SC Lawyer, March 2009, #2. The Economic Loss Rule Survives Colleton Prep.

• Author: By Susan M. Glenn and Paula M. Burlison

South Carolina Lawyer

2009.

SC Lawyer, March 2009, #2.

The Economic Loss Rule Survives Colleton Prep

South Carolina LawyerMarch 2009The Economic Loss Rule Survives Colleton PrepBy Susan M. Glenn and Paula M. BurlisonThe economic loss rule is a confusing doctrine, the subject of numerous articles attempting to sort through the possible rationales for the rule and the various ways in which it can be applied. See, e.g., Anita Bernstein, Keep It Simple: An Explanation of the Rule of No Recovery for Pure Economic Loss, 48 Ariz. L. Rev. 773 (2006); R. Joseph Barton, Note, Drowning in a Sea of Contract: Application of the Economic Loss Rule to Fraud and Misrepresentation Claims, 41 Wm. & Mary L. Rev. 1789 (2000). Simply stated, the economic loss rule is a method developed by courts over the years for delineating recovery in tort and contract. In South Carolina, the economic loss rule appears to be more honored in the breach than the observance, and courts continue to develop exceptions to the rule, as illustrated by the S.C. Supreme Court's recent decision in Colleton Preparatory Acad. v. Hoover Universal, Inc., 379 S.C. 181, 187, 666 S.E.2d 247, 250 (2008).

In Colleton Prep, the Supreme Court of South Carolina considered the application of the economic loss rule in the "commercial construction arena" to answer questions certified to it by the U.S. District Court for the District of South Carolina. Id. at 190, 666 S.E.2d at 252. The Court held that for a plaintiff to recover in tort when only the product itself has been injured, there must be a breach of duty accompanied by a clear, serious and unreasonable risk of bodily injury or death. Id. at 194, 666 S.E.2d at 254. Three justices agreed with this holding. Two justices dissented.

In its decision, the Court outlined the facts alleged in the complaint, which were taken as admitted because the defendant failed to timely answer. According to the complaint, Plaintiff Colleton Preparatory Academy's roof, constructed in 1972, contained a roof truss system that had been treated with "Fire-X," a fire retardant Defendant Hoover's predecessor manufactured. Id. at 184, 666 S.E.2d at 249. In 2002, Plaintiff discovered that the fire retardant treated (FRT) wood was deteriorating, causing structural problems that "would eventually lead to truss failure and partial or full roof collapse." Id. at 184-85, 666 S.E.2d at 249. "The majority of the roof trusses and sheathing had failed or were about to fail, the roof framing and sheathing were substantially impaired, and the truss system had to be replaced for safety reasons." Id. at 185, 666 S.E.2d at 249. Plaintiff sought damages "caused by the deterioration of the wood under theories of negligence, reckless/gross negligence, and violation of the UTPA." Id.

Because the plaintiff sued in negligence rather than contract and because the case concerned a commercial entity which had commissioned a new building rather than a residential homebuyer, the case raised what the district court viewed to be a novel question of South Carolina law, which it posed as follows: "Can the user of a defective product recover in tort when only the product itself has been injured and when the product either violated generally accepted industry standards or posed a serious risk of bodily harm?" Id. at 186, 666 S.E.2d at 250. The S.C. Supreme Court understood this question to concern the economic loss rule and reframed it as follows:

[W]hether the legal duties to conform to industry standards and to avoid creating a serious risk of bodily harm