Davencourt — The Economic Loss Portion

Section 1: The Economic Loss Rule

The Davencourt opinion begins with the analysis of the most eagerly anticipated portion of the opinion; how the Court would deal with the economic loss rule.

Background on the Economic Loss Rule

The economic loss rule, as it applies to construction disputes in Utah and more particularly with community associations, began with the 1996 ruling in the case of American Towers Owners Ass’n v. CCI Mechanical. In that case, the Court held that in the absence of physical property damage to “other property,” or personal injury, economic losses could not be recovered through a negligence claim. (Simply stated, a negligence claim involves an assertion that one party failed to comply with duties involved to another – in building, for example, to meet the “standard of care” expected of a contractor.) Because of the American Towers ruling, it has been difficult for community associations to pursue claims against developers.

In 2002, the Court limited the Economic Loss Doctrine somewhat in the case of Hermansen v. Tasulis; in that case, the court held that the doctrine did not bar claims where one party owed an “independent duty” to the other party. The Hermansen case, which we filed and argued, involved claims against real estate agents.

Davencourt’s Holdings Respecting the Economic Loss Rule

The plaintiff homeowners association, and I acting as amicus counsel for the Community Associations Institute, had hoped that the Court would further limit, or even overrule the American Towers case, because of its adverse consequences to community associations. The ultimate goal would have been the elimination of the doctrine, at least as it related to construction defect claims asserted by community associations which, by their nature, do not have contractual relations with the builders. A lesser, but still desirable result, would have been the establishment of an independent duty to be owed from builders to the purchasers in community associations.

In Section I.A. of the opinion, the Court rejected an outright reversal of American Towers, stating that the doctrine was “particularly applicable to claims of negligent construction.” Furthermore, the opinion expressed an inability to overrule the doctrine based upon the “codification” of the doctrine in Utah Code Ann. 78B-4-513. (That section of the code arose from the Legislature’s passage of Senate Bill 220, in 2008.

In Section I.B., the Court next refused the Association’s request that the Court recognized that the unique status of community associations warranted that the doctrine not be applicable to associations. The Court declined, asserting that contractual expectations created in the contracts among the Unit Owners, the Developer and the Builder” could not be ignored. Under the ruling, then, neither an individual owner nor an association can pursue a claim, in negligence, against the Builder.

The third argument rejected by the Court was a contention that various components of the structures had been damaged by defects in other components, triggering the “other physical damage” exception to the doctrine. Again, the Court rejected this argument, finding that Unit Owners had not bargained for individual components, but rather for “a finished product, which included the integral components of the roof, the foundation and the siding.”

Turning to the review of “independent duties,” the Court rejected a request to extend the independent duty between a contractor-seller and a home purchaser to a similar duty between a contractor-seller and the Association. Interestingly, however, the Court appears to have clearly established that a contractor-seller’s duty “to disclose known material information” to a buyer. If the Developer of a condominium project was also the contractor-seller, that developer/contractor-seller would owe each unit owner a duty to disclose known defects in the units and the common areas, an interest in which was also being sold.

Next, the Court held, to a limited degree, that the developer’s limited fiduciary duty to the Association does fall outside of the doctrine. The Court expressly recognized and acknowledged “the inherent conflict that a developer faces in promoting and marketing property for a profit, while simultaneously ensuring the interests of a homeowners association and its members…” In light of the conflict, the Court expressly adopted Section 6.20 of the Restatement (Third) of Property, which establishes several clear and important duties owed by a developer to an association. These duties, set out in full here, include 1) “reasonable care and prudence in managing and maintaining the common property;” 2) establishment of a sound fiscal basis for the association; 3) disclosure of developer subsidies, if any; 4) records and an accounting; 5) compliance with governing documents; 6) disclosure of “material facts and circumstances affecting the condition of the property that the association is responsible for maintaining; and 7) disclosure of “all material facts and circumstances affecting the financial condition of the association…”

The Court’s opinion stated: “In adopting this limited fiduciary duty, we recognize that it constitutes a newly-recognized independent duty of care in Utah.” These types of claims, the Court stated, “lie outside of the economic loss rule.” Recovery under this independent duty, however, is restricted to the common areas. The Court indicated that the association could “bring its claims for negligence and negligent misrepresentation against the [developer] insofar as the claims stem from the limited fiduciary duty owed.”

In the next successive sections of its opinion, the Court declined to find an independent duty to comply with the building code, and declined an independent duty to build without negligence in the construction of a home. The Court’s opinion seems to intentionally leave open the possibility, however , that the Court could find such a duty in a sale between a contractor/seller of a new home, and a buyer.

