Economic Loss Rule
Precludes Tort Claims Between Contracting Parties
An
Arizona U.S. District Court ruling holds that, in the absence of non-monetary
damages, contracting parties may not maintain tort claims against one another
In 1998, an Arizona
distributor of construction supplies, Cohill’s Building Specialties, entered
into an agreement with California-based QC Construction Products for the
distribution of Bayferrox by QC, an iron oxide pigment manufactured by
QC. In their contract, QC and Cohill agreed that, for ten years, Cohill would be
QC’s exclusive Arizona distributor of Bayferrox by QC, and Cohill would not
purchase or sell products that competed with Bayferrox by QC.
The relationship quickly
soured. According to QC, Cohill stopped ordering Bayferrox by QC and
failed to develop the Arizona market. Cohill contended that, immediately after
the parties entered into their agreement, QC began selling Bayferrox by QC
to other Arizona buyers and failed to deliver products as required in the
contract. QC sued Cohill in federal court, asserting a number of claims,
including breach of contract, interference with business relationships and
prospective economic advantage, fraud and deceit, and unfair competition.
Counts two, three and
four are considered “torts,” a fact that would have a major impact on the
outcome of this case. (A tort is a wrongful act, not including a breach of
contract or trust, that results in injury to another’s person, property,
reputation, or the like, and for which the injured party is entitled to
compensation.)
Cohill countersued,
claiming that it was in fact QC that breached the parties’ contract (by not
honoring Cohill’s exclusivity and by failing to supply the product
satisfactorily) and further claiming that QC interfered with Cohill’s
prospective contractual relations. (Cohill was represented in this case by
Kent Lang and
Bill Klain of Lang Baker &
Klain.)
Both parties filed
motions for summary judgment: QC seeking judgment on its breach of contract
claim, Cohill to dismiss all of QC’s claims and to recover on its own breach of
contract claim against QC.
Ruling for Cohill.
Cohill was able to show that QC breached the contract first when, in violation
of Cohill’s exclusive contractual right to sell Bayferrox by QC in
Arizona, QC sold the product to other Arizona sellers. The court ruled that QC’s
breach excused Cohill’s obligation to perform the contract. Consequently, the
court denied QC’s motion for summary judgment on its breach of contract claim.
As for Cohill, the court granted its motion in part, ruling that QC breached its
contract with Cohill and barring QC from recovering for Cohill’s alleged
subsequent breaches. In another victory for Cohill, the court also ruled that
QC’s claims for interference with business relationships, fraud and deceit, and
unfair competition were barred by the “economic loss rule.” (In two relatively
minor wins for QC, the court ruled that Cohill could not recover under its
counterclaim of international interference with prospective contractual
relations, and further ruled that the issue of Cohill’s damages must be
determined at trial.)
Economic loss rule.
Of particular interest in this case, and of importance to construction
companies and other businesses that enter into contracts, is the court’s
application of the economic loss rule. As formulated by the Arizona Court of
Appeals, the economic loss rule “bars a party from recovering economic damages
in tort unless accompanied by physical harm, either in the form of personal
injury or secondary property damage.” In its 2003 ruling in
Carstens v. City of Phoenix, the Court of Appeals wrote, “[U]nder the
economic loss rule, a contracting party who suffers monetary harm (as opposed to
personal injury or injury to property other than that governed by the contract)
cannot recover tort damages from the other contracting party but, rather, is
limited to contract remedies.”
QC’s tort claims – for
interference with business relationships, fraud and deceit, and unfair
competition – exclusively sought recovery of economic damages. There was no
non-monetary harm to QC. Consequently, the court ruled, the “purely economic
harm resulting from actions that were breaches of the parties’ contract falls
squarely under the economic loss rule.”
Exception. In a
recent Colorado case, that state’s Supreme Court reached a similar conclusion,
with this clarification that construction companies will find useful. The
Colorado court ruled that the economic loss rule does not apply when a tort
claim arises from a duty of care independent from the contract. The court noted
that, aside from any contractual obligations, contractors and subcontractors
have a duty of care to act without negligence in the construction of homes.
Under that exception, contractors and subs that are negligent in their work may
be liable for tort claims even if the harm that their negligence caused is
purely economic.
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