In states that adhere to the ELD, design professionals have a strong defense against third-party claims for economic damages. Know the law in your project state.
Law books are full of various “doctrines” that have been created and accepted by the courts over the years. One that applies most often to design professionals is known as the Economic Loss Doctrine, or ELD. In states that have adopted the ELD, it stands generally for the proposition that a party seeking purely “economic damages,” as opposed to personal injury, death or property damages, must seek relief through contract remedies in order to recover, and the injured party cannot sue in “tort.”
For example, under the ELD, a contractor who suffers delay costs due to a design error cannot sue the architect directly (because those two have no direct contract). Instead, the contractor must pursue the owner under their contract, and the owner may have a contract claim back against the architect. If there is personal injury or property damage, however – as in an auto accident or slip and fall – there is no need for a contract between the parties. Tort law applies to those “non-economic” claims and allows a suit for damages regardless of any contract.
The intent of this rule is to protect the parties’ expectations when they negotiate contracts in commercial transactions. So, for example, a design professional may negotiate a lower fee in exchange for a limitation of liability with the project owner, or provide some contingency for anticipated design errors or omissions. Lawyers call this the “benefit of the bargain.” It would seem unfair, then, if a contractor could bypass those bargained-for limitations and sue the architect for unlimited liability. Courts talk of people who “are in privity of contract” when referring to parties who have a written contract. The ELD bars those “not in privity” from suing in tort (i.e. negligence) for purely economic losses. But, as with most legal doctrines, there are exceptions to the rule, and contractors and subcontractors have found ways to avoid the ELD in some states.
Early roots. The ELD traces its roots to a 1986 U.S. Supreme Court case, East River S.S. Corp. v. Transamerica Delaval, Inc. This was not a construction case, but a dispute involving charterers of supertankers who sued a turbine manufacturer for damages resulting from alleged design and manufacturing defects which caused the supertankers to malfunction on the high seas. Nobody was injured, and the turbines did not damage anyone’s property. The only damages sought were “economic,” i.e. the cost of repairing the ships and the income lost while they were out of service.
The trial court ruled for the manufacturer, which was affirmed by the U.S. Supreme Court. In that case, the court said, “loss due to repair costs, decreased value, and lost profits is essentially the failure of the purchaser to receive the benefit of its bargain – traditionally the core concern of contract law.” Over time, the ELD was raised as a defense by design professionals, mostly in suits by contractors and subcontractors who claimed they suffered added labor and material costs, overhead expenses or lost profits due to design errors and delays. Courts across the nation have either accepted the ELD whole cloth, without exceptions, or rejected it, or created exceptions.
Exceptions to the rule. The most commonly raised exception is known as “negligent misrepresentation.” Courts cite to the Section 552 of the Restatement (Second) of Tort, which states that when a person (or entity) who, in the course of his business, profession or employment, or in any other transaction in which he has a pecuniary interest, “supplies false information for the guidance of others in their business transactions,” that person is subject to liability to those whose “justifiable reliance upon the information” results in economic loss due to the defendant’s failure to exercise reasonable care or competence in obtaining or communicating the information.
This stops short of “fraud” or “fraudulent misrepresentation,” and only requires a showing that the plaintiff “justifiably relied” on the information which was negligently provided. Contractors who bid on plans and specifications argue that they fit into this exception in relying on the information provided to them, albeit indirectly, by the project designer.
A Georgia court ruled in 2017 that Section 552 created an exception in the ELD in a case against an environmental consulting firm. A 2016 Kentucky case similarly found that the economic loss doctrine “does not apply to a claim of negligent misrepresentation in the architect/contractor scenario.”
Firm rulings. By contrast, the Maryland Supreme Court adopted the ELD in 2017 in a case involving a contractor’s suit against an engineering firm. The court said, “The economic loss doctrine represents a judicial refusal to extend tort liability to negligence that causes purely economic harm in the absence of privity, physical injury, or risk of physical injury.”
In a 2017 Florida case, a hospital hired a geotechnical engineer to do a soil study. The construction manager hired a sub to perform cast auger piles. After the building foundation settled, work was stopped. The hospital sued the geotechnical engineer, and the engineer sued the pile sub (no “privity” of contract between them). The sub raised the ELD as its defense and the court agreed, finding the sub owed no duty to the engineering firm for pure economic losses.
In a 2017 Oklahoma case, a paint manufacturer was sued by a contractor when the coating system blistered and required repairs. Citing to the 1986 U.S. Supreme Court case of East River S.S. Corp, the court agreed that there was no liability in tort for pure economic losses; however, the court allowed a claim for breach of warranty to remain.
In a 2016 Texas case, a contractor sued an architectural firm for negligence, and won at trial. However, the Texas Court of Appeals reversed based on the ELD. In this case, however, there was an actual contract between the contractor and architect, yet the suit was for “negligence,” not breach of contract. The court said, “Texas courts have long adhered to the economic loss doctrine, which precludes the recovery of purely economic damages that are unaccompanied by injury to the plaintiff or its property in actions for negligence.”
Finally, in a 2015 Texas case, an engineering firm had limited its liability with a design-build contractor through a contractual provision. The court said, “Holding [engineer] liable to [the owner] through a separate tort action would judicially renegotiate the private risk allocations to which the parties contractually bound themselves.”
What to watch for. In states that adhere to the ELD, design professionals have a strong defense against third-party claims for economic damages. Watch for clauses that make others “third-party beneficiaries” of your contract, as that can void the ELD defense. Also, be aware of those states that do not follow the ELD or which carve out exceptions. Know the law in your project state and, if you have questions, talk to a lawyer before signing up for work there to see if the ELD is upheld, rejected, or has exceptions.
G. William Quatman, Esq., is general counsel and senior vice president at Burns & McDonnell Engineering Co. He can be reached at firstname.lastname@example.org.