The economic loss doctrine has long stood for the proposition that one cannot recover purely economic damages (i.e., harm without property damage and/or personal injury) in tort, generally leaving the potential for recovery of economic losses available only to those in privity of contract. In the construction context — with many extracontractual parties involved in work that necessarily implicates the others— the economic loss doctrine can present serious hurdles to a harmed party’s recovery of damages actually incurred.
As a case in point, design professionals commonly contract directly with only the owner of a project, but issue reports, plans, and specifications that are for the purpose of, and must be relied upon by, other parties for the performance of their work on the project. If purely economic losses result from delays to the construction schedule or costs to repair or replace work as a result of design deficiencies, these impacted parties have limited recourse against the design professional under traditional applications of the economic loss doctrine.
As a result, various jurisdictions continue to struggle with the question of whether third parties may sue design professionals for purely economic loss, resulting in inconsistent applications of the doctrine.
This article discusses the different approaches taken by New York and California in applying the economic loss doctrine with regard to damages resulting from services provided by design professionals on a construction project.
While New York generally prohibits tort claims seeking to recover economic damages against design professionals without personal injury or property damage, two limited exceptions may apply: (1) where the functional equivalent of privity of contract exists, or (2) where violations of a professional duty to the public could result in catastrophic consequences.
The Functional Equivalent of Privity of Contract
In Ossining Union Free School District v. Anderson LaRocca Anderson, 73 N.Y.2d 417 (1989), the Court of Appeals (the highest court in the State of New York) explained that, even without contractual privity, New York law permits a third-party’s negligence and misrepresentation claims against a design professional if the relationship creates a “bond between them so close as to be the functional equivalent of contractual privity.” Id. at 419. In holding that an engineering consultant could be held liable for economic losses without contractual privity, the court explained that the functional equivalent of privity exists if the following criteria is met: “(1) awareness that the [engineer’s] reports were to be used for a particular purpose or purposes; (2) reliance by a known party or parties in furtherance of that purpose; and (3) some conduct by the defendants linking them to the party or parties and evincing defendant’s understanding of [the plaintiff’s] reliance” on the engineer’s reports. Id. at 425 (citation omitted).
Violations of a Professional Duty to the Public Resulting in Catastrophic Consequences
A recent decision potentially expands New York design professionals’ liability in tort, although the full impact of the decision remains to be seen. In Dormitory Authority of State of New York v. Samson Construction Co., 27 N.Y.S.3d 114 (N.Y. App. Div. 2016), the First Department Appellate Division (an intermediate court) held that an architect can be liable for pure economic loss when violations of a professional duty to the public result in “catastrophic consequences.” In that case, the Dormitory Authority of the State of New York (DASNY) hired an architect to design a forensic biology laboratory for New York City. After the foundation contractor began driving piles for the project, surrounding structures sustained damage, including an adjacent building that settled as much as eight inches. Based on the architect’s alleged failure to conduct an adequate site investigation and provide an adequate foundation design, DASNY sued the architect for breach of contract and negligence for failure to exercise due care.
The court held that DASNY could proceed with its negligence claim against the architect. While acknowledging that if DASNY were “merely seeking the benefit of its agreement, it is limited to a contract claim,” the court found that the design professional could also be subject to tort liability because “the particular project … is so affected with the public interest that the failure to perform competently can have catastrophic consequences.” Id. at 116–17 (quotations omitted). In denying DASNY’s motion for summary judgment, the court found it a question of fact as to whether the destruction of road beds, sidewalks, sewers, and water pipes near a major medical center in a crowded city “could lead to catastrophic consequences.” Id. at 117.
The court then summarily disposed of the design professional’s argument that allowing liability in tort would violate the economic loss doctrine, stating without further explanation that “the ‘economic loss’ doctrine does not apply to negligence claims arising out of a violation of a professional duty.” Id. at 118. The court did not address whether the existence of privity between the parties (which was present in this case) was essential to its reasoning. It therefore remains unclear what effect, if any, Dormitory Authority will have on New York’s approach to the economic loss doctrine with regard to tort claims against design professionals.
Similar to New York, California has created narrow exceptions to the economic loss doctrine as applicable to design professionals, requiring the evaluation of various factors that might permit a third party to pursue negligence claims for purely economic losses.
The Residential Construction Exception
In Beacon Residential Community Ass’n v. Skidmore, Ownings & Merrill LLP, 59 Cal.4th 568 (2014), the California Supreme Court held that the “principal architects” of condominium units (defined as those not subordinate to other design professionals) have a duty of care to subsequent purchasers of those units and can therefore be sued for negligent design deficiencies without privity of contract between the architects and the unit owners. Id. at 581.
In refusing to permit the architects to rely on a lack of privity defense, the court noted that “[t]he declining significance of privity has found its way into construction law.” Whether in a specific case a defendant can or cannot be held liable to a third party is a matter of policy and requires the balancing of certain factors, which the court had previously articulated in Biakanja v. Irving, 49 Cal.2d 647 (1958):
- The extent to which the transaction was intended to affect the plaintiff;
- The foreseeability of harm to him;
- The degree of certainty that the plaintiff suffered injury;
- The closeness of the connection between the defendant's conduct and the injury suffered;
- The moral blame attached to the defendant's conduct; and
- The policy of preventing future harm.
Id. at 574 (quoting Biakanja at 650). The Beacon court did not address the issues of the manner of harm suffered or the applicability of the economic loss doctrine thereto, but that case has since been interpreted to stand for the proposition that some tort actions for purely economic losses may be permitted against design professionals in California.
Potential Expansion of Beacon Beyond the Residential Context
Relying on Beacon and the Biakanja factors, the U.S. District Court for the Northern District of California held that an engineering company could be held liable for professional negligence for purely economic loss on an infrastructure project. Apex Directional Drilling, LLC v. SHN Consulting Engineers & Geologists, Inc., 119 F.Supp.3d 1117 (N.D. Cal. 2015).
In Apex, a contractor sued the lead engineer and project manager on a municipal sewage construction project for breach of professional duty, negligent misrepresentation, and tort of another. The contractor had relied on the lead engineer’s geotechnical report to bid and then install a new wastewater pipeline. Subterranean conditions differing from those indicated in the report caused the contractor to lose equipment and sustain unexpected costs.
Interpreting Beacon to apply beyond the residential context, the court held that, when the Biakanja factors have been met, a contractor performing work on a municipal project could pursue a negligence claim against a design professional for purely economic loss.
No California state court has yet weighed in on the district court’s interpretation of Beacon as applied in Apex.
As demonstrated by recent decisions in New York and California, application of the economic loss doctrine in the construction industry – and especially with regard to design professionals – is fluid and constantly evolving. Practitioners and clients are advised to familiarize themselves with the recent decisions in their jurisdictions so as not to be caught flat-footed when extracontractual disputes among the various project participants may arise.