By: Gail S. Kelley, P.E., Esq., ConstructionRisk Counsel, PLLC

Where a condominium homeowners’ association brought claims for breach of implied warranty and negligence against the general contractor that built the condominiums, but not the developer who engaged the contractor and who actually sold the units to purchasers, the court dismissed the suit due to lack of privity of contract giving rise to warranties, and due to the economic loss doctrine that prohibits negligence actions like this one. The complaint had sought general damages for the cost of repairing the building, special damages for alleged lost use of the building and impairment of the condominium operation, and punitive damages. Carolina Winds Owner’s Assoc., Inc. v. Joe Harden Bldrs., Inc., 374 SE 2d 897 ( SC Court of Appeals 1988).

In this case, the developer contracted with a contractor to build a twelve-story condominium building. Once construction was complete, the developer sold residential units in the building to various individual owners. The homeowner’s association (the “Owners”) was incorporated for the purpose of managing the building’s common elements on behalf of the unit owners. Subsequently, the exterior brick walls of the building began to crack and buckle.

When an investigation revealed that the cracking and buckling was caused by latent defects due to negligent construction, the Owners sued both the contractor and the masonry subcontractor, alleging that they were liable for repair costs because they breached an implied warranty that the building was fit for its intended use, in this case an implied warranty of habitability.

Implied Warranty of Habitability

 In discussing previous case law, the Appeals court stated that an implied warranty of habitability from the initial vendor of a house does no more than fulfill the reasonable expectations of the parties under the contract.   If a buyer has paid a fair price for a house and the house is defective, the buyer’s expectancy interest is injured and he has a right to recover his damages from the seller.

The cost of repair is a common measure of the buyer’s damages. However, when a contractor is building a house for a developer, the contractor cannot be held liable under an implied warranty of habitability to a subsequent purchaser of a condo unit because it was actually the developer, not the contractor, that was the initial vendor of the property.

In this case, neither the contractor nor its masonry subcontractor were parties to the contract for the initial sale of the condominium units, thus the court held that they were not liable to the Owners on an implied warranty arising from the sale. The Owners’ remedy, if any, was against the initial seller of the condominium units (the developer).

Economic Loss Rule

 The Appeals court also agreed with the trial court that the Owners’ claim for negligence for the defective construction was barred by the “economic loss rule.”

The holding that an action in negligence cannot be brought when the only damages are to the economic interests of the injured party has come to be known as the “economic loss rule” (also called the “economic loss doctrine”).

In discussing the economic loss rule, the court stated:

“In effect, the ‘economic loss rule’ simply observes the traditional distinction between recovery in contract and recovery in negligence in those cases where the damage consists of a diminution in the expected value of a product. Unless the plaintiff has contracted with a party who warrants, expressly or impliedly, that the product meets a standard of quality, value, or fitness for an intended use, he has no claim for inferior or negligent manufacture of goods in the steam of commerce.

These general principles apply with equal force to the sale of a dwelling. When the harm is to the purchaser’s expectation that the dwelling is fit for an intended use, contract, not negligence, principles are involved. … This loss is occasioned not by a failure of the actor to conform his conduct to a standard of care imposed by law, but by his failure to fulfill a standard of quality imposed by the contract. Unlike the risk of physical injury to one’s person or property, the risk to the expectancy interest can be fairly allocated by agreement of the parties to the sale. To protect himself, the purchaser may either take warranties, bargain for a lower price, or insure the risk.”

The court went on to say that:

“… holding a builder liable to remote purchasers of a defective dwelling would have entirely different consequences. By definition, liability would attach because of a contract to which the builder was not a party. He would be deprived of the normal opportunity to limit his liability for commercial or pecuniary losses, direct and consequential. Unrestricted liability to remote parties in the stream of commerce would destroy the fundamental principle of the common law that a contract between two parties cannot give rise to an obligation in a third who is a stranger to the bargain. It would also violate the common law principle which give parties in the marketplace freedom to allocate the risk of purely economic loss by agreement.”

The court was not persuaded by the Owners’ claim that the economic loss rule left them without a remedy for the defective construction. The court stated that the Owners, as original purchasers without knowledge of the defect, had a complete remedy against the developer on the implied warranty of fitness for intended use.

