By W. Robert Vezina, III & Megan S. Reynolds
Vezina, Lawrence & Piscitelli, P.A.

The Economic Loss Rule is Now Dead to Contracting Parties — Does a Contract Still Mean Anything?

The commercial contracting arena is in a stir based on a recent Florida Supreme Court decision that eliminated the application of a doctrine known as the “economic loss rule” in actions involving contracts. Tiara Condominium Association v. Marsh & McLennan Companies
1prompted a flurry of e-mails and articles warning that the decision will result in increased litigation or, worse, allows contracting parties to bring negligence claims against one another for economic losses and thereby circumvent the allocation of risks set forth in the contract.

Notably, the chief justice of the supreme court, writing in dissent, declares that “Florida’s contract law is seriously undermined” by Tiara.2 In his view, the elimination of the economic loss rule greatly expands what tort claims and remedies are available regardless of a contract. Stated differently, “[n]ow, there are tort claims and remedies available to contracting parties in addition to the contractual remedies which, because of the economic loss rule, were previously the only remedies available.”3

But it is not entirely clear that Tiara will have this effect. One justice maintains in her concurring opinion that the decision does not alter what claims can be pursued when a contract exists, nor does it weaken the terms contracting parties bargain for.4 Under this view, the same contract law principles that have been in place for decades should still protect contracting parties under most circumstances. Those principles should ensure that the risk allocation parties negotiated cannot be bypassed when the conduct complained of is really an alleged breach of the contract. It remains to be seen, however, whether these principles will offer sufficient protection in practice.

This article presents a discussion of those contract law principles, the protections they do and do not offer, and examples of their application.

The Law Tries to Protect Economic Expectations

A contractor contracts with a public owner to widen an existing roadway. Just before final striping, the owner discovers what it believes is a defect in the structural asphalt. The contractor contends, and the surety agrees, that no defect exists and refuses to mill and repave. The owner declares the contractor in default and sues the contractor for breach of contract and negligence, both based on an allegation of defective work.

Before Tiara, the economic loss rule would have barred the negligence claim. After Tiara, contract law principles should still bar the negligence claim, as there is no “independent tort” alleged – that is, the alleged negligent conduct (defective work) is the same conduct that constitutes the alleged breach of contract.

To understand why the elimination of the economic loss rule in the contract context theoretically should not do away with bargained-for protections, a brief explanation of contract law, tort law, and the economic loss rule is in order. Contract law, which includes warranty law, is based how parties agree to allocate financial risk before they do business, such as agreeing to liability limitations and what remedies will be available if a party breaches the contract. Put differently, contract law is based on protecting parties’ economic expectations. In contrast, tort law, which includes negligence, is based on every person’s duty to act reasonably so as not to injure other persons or damage property.

The economic loss rule was developed by courts to protect economic expectations where the only injury is economic loss (such as repair or replacement costs or lost profits). In the products liability context, the rule was intended to limit a manufacturer’s liability for a defective product to the terms of the product’s warranty, as long as the product did not cause any personal injury or property damage.

For example, if a contractor purchased a new asphalt plant and that plant malfunctioned, the company’s only avenue to recover costs of repair or replacement was through warranty. If the faulty plant started an electrical fire and damaged the company’s adjacent shop facility, however, the company might have a cause of action in tort, as the defective plant damaged property other than the plant itself and the plant’s warranty likely would not cover the shop damage. The Tiara decision did not change the economic loss rule’s application to products liability cases, and plaintiffs seeking damages outside of warranty for a defective product still must prove injury to a person or other property.

With the same goal of protecting economic expectations, courts eventually extended the economic loss rule’s application to the contract context. There, the rule prevented contracting parties from circumventing their bargained-for risk allocation – in other words, the rule prevented parties from suing in tort to get around the contract and seek a better bargain.

For example, if a contract for construction of a $5 million apartment building limited the builder’s liability to $1 million and the builder never completed the job, the economic loss rule barred the owner from using a negligence claim to recover damages over $1 million. Similarly, if the same contract prohibited consequential damages (such as lost profits), the economic loss rule barred the owner from using a negligence claim to recover the lost rental income.

