supreme Court seemingly put it in jeopardy, potentially exposing the construction industry to new risks in the process.
The Supreme Court decision came during a case involving the Seattle Monorail. The facts of the case are common in the construction industry. An engineering firm had a monorail maintenance contract with the owner. The monorail operator, distinct from the owner, brought a negligence claim against the engineering firm for a faulty grounding system design, which allegedly caused a fire. The operator sought the losses it incurred as a result of business interruptions, which is purely economic and not based on property damage or bodily injury. The engineering firm argued that the operator could not bring the claim under the economic loss rule because the operator and engineering firm maintained no direct contract. However, the Supreme Court was not concerned about whether a contract existed. Instead, the court examined whether the engineering firm owed a measurable duty of care toward the operator and whether the scope of that duty extended to a party that had no contractual relationship with the firm. Its analysis created what is called the “independent duty doctrine.”
The court basically applied negligence principles that are found in property damage and bodily injury cases to contract-based losses. Before this case, courts recognized parties allocate risks and remedies for purely economic losses in their contract. If no contract exists, then there is usually no claim. By imposing its new “independent duty doctrine,” the Supreme Court may have opened the door for additional claims and claimants alleging lost profits or other contract-based losses regardless of whether a contract existed between the parties.
Interestingly, although a majority of the court agreed with the outcome in the monorail case, they agreed on different bases. Thus, the precedential value of the case is debatable. In fact, Justice Madsen, in a concurring/dissenting opinion, was troubled with how the court disregarded the economic loss rule in favor of the new doctrine.
The state of the law raises serious questions. Suppose a contract contains a provision that limits damages as many in the construction industry do, such as a waiver of consequential damages. Does the current legal climate now allow a claimant to disregard limitation provisions if it can succeed on negligence claims? What force will limitation provisions now have against claimants that have no contract with a defendant, but show that a duty is owed under the new doctrine? It is safe to assume that indemnity clauses and insurance policies may look slightly different to account for the “independent duty doctrine” and construction industry participants should now examine how their contracts insulate them from third-party claims and negligence claims for purely economic losses.
Joaquin Hernandez is an attorney at the Seattle office of Schwabe, Williamson & Wyatt, P.C. He focuses his practice on counseling corporate, partnership, and individual clients on governmental matters and can be reached at email@example.com.