The court was also not persuaded by the Owners’ claim that the economic loss rule allows a negligent builder to escape responsibility for his carelessness. When a builder contracts to construct a dwelling, he gives an implied warranty that the work undertaken will be performed in a workmanlike manner. Subcontractors assume the same obligation under their contracts with the general contractor. The person contracting with the builder acquires a corresponding right to receive a well-constructed building.

If the construction is defective because of the builder’s unworkmanlike performance, the person who contracted to have the work done will have a claim for damages for loss of his expectancy. This is a liability arising from the construction contract to which the builder is a party; it allocates responsibility for negligently-caused defects between the parties to the contract and gives them the opportunity to adjust the allocation of risk by agreement. A cause of action would thus be based on breach of contract and rather than negligence.

Likewise, the court disagreed with the Owners’ suggestion that the economic loss rule is out of step with modern case law. The court found that the great majority of courts deciding the issue in the past ten years have upheld the economic loss rule and provided the following comprehensive listing of such cases.

East River S.S. Corp. v. Transamerica Delaval. Inc., 476 U.S. 858, 106 S.Ct. 2295, 90 L.Ed. (2d) 865 (1986); State ex rel. Smith v. Tyonek Timber, Inc., 680 P. (2d) 1148 (Alaska 1984); Sacramento Regional Transit Dist. v. Grumman Flexible, 158 Cal. App. (3d) 289, 204 Cal. Rptr. 736 (1984); Affiliates For Evaluation and Therapy, Inc. v. Viasyn Corp., 500 So. (2d) 688 (Fla. Dist. Ct. App. 1987); McClain v. Harveston, 152 Ga. App. 422, 263 S.E. (2d) 228 (1979); Clark v. Int’l Harvester Co., 99 Idaho 326, 581 P. (2d) 784 (1978); Moorman Mfg. Co. v. Nat’l Tank Co., Ill.2d 69, 61 Ill. Dec. 746, 435 N.E. (2d) 443 (1982); Dutton v. Int’l Harvester Co., 504 N.E. (2d) 313 (Ind. App. 1987); Nebraska Innkeepers, Inc. v. Pittsburgh — Des Moines, Corp., 345 N.W. (2d) 124 (Iowa 1984); Marcil v. John Deere Indus. Equip. Co., 9 Mass. App. 625, 403 N.E. (2d) 430 (1980); Superwood Corp. v. Siempelkamp Corp., 311 N.W. (2d) 159 (Minn. 1981); Sharp Bros. Contracting Co. v. Am. Hoist & Derrick Co., 703 S.W. (2d) 901 (Mo. 1986); Nat’l Crane Corp. v. Ohio Steel Tube Co., 213 Neb. 782, 332 N.W. (2d) 39 (1983); Local Joint Executive Bd. of Las Vegas, Culinary Workers Union, Local No. 226 v. Stern, 98 Nev. 409, 651 P. (2d) 637 (1982); Ellis v. Robert C. Morris, Inc., 128 N.H. 358, 513 A. (2d) 951 (1986); Spring Motors Distrib., Inc. v. Ford Motor Co., 98 N.J. 555, 489 A. (2d) 660 (1985); Schiavone Constr. Co. v. Elgood Mayo Corp., 56 N.Y. (2d) 667, 451 N.Y.S. (2d) 720, 436 N. E. (2d) 1322 (1982); Hagert v. Hatton Commodities, Inc., 350 N.W. (2d) 592 (N.D. 1984); Ore-Ida Foods, Inc. v. Indian Head Cattle Co., 290 Or. 909, 627 P. (2d) 469 (1981); Lupinski v. Heritage Homes, LTD., 369 Pa. Super. 488, 535 A. (2d) 656 (1988); Mid Continent Aircraft Corp. v. Curry County Spraying Serv., Inc., 572 S.W. (2d) 308 (Tex. 1978); Blake Constr. Co., Inc. v. Alley, 233 Va. 31,353 S.E. (2d) 724 (1987); Wells v. Clowers Constr. Co., 476 So. (2d) 105 (Ala. 1985).

This article is published in Report, Vol. 17, No. 2 (February 2015).

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