For over a decade, we've safely assumed that the economic loss rule does not bar typical homeowners (i.e., individuals who buy a home as their primary residence) from bringing negligence claims for alleged construction defects. But a new decision from the Colorado Supreme Court suggests that the "homeowner exception" to the economic loss rule protects only "subsequent homeowners" and does not apply to the original home purchasers. S K Peightal Engineers, LTD v. Mid Valley Real Estate Solutions V, LLC, 2015 CO 7.
The appellate Courts in Colorado have long recognized that homeowners in general may bring negligence claims for construction defects. In Stiff v. BilDen Homes, Inc., 88 P.3d 639 (Colo. App. 2003), plaintiff purchased a home directly from a builder/vendor. After the home began to show signs of shifting and settlement in the basement, plaintiff sued the builder/vendor. Id. at 640. The trial court dismissed plaintiff's negligence claim based on the economic loss rule, but the Court of Appeals reversed. Id. at 641-42. The Court of Appeals' reasoning was that, under Cosmopolitan Homes, Inc. v. Weller, 663 P.2d 1041 (Colo. 1983), "[a] homebuilder has an independent duty to act without negligence in the construction of a home." Stiff, 88 P.3d at 641. The Court of Appeals even directly quoted Cosmopolitan Homes, writing, "[a]n obligation to act without negligence in the construction of a home is independent of contractual obligations . . . ." Id., quoting Cosmopolitan Homes, 663 P.2d at 1042. Thus, under the Stiff v. BilDen Homes decision, even the first owner who purchased a home directly from a builder/vendor could maintain a negligence claim directly against the builder/vendor for alleged construction defects.
Two years after Stiff v. BilDen Homes, the Colorado Supreme Court decided A.C. Excavating v. Yacht Club II Homeowners Ass'n., Inc., 114 P.3d 862 (Colo. 2005). In A.C. Excavating, the Colorado Supreme Court held that the economic loss rule did not bar a homeowner's association's negligence claims brought against construction subcontractors for alleged construction defects. The Court extended the "homeowner exception" to the economic loss rule, and held, "as a matter of law, that subcontractors owe homeowners a duty of care, independent of any contractual obligations, to act without negligence in the construction of a home." Id. at 864. Just like the Court of Appeals did in Stiff v. BilDen Homes, the Colorado Supreme Court in A.C. Excavating noted that it previously "recognized in Cosmopolitan Homes that builders have '[a]n obligation to act without negligence in the construction of a home [ ] independent of contractual obligations . . . .'" A.C. Excavating, 114 P.3d at 866, quoting Cosmopolitan Homes, 663 P.2d at 1042. The Court further explained that its "decision in Cosmopolitan Homespermitted the homeowners' negligence claim to proceed because it was a based on a recognized independent duty of care requiring builders to construct homes without negligence." A.C. Excavating, 114 P.3d at 866.
In A.C. Excavating, the focus of the Court's inquiry was what class of defendants owed an independent duty to construct a home without negligence. In S K Peightal Engineers, LTD v. Mid Valley Real Estate Solutions V, LLC, 2015 CO 7, the Court's inquiry was what class of plaintiffs is that independent duty owed to. According to the Court, the independent duty of care requiring builders to construct homes without negligence "is only owed to subsequent purchasers and transferees." Id. at ¶18 (emphasis original).
The facts in S K Peightal Engineers involve the construction of a "spec" home which the developer planned on constructing and then selling on the open market. The developer obtained financing from Alpine Bank. Id. at ¶3. After the developer completed the home and defaulted on its loan, it entered into a deed-in-lieu-of-foreclosure agreement with Alpine Bank. But instead of taking title directly, Alpine Bank created a wholly-owned subsidiary, Mid Valley, to take title under the deed-in-lieu agreement. Id. at ¶3. Mid Valley was specifically mentioned in the deed-in-lieu agreement, and was an intended third-party beneficiary of that agreement. Id. at ¶13. Mid Valley discovered cracks in the walls of the home due to settling soils, and then sued several parties involved in the construction of the home for negligence. Id. at ¶4.
