California Supreme Court Adopts "Economic Loss" Limitationon Defective Construction Claims, as Does Nevada Supreme Court

Journal of Risk and Insurance, Sept, 2001 by Jeffrey W. Stempel

Aas v. Superior Court, 12 P.3d 1125, 101 Cal. Rptr. 2d 718 (Cal. 2000).

Calloway v. City of Reno, 993 P.2d 1259 (Nev. 2000).

One theory of the law is that, for every wrong done, there should be a remedy. The notion is largely but not completely accepted in our system. For example, while there is civil liability (and often insurance coverage) for most inflicted injuries of significance, it is unlikely that claims will ever be permitted against persons who inflict small injuries or commit trivial "wrongs" such as being rude. In addition, sovereign immunity still protects governments from being called to account for some injurious conduct. Some injured persons may not have legal "standing" to qualify to invoke a statutory or other legal protection. Other blameworthy conduct may be considered serious by many persons but not illegal by the justice system. For example, under the "employment-at-will" doctrine, an employer could fire an employee simply for having a bad haircut (unless the employee is in a union or working under a contract that prevents this type of adverse job action). Before statutes like the Civil Rights Act of 1964 (Tit le VII), an employer could reject black job applicants and the job applicant would have no legal recourse.

But even when everyone agrees that a wrong has been committed and the victim has a remedy, courts and commentators may differ as to the characterization of the cause of action and the contours of the remedy. Construction defects have been a particularly pronounced example of this, as well as something of a litigation boom in the rapidly growing sunbelt states such as California and Nevada. A homeowner buys a home (or a business buys a building) pursuant to a contract, of course. When defective work of the builder or its subcontractor agents occurs, all agree that the buyer is injured. Courts have disagreed, however, as to whether the buyer's legal remedies are sound in contract or tort. In other words, should the aggrieved buyer be permitted to prosecute the tort of negligence against the builder or is the buyer required to prosecute a defective construction claim as one sounding in breach of contract/breach of warranty? The Aas court referred to the issue as arising "from the nebulous and troublesome margin between tort and contract law." See 12 P.3d at 1130.

Nonlawyers and lawyers both might not be blamed for questioning the importance of the classification. In the average construction defect case, the remedy available to the buyer is likely to be the same under either liability regime. A buyer victimized by a breach of contract (or the related breach of express warranty, breach of implied specific warranty, or breach of implied warranty of adequacy and fitness for a particular purpose) is in most states entitled to an award of funds equal not only to the cost of repair (or the difference in market value between the building that should have been and the building actually built) but also for the incidental and consequential damages caused by the breach of contract.

For example, if the buyer's home has a malfunctioning air conditioner, the home may not be habitable during a Southwestern United States summer, and the homeowner may be forced to live in a rented apartment during repair. There may be no "property damage" as such and the home may become habitable again simply upon repair or replacement of the air conditioning system. Buyer personal property such as furniture could be damaged and this attendant property damage in most states will allow a buyer to sue in tort for the alleged negligence (perhaps even strict product liability, but most states do not apply this doctrine to housing). The apartment rentals (including furniture rental and other costs of the alternate housing) are incidental damages (the out-of-pocket costs occasioned by the breach of contract/warranty). Possible consequential damages are things like extra commuting costs (the rental apartment may be in a more distant bus fare zone or require crossing a toll bridge).

In fact, some lawyers would classify the above examples, particularly the bridge tolls, as incidental damages. The dividing line is not always clear. What is clear is that breach of contract/warranty plaintiffs can get them, provided they can show that such damages were within the reasonable contemplation of the parties (more on that below). A tort plaintiff also can obtain the damages inflicted by the defendant's breach of duty. In the typical construction defect case, the buyer will get the same remedies under either a contract or tort theory. In many cases, however, the classification may make a difference.

Perhaps most important, no state permits a breach of contract plaintiff to recover punitive damages unless the breach is accompanied by an independent tort such as fraud. Thus, the buyer who accuses the builder of willful indifference to the buyer's rights ("Louie, don't waste your time running to Home Depot for the long nails for the roof! Just use the short ones we used for the sheet rock.") cannot recover punitive or "extra-contractual" damages even if the buyer proves really bad behavior by the builder or its agents. Not surprisingly, most buyer-plaintiffs and their counsel would prefer to prosecute these claims as sounding in tort so as to have the leverage of creating at least some fear of a possible punitive damages award in the builder defendant.