Although the Florida Supreme Court initially approved applying the economic loss rule in the contract context, over the years the court voiced concerns that courts of all levels were applying the rule too expansively. Finally, in Tiara the court altogether did away with the economic loss rule’s application to disputes between contracting parties.

In theory, Tiara’s holding should not mean that contracting parties are now free to sue each other for negligent performance of contractual obligations. The economic loss rule was a fairly straightforward rule for courts to apply when a contracting party brought a tort claim. But the logic behind respecting bargained-for risk allocation and remedies still holds in contract.

Regardless of the economic loss rule, as one justice noted, “[b]asic common law principles already restrict the remedies available to parties who have specifically negotiated for those remedies . . . .”5 This means that other than under the exceptions described below, contract law should still prohibit contracting parties from seeking a better bargain by suing in tort. On the other hand, those same principles often require courts to conduct a more in-depth, subjective analysis, which may result in inconsistent application of the principles and less protection for contracting parties than contract law intends.

Exceptions to Contractual Protections

As the economic loss rule evolved, courts created several exceptions to its application. Those same exceptions still apply to lawsuits between contracting parties: just like the economic loss rule, contract law includes exceptions for independent torts, professional malpractice, and freestanding statutory causes of action.

Independent torts

The primary exception to the prohibition on contracting parties bringing claims outside of contract is the “independent tort” exception, which allows tort claims based on conduct that is independent of performance of the contract.

A contractor contracts to build a parking lot for a convention center building. During construction, the contractor negligently causes a fire that damages a portion of the building. The convention center owner sues the contractor for negligence to recover costs of repair.

Here, the negligence claim is not barred by contract law, as the basis for the claim is conduct that is distinct from and unrelated to performance of the contract – an independent tort. A less clear-cut scenario arises with a tort like fraud in the inducement or negligent misrepresentation.

On the same project as above, when submitting its bid the contractor uses a quote from an asphalt paving sub that claims to have 10 years of comparable paving experience and be financially stable. The contractor is awarded the contract. When the sub begins to perform, the contractor discovers that the sub in fact has no large-scale paving experience and improperly placed the asphalt, requiring the sub to mill and repave. Additionally, partway through completing its scope of work the sub fails to show up on the project and shuts down its business. The contractor learns that the sub has been in financial trouble since well before submitting its quote. The contractor is forced to hire a replacement paving sub to complete the work at a higher price.

In addition to a breach of contract claim, the contractor here has a claim for fraud in the inducement – but only as to the subcontractor’s fraudulent statements about its finances. Fraud in the inducement occurs where one party’s fraudulent behavior or statements during the contract negotiation process undermines the other party’s ability to negotiate fair contract terms and make an informed decision.

Whether this type of fraud falls under the independent tort exception mainly depends on whether the fraudulent statement ultimately relates to performance of the contract. Here, although the subcontractor made both the statement about its finances and the statement about its experience to convince the contractor to enter a contract, the statement about the subcontractor’s experience relates to, or is “interwoven with,” performance of the contract. Therefore, making that statement – no matter how fraudulent it is – is not a tort that is independent of the contract. The statement about the finances is an independent tort, however, and that claim is barred by contract law.

Further clouding the independent tort exception is one significant catch: even a fraudulent statement or misrepresentation unrelated to contract performance is barred if the contract contains an “integration,” or “merger,” clause, which is a clause providing that the written contract supersedes all prior agreements or understandings.

Professional Negligence

Another exception exists for claims for professional negligence, or malpractice, such as claims brought against a professional engineer or architect.

A contractor and an engineer enter a contract for a design-build bridge project. During construction, it becomes clear that the bridge design is defective and requires extensive redesign. The contractor incurs additional costs in constructing the new design. The contractor brings claims against the engineer for both breach of contract and professional negligence based on the defective design.

The contractor’s professional negligence claim is not barred by contract law. Florida law has long allowed malpractice claims against individual professionals and professional service corporations, such as engineering firms, even where the parties have a contract. The exception was created because professionals (whom the law defines as those persons with a vocation requiring at least a four-year college degree before a license can be obtained) have a duty to perform the requested services in accordance with the standard of care used by similar professionals in the community under similar circumstances.