The key legal issue in S K Peightal Engineers was whether or not the economic loss rule would bar Mid Valley's negligence claims, or whether the "homeowner exception" to the economic loss rule would apply. Both the trial court and the Court of Appeals held that the economic loss rule did not bar Mid Valley's negligence claims, but the Colorado Supreme Court disagreed. Although the issues that the Court granted certiorari were framed differently, the main issue that the Court focused its opinion on was whether or not Mid Valley qualified as a "subsequent" owner of the home in question.
In S K Peightal Enterprises, the Court made a conscious effort to limit its holding in Cosmopolitan Homes to apply only to "subsequent" purchasers or transferees of a home. According to the Court, the duty recognized in Cosmopolitan Homes to construct homes without negligence "is owed only tosubsequent purchasers and transferees." Id. at ¶18 (emphasis original). As if the point had not been made already, the Court again stated that, "[c]rucially, the Cosmopolitan Homes duty is owed only to 'subsequent home owner[s].'" Id. at ¶22. Later on, the Court again stated that, in Cosmopolitan Homes, "we limited this duty so as to allow only 'subsequent home owner[s] to maintain an action against a builder." Id. at ¶23 (emphasis original).
In footnote 10, the Court even addressed the fact that in A.C. Excavating it did not expressly limit the duty to "subsequent" owners. But the Court explained that A.C. Excavating only involved the scope of the class of the defendants who owed the duty, not the scope of plaintiffs that the duty was owed to. The Court also presumed that the unit owners represented by the HOA plaintiff in A.C. Excavating were "natural homebuyers with no connection to the construction contracts" and thus were themselves subsequent purchasers. Id. at fn10.
The Court ultimately held that Mid Valley, since it stood in the shoes of the construction lender, did not qualify as a "subsequent homeowner" of the property. Id. at ¶¶23-24. Instead, it was a third-party beneficiary of a contract related to the financing and construction of the home. Thus, the economic loss rule applied, and the independent duty owed by construction professionals in the construction of a home were not owed to Mid Valley.
After S K Peightal Enterprises, the question now becomes whether or not original home buyers can maintain a negligence claim for construction defects. That's exactly the scenario in Stiff v. BilDen Homes. But under S K Peightal Enterprises, "[w]hen an entity is a party to a contract that is interrelated with a defendant's duty-containing contract – or is a third-party beneficiary therefor, as is the case here – the economic loss rule can bar that entity from suing the defendant in tort." Id. at ¶12. The homeowner who purchases a house directly from a builder/vendor is typically "a party to a contract that is interrelated with a defendant's duty-containing contract . . . ." And that might be the differentiating factor. An original homeowner does have potential claims that a subsequent owner does not: Namely, claims for breach of contract and breach of implied warranties.
The plaintiffs in Cosmopolitan Homes were the fourth owners of the house at issue. Cosmopolitan Homes, 663 P.2d at 1042. The plaintiffs' claim therefore was grounded in negligence, and they did not make a claim under the implied warranty of habitability. Id. at 1042 fn1. Claims such as the implied warranty of habitability and implied duty to build in a workmanlike manner arise in a contractual setting. Id. at 1043. The plaintiffs in Cosmopolitan Homes could not bring implied warranty claims because they did not have a contract with the builder. So the Court held that the plaintiffs could bring a negligence claim. In so holding, the Court explained that "[t]he policy supporting the extension of the negligence remedy to a subsequent purchaser is based on many of the reasons for implying a warranty of habitability to the first purchaser." Id. at 1045. So an important part of the reasoning behind the holding in Cosmopolitan Homes was that subsequent owners cannot bring a claim for breach of the implied warranty of habitability like the first purchaser can. Thus, in order to protect that class of homeowners, the Court held that subsequent owners can sue builders for negligence.
Excluding the original home owners from the class of plaintiffs who can bring a negligence claim for construction defects might not be the intent of the Court in S K Peightal Enterprises. After all, it would be an odd situation if the duty not to construct a home without negligence is owed to every potential owner of a home except for the very first purchaser. The reasoning perhaps might be that the first purchaser has the ability to negotiate for additional contractual duties and the potential to bring a claim for breach of the implied warranty of habitability. But there are limits to the implied warranty of habitability, and some would argue that such a warranty can be waived if done properly. And ultimately, it probably would not make sense for a subsequent purchaser of a home to have greater rights against the builder than the original purchaser does.