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Where Contractor’s insurance carrier brought a subrogation action against the project’s design professional for negligent performance, including failure to prepare contract drawings and specifications in a manner “fully coordinated for bidding by the various contractors” as required in the design professional’s scope of service, it was held that the insurer had no third-party beneficiary rights under the contract between the contractor and design professional, and it was also held that the economic loss doctrine barred recovery for alleged negligent performance, and that the sole exception to the doctrine for “negligent misrepresentation” claims had not been proven because no special relationship between the contractor and designer existed.  Travelers Casualty v. Dormitory Authority-State of New York, 734 F. Supp.2d 368 (U.S. Dist Ct., NY, 2010).

This case arose out a series of complex litigation cases involving a 785,000 square foot vertical campus for part of the City University of New York (“CUNY”).  As a result of delays, problems, and deficiencies, the dormitory authority issued dozens of change orders to extend the time for work and provide extra compensation to various contractors.  This did not adequately satisfy all the costs claimed, and litigation ensued.  Travelers filed suit against the design professional and construction manager for negligence and breach of contract.  The essence of the negligence claim was that the defendants owed a “duty of care to [Contractor] and or [Contractor’s subcontractors/suppliers” either “based on those contractors’ “status as third-party beneficiaries” of the Owner-design professional contracts, or alternatively “as a result of the functional equivalent of privity existing” among the parties.

An expert witness report by Travelers concluding that the bidding documents were “not thoroughly checked for accuracy” and were “not fully coordinated for bidding,” and that the designer’s failure to provide clear, coordinated and unambiguous bid documents caused numerous RFI’s, change orders and delays on the project.  The expert also stated that the designer “failed to provide timely interpretations of its Contract Documents and design” thereby causing delays, and that “the abilities of [Contractor] to perform their contractual scopes of work were unreasonably and chronically hindered by the style and substance of KPF’s professional services.”

Travelers argued that the contractor was an intended beneficiary of the DP-Dormitory Authority contract and entitled to enforce its terms by recovering damages directly against the designer.  In holding that Travelers claim must be dismissed, the court stated that the contract between the designer and Authority “in no way suggests that the purpose of those contractual provisions was to confer a benefit upon [Contractor] as opposed to giving [Contractor] that which was ‘necessary to assist it in its own performance.”  The court explained that “It is ancient law in New York that to succeed on a third party beneficiary theory, a non-party must be the intended beneficiary of the contract, not an incidental beneficiary to whom no duty is owed.”

On the Travelers claim to recover the contractor’s economic losses from the designer on a negligence theory, the designer moved for summary judgment on the basis that New York’s “economic loss doctrine” prevents recovery of pecuniary damages in the absence of contractual privity or proof of a special duty of care owed by the designer to the contractor.  The designer also argued that sole exception to the economic loss doctrine in New York for negligent misrepresentation under a “functional equivalent of privity” theory was not applicable under the circumstances.  In granting summary judgment for the designer (and also the construction manager), the court stated “New York’s economic loss doctrine is a jurisprudential principle that a plaintiff cannot recover in tort for purely economic losses caused by the defendant’s negligence.”  Under this principle, says the court, “the defendant is not liable to a plaintiff for the latter’s economic loss unless there exists ‘a special relationship that requires the defendant to protect against the risk of harm to plaintiff.”  The court found no such special relationship in this case and therefore enforced the economic loss doctrine to bar the claim.

The decision of the court so nicely presents the rationale for the economic loss doctrine that it seems worthy of quoting from the decision at length as follows:

This principle is justified on several grounds. First, to the extent that a plaintiff claiming economic damages is seeking to recover the loss of an expectancy interest created by contract in the first instance, the doctrine channels the dispute into a breach-of-contract action, in keeping with the nature of the interest that the plaintiff claims has been damaged. “[C]ourts have applied the economic loss rule to prevent the recovery of damages that are inappropriate because they actually lie in the nature of breach of contract as opposed to tort.” [citation omitted].

Second, to the extent that “economic loss” is difficult to quantify, but also a highly foreseeable outcome of negligence in the commercial context, the economic loss doctrine reflects a policy interest in protecting defendants from disproportionate, and potentially limitless, liability. “[R]elying solely on foreseeability to define the extent of liability in cases involving economic loss, while generally effective, could result in some instances in liability so great that, as a matter of policy, courts would be reluctant to impose it.” [citation omitted]. As a result, to avoid “crushing exposure” to suits by countless parties who have suffered economic loss, New York courts have concluded that “[a]bsent a duty running directly to the injured person there can be no liability in damages, however careless the conduct or foreseeable the harm.” [citation omitted].

The decision of the court also provides six pages of analysis regarding the limited exception to the economic loss doctrine for negligent misrepresentation, and in particular what is required to prove a relationship between the parties so close as to approach that of privity of contract.

Comment: The court’s decision provides an excellent analysis of the law concerning the economic loss doctrine, as well as a persuasive rationale for the doctrine and the public policy benefits derived from it.  In addition, the six pages of the opinion explaining the limited exception to the economic loss doctrine for negligent misrepresentation, and in particular what is required to prove a relationship between the parties so close as to approach that of privity of contract is commended reading, especially for any one involved in arguing a case against a plaintiff that is trying to get around the economic loss doctrine by pleading counts of “misrepresentation”.

About the author: Article written by J. Kent Holland, Jr.,  a construction lawyer located in Tysons Corner, Virginia,  with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners.  He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk.com Report, Vol. 13, No.6  (May 2011).

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