This duty is distinct from the duty of one who provides manual services or delivers a product, as a professional’s duty arises not from a contract, but from public policy and statute. Courts have held that a professional’s duty cannot be abrogated, even by contract. Accordingly, the existence of a contract does not eliminate the professional’s duty and does not bar a professional negligence claim.

Free-Standing Statutory Causes of Action

Finally, an exception exists for free-standing statutory causes of action. For example, the Florida Legislature created a cause of action for violation of the State Minimum Building Codes. The Florida Supreme Court declared this cause of action to be an exception to the economic loss rule, mainly because courts do not have the power to override rights and remedies granted by the legislature. The same court has recognized exceptions for intentional torts arising from violation of a statute, such as civil theft and conversion, as those torts require proof of intent, which is not a factor in contract performance. Although courts have applied this exception somewhat inconsistently over the years, the Tiara court clarified that exceptions for free-standing statutory causes of action still apply to cases involving a contract.6

Contract Provisions Limiting Liability and Available Damages

An important consideration after Tiara is how contract law treats contract provisions purporting to apply to noncontract-based claims that fall under one of the above exceptions – particularly those provisions limiting liability and available damages.

For example, take the convention center scenario mentioned above and add a consequential damages waiver to the parties’ contract:

A contractor contracts to build a parking lot for a convention center building. The contract includes a consequential damages waiver. During construction, the contractor negligently causes a fire that damages a portion of the building and causes scheduled conventions to be cancelled. The convention center owner sues the contractor for negligence to recover for the lost business.

Here, the owner’s negligence claim arises from an independent tort and is not barred by contract law. The consequential damages waiver likely would be enforceable against a breach of contract claim. But what about as to the negligence claim – may the owner recover consequential damages in negligence for the lost business?

The answer is “maybe.” The basis for the exceptions described above lies outside any contract, and therefore a contract’s terms generally will not apply to a cause of action brought under one of those exceptions. Parties do not have the power to contract around public policy (which controls professional negligence and intentional torts) or statutorily created duties. A carefully worded contract, however, might be able to limit liability for an independent, non-intentional tort such as inadvertently causing a fire in the convention center building.

Conclusion

In theory, the Tiara decision should not change the outcome of disputes between contracting parties. The risk allocation that parties negotiate should still be protected by common law contract principles that prevent a party from getting around the contract and obtaining a better bargain by suing in tort. But in practice will contract law provide the same protections provided by the economic loss rule? The Florida Supreme Court is not of a single mind on the answer to this question, and we will see if the majority decision in Tiara “greatly expands the use of tort law at a cost to Florida’s contract law” or “does nothing to alter [the] common law concepts” that have existed in contract law for years.

Rob Vezina is the managing shareholder of Vezina, Lawrence & Piscitelli, P.A., Tallahassee and Ft. Lauderdale, practicing in the fields of construction and public contracts law. He received his law degree from Duke University and has for many years served as general counsel to the FTBA.

Megan Reynolds is a senior associate in the firm’s Tallahassee office and likewise practices construction and public contracts law. She received her law degree from Florida State University, where she served as editor in chief of the FSU Law Review.

1— So. 3d –, No. SC10-1022, 2013 WL 828003 (Fla. 2013).

2Id. at 11 (Polston, C.J., dissenting). Chief Justice Polston took great issue with the majority’s decision, asserting that the majority acted without justification. Id.

3Id.

4See generally id. at *8-10 (Pariente, J., concurring). Justice Pariente also felt that, contrary to the dissenting views, the majority’s decision was fully consistent with the development of previous law on the economic loss rule. See id. at *8.

5As observed by Justice Pariente. Id. at *9.

6See id. at *6-7 (The Tiara opinion acknowledged that an exception for free-standing statutory causes of action was reaffirmed in Indemnity Insurance Co. of North America v. American Aviation, Inc., 891 So. 2d 532, 543 (Fla. 2004), a decision that is still good law except to the extent the decision considered the economic loss rule to apply to contract cases.) (majority op.).

7As set forth by Chief Justice Polston in his dissent. Id. at *11 (Polston, C.J., dissenting).

8As maintained by Justice Pariente in her concurrence. Id. at *9 (Pariente, J., concurring).