Keeping Contract Law from Drowning in a Sea of Tort
The North Carolina Supreme Court Applies the Economic Loss Rule to Bar Recovery in Tort by Commercial Developers in Complex Construction Litigation
The North Carolina Supreme Court’s decision in Crescent University City Venture, LLC v. Trussway Manufacturing, Inc. and Trussway Manufacturing, LLC, No. 407A19 provides clarity to the lower courts on the application of the economic loss rule in commercial real estate development projects. Crescent holds that the economic loss rule precludes recovery by a project owner or commercial developer for negligence claims against a subcontracted manufacturer with whom the project owner had no contractual privity.
Crescent was the project owner and developer of a $25 million project to construct student apartment buildings at UNC Charlotte. The construction project was governed by a series of contracts typical in the construction industry: Crescent contracted with AP Atlantic, Inc., the general contractor, which contracted with Madison, the framing subcontractor, which in turn subcontracted with Trussway Manufacturing, LLC, the floor truss manufacturer. At some point after students occupied the buildings, the floors in several apartment units began to sag. A structural engineering firm concluded the sagging floors were caused by defective floor trusses. Crescent hired another general contractor to repair all the defective trusses, incurring millions of dollars of damages in repair costs and costs to provide housing to displaced students.
The structural defects and project-wide repairs led to three separate lawsuits: (1) AP Atlantic sued Crescent and Crescent’s surety for failure to pay; (2) Crescent sued AP Atlantic’s parent corporation for damages caused by failure of the floor trusses; and (3) Crescent filed a later suit against Trussway asserting negligence for its manufacturing and supply of the allegedly defective trusses. The first two cases were consolidated by the North Carolina Business Court, and Crescent’s later case against Trussway was also consolidated with the lead case in Crescent Univ. City Venture, LLC v. Trussway Mfg., 2018 NCBC 71.
The Economic Loss Rule
The neat delineations in tort and contract law seem to blur when one considers the economic loss rule. Can a party sue in tort when it alleges that the other party was negligent in failing to perform its contract? What if the parties are not in privity of contract? What does the phrase “a product injuring itself” mean? When you add to these questions the concepts of strict-liability and express and implied warranties, the economic loss rule can become very confusing.
The classic description of the economic loss rule’s purpose is to prevent “contract law [from] drown[ing] in a sea of tort.” East River S.S. Corporation v. Transamerica Delaval, Inc., 476 U.S. 858, 866 (1986) (citing G. Gilmore, The Death of Contract 87-94 (1974)). In East River, the United States Supreme Court held that ship charterers could not recover in tort where turbine engine propulsion units for four oil-transporting supertankers failed. Only the turbines themselves were damaged, so the plaintiff ship charterers were limited to breach of warranty or breach of contract claims to recover their economic losses.
There are three key North Carolina cases: Ports Authority, Moore, and Oates. In Ports Authority, the North Carolina Supreme Court adopted the economic loss doctrine in principle although it did not use that terminology. See North Carolina State Ports Authority v. Lloyd A. Fry Roofing Co., 294 N.C. 73, 240 S.E.2d 345 (1978), rejected in part on other grounds by Trs. of Rowan Technical Coll. v. J. Hyatt Hammond Assocs., Inc., 313 N.C. 230, 328 S.E.2d 274 (1985). The North Carolina Supreme Court held in Ports Authority that an owner had no right to assert tort claims against the general contractor or a subcontractor for roof leaks in two buildings. In Moore v. Coachmen Industries, Inc., 129 N.C. App. 389, 499 S.E.2d 772 (1998), the North Carolina Court of Appeals held that owners of a recreational vehicle were not permitted to recover in negligence for the destruction of the vehicle in a fire caused by faulty wiring. In Moore, the Court of Appeals used the term “economic loss rule,” articulating the principle that a party has no remedy in tort when defects in a product damage the product itself—although damage to property other than the product itself is recoverable in tort. In Oates v. JAG, Inc., 314 N.C. 276, 333 S.E.2d 222 (1985), the North Carolina Supreme Court held that a subsequent purchaser of a residential home may sue the builder and general contractor for negligent construction. The North Carolina Supreme Court in Oates was persuaded in part by public policy concerns, including ordinary home buyers’ inabilities to discover latent defects and the prospect of leaving home buyers without any remedies against careless contractors when it comes to the most important investment they make.
Application of the Economic Loss Rule in Crescent University
In Crescent, the North Carolina Supreme Court affirmed the Business Court’s holding granting summary judgment for Trussway on Crescent’s negligence claim. The Supreme Court rejected Crescent’s argument that the application of the economic loss rule requires the existence of a contract between the plaintiff and defendant. The Supreme Court concluded that Crescent’s argument was inconsistent with its holding in Ports Authority, giving precedential effect to its prior decision. The Supreme Court indicated that in sophisticated commercial contracts, the lack of privity is incorporated—or in the court’s language, is “assimilated”—into the construction contract between the plaintiff owner or developer and its general contractor. The opinion does not discuss in detail the specific provisions of Crescent’s contract with AP Atlantic. Typically, parties use form contracts developed by the American Institute of Architects (AIA), which are the industry standard and have been used for 120 years. The opinion suggests that Crescent could control AP Atlantic’s choice of subcontractors and suppliers. Although this may be accurate under the provisions of the construction contracts, it is not clear that project owners or developers in practice control general contractors’ decisions when hiring subcontractors and suppliers.
Crescent’s breach of contract claim will proceed against AP Atlantic. A jury will be required to decide factual issues as to what caused the apartments’ ceilings to sag and whether alleged problems with the trusses developed during manufacturing or after delivery to the project site.
In keeping with the seaside metaphor, it is apt to say that the North Carolina Supreme Court drew a line in the sand between residential home purchasers and sophisticated commercial developers. The opinion notes that Trussway’s position is more like the component-parts suppliers in East River and Moore and the roofing subcontractor in Ports Authority than the residential home purchasers in Oates.The opinion appears to leave the holding in Oates undisturbed. Thus, subsequent residential homebuilders may bring negligence claims for defective construction without those claims being barred by the economic loss rule. The boundaries of the holding in Oates are unclear due to conflicting indications in Lord v. Customized Consulting Specialty, Inc., 182 N.C. App. 635, 643 S.E.2d 28 (2007), and an unpublished decision of the Court of Appeals, Buffa v. Cygnature Construction and Development, Inc., No. COA16-237, 2016 N.C. App. LEXIS 1334 (N.C. Ct. App. Dec. 30, 2016).
One interesting procedural twist is that Crescent’s appeal related solely to the summary judgment ruling in the third consolidated case. The Business Court’s summary judgment ruling as to Crescent’s negligence claim against Trussway was final as to all claims and all parties, but the other two consolidated cases were not fully resolved by summary judgment. The North Carolina Supreme Court did not directly address whether a case is considered separate from other consolidated cases when determining finality for purposes of appellate review. The North Carolina Supreme Court appears to have followed the federal courts’ approach on that procedural question.
The clarity from the North Carolina Supreme Court in Crescent indicates that project owners and commercial developers in complex construction projects should limit their causes of action against contractors and subcontractors to breach of contract claims. The decision provides guidance to the lower courts in the event owners and developers continue to assert negligence claims in those types of cases. Under Oates, residential home purchasers may still bring tort claims for construction defects. The appellate courts likely will be called on to clarify the boundaries of the economic loss rule in those cases.
The other two consolidated cases involving the Crescent University City project are still proceeding in the North Carolina Business Court.