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“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.)
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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