On June 16, 2011, Kentucky’s highest court adopted the economic loss doctrine. This doctrine holds that when a product causes only property damage, with no personal injury or physical harm, the owner of the product cannot bring tort claims and is limited to the recovery allowed under the contract between the parties. Negligence claims and strict liability claims are prohibited. See Giddings & Lewis, Inc. v. Industrial Risk Insurers, __ S.W. 3d ___, 2011 WL 2436154 (Ky. 2011). In the Giddings’ case, an insurer of a diffuser cell system attempted to recover amounts paid to the owner of the product from the manufacturer of the system based on breach of contract, negligent strict liability, negligent misrepresentation and fraud by omission. The court rejected the tort based claims and damages, including economic loss for lost profits, costs for repair and replacement of the defective commercial product. Recovery was allowed only under the terms of the parties’ contract, which could include express or implied warranties negating certain damages.
This case is of renewed importance to the construction industry. While the Giddings’ case dealt with a product, a number of cases have applied the economic loss doctrine to construction processes and services. In Indianapolis – Marion County Public Library v. Charlier Clark & Linard, P.C., 929 N.E. 2d 722 (Ind. 2010), Indiana’s highest court applied the economic loss doctrine to services performed in connection with engineering, administration and design work for a library building. This decision outlines a number of cases where homeowners and other building owners were not allowed to sue a contractor for economic loss and were limited to their contractual remedies. The Indiana court specifically held that engineers and design professionals can invoke the economic loss rule as a defense. The Arizona Supreme Court has adopted the same result. Flagstaff Affordable Housing Limited Partnership v. Design Alliance, Inc., 223 P.3d 664, 673 (Ariz. 2010). In West Ridge Group LLC v. First Trust Company of Anaga, 414 Fed. Appx. 112, 2011 WL 635567 (10th Cir. 2011) (applying Colorado law), the federal appeals court held that Colorado law applied the economic loss doctrine to the appraisal process used in a real estate transaction.
Since Kentucky just adopted the economic loss doctrine, it has not yet decided its application to “processes” or “services.” However, in Presnell Construction Managers, Inc. v. EH Construction LLC, 134 S.W.3d 575 (Ky. 2004), a concurring opinion by Justice Keller asserted that the owner’s common law negligence claim against the contractor in a construction case for negligent supervision should be barred by the economic loss doctrine. Justice Keller urged the Court to adopt the economic loss doctrine in order to encourage contracting parties to allocate risks themselves. The facts in the Presnell case involved a claim by a contractor against the construction manager and did not involve any particular product, but instead involved either construction management services or the construction process. The Kentucky Supreme Court’s 2011 decision, in Giddings & Lewis, Inc., supra, expressly recognized Justice Keller’s analysis in the 2004 Presnell case. The Giddings’ Court described the dispute in Presnell as the provision of construction services.
The policies supporting application of the economic loss doctrine to commercial transactions should apply whether a product, a process or a servicer is involved. The three policies used by the Giddings Court to adopt the doctrine are: (1) maintaining the historical distinction between tort and contract law; (2) protecting the parties’ freedom to allocate economic risk by contract; and (3) encouraging the party best situated to assess the risk of economic loss, usually the purchaser, to assume, allocate or insure against that risk.
Based on these policies focused on controlling risk by contract rather than tort law, contractors should promptly review contracts with owners, suppliers, and subcontractors to determine the contractually allowed remedies, absent any personal injury. Those contract based remedies will have greater importance and likely the sole application in the future.