A Quick Read of the Davencourt Opinion…

and it looks like a mixed bag. The Court refused to overrule the American Towers case (I think a bad thing, but ameliorated by the rest of the opinion), expressly adopted Section 6.20 of the Restatement, Third of Property (I think a very good thing), and adopted an implied warranty of habitability on the sale of new property (also a very good thing).

They also made some really interesting rulings and made some interesting comments on the independent duties that will result in allowable negligence claims, even despite the economic loss doctrine. It will take some time, and probably more rulings, to clarify this area of the law.

I’ll post some more details, which will presumably be more meaningful to non-followers of the law, in the next few days.

Davencourt, at last!

I’m wrapping up a jury trial (hence the hour of this post), but have been informed by a reliable source that the Utah Supreme Court’s opinion in the Davencourt opinion (dealing with the “economic loss doctrine”) will be issued to the public at 10 a.m. tomorrow.

That’s all for now; check back tomorrow for updates. (It won’t be at 10 a.m., that’s the scheduled time for arguments to the jury.) I will, however, post an update and a link to the opinion at my earliest opportunity; that will be followed by a summary, sometime tomorrow or this weekend.

The Argument…

before the Utah Supreme Court on the continued vitality of the Economic Loss Doctrine (which regular readers know that I “love to hate”), will be heard on Tuesday, December 2, at 9 a.m.

Arguments will be at the Utah Supreme Court, 450 South Main, 5th Floor, Salt Lake City, Utah.

The appeal arises from a dispute between the Davencourt at Pilgrim’s Landing Townhome Owners Association and the entities involved in the development of the project. The lawsuit involves allegations of serious construction defects; the development entities successfully argued in the trial court that the economic loss doctrine precluded most of the plaintiff’s claims.

I won’t get to argue to the court, but I’ll be in the audience cheering the plaintiffs on. I was allowed to file an amicus curiae (friend of the court) brief on behalf of the Community Associations Institute. A copy of my brief is available here.

I hope to see you there. And remember, although the public is allowed, literal cheering from the courtroom is strongly discouraged.

Snow Flower HOA v. Snowflower

31 P.3d 576 (Ut. Ct. App. 2001)

The Snowflower case was another construction defect case with an unfortunate outcome for the association and its members. In Snowflower, the Association discovered construction defects in connection with a remodelling project; their claims against the developer were all thrown out by the Utah Court of Appels, based largely upon the “economic loss rule” and the absence, in Utah, of implied warranties of habitablity and fitness.

The Snowflower case did not create any shocking new law in Utah, and its conclusion was rather predictable, given the then-existing status of the “economic loss rule” in Utah and the length of time that had elapsed since construction. Time will tell, however, whether or not the Snowflower case remains viable following the recent developments in case law presented by Hermansen and Yazd.

American Towers v. CCI Mechanical, et. al.

930 P.2d 1182 (Utah 1996)

The American Towers opinion, dealing with an association’s right to pursue developers and contractors for construction defects, put a disastrous impediment – “the economic loss rule” – in the way of associations’ efforts to seek redress for poor construction. Fortunately, the underpinnings of American Towers have been limited by several subsequent cases, and the viability of the opinion is questionable. Because of its historical significance, however, a review of the case is warranted.

The first claim for relief which was rejected in American Towers was the association’s claims for breach of contract and warranty. The court held that the association was not a party to any contracts with the contractors, and held that the association was not a clearly intended third-party beneficiary of the contracts between the developer and the contractors.

Next, the Court discarded the association’s negligence claims based upon the determination that negligence claims cannot stand for purely economic losses resulting from negligence, in the absence of physical harm to persons or other property. The Court held that the association’s (and the owners) damages were all economic in nature, and thus should be protected by contracts agreed to between the parties.

The Court’s determination that the association was not entitled to sue under the contracts to which they were not parties, followed by the preclusion of a negligence claim, effectively left associations with few, if any methods of recourse against builders. American Towers left the option of pursuing developers, but developers often insulate themselves from liability through the use of limited liability companies that are disolved at the end of construction. Naively, the court suggested that “A buyer can avoid economic loss resulting from defective construction by obtaining a thorough inspection of the property prior to purchase and then by either obtaining insurance or by negotiating a warranty or reduction in price to reflect the risk of any hidden defects.”

Lastly, the Court rejected the imposition of an implied warranty of habitability in condominiums, again based upon the naive determination that “a condominium homeowners’ association typically oversees the management, maintenance, and operation of the units. The potential buyer can contact this association, which is equipped to know of respond to, and guard against defects in the complex.” In making this assertion, the Court closed its eyes to the reality that the association is inevitably controlled by the developer/seller during the initial sales period, and it is often conflicted from “responding to” defects.

Fortunately, the subsequent opinions of Hermansen and Yazd have significantly cut back upon the pronouncements of American Towers, and associations do, in fact, now have options and remedies available when construction defects are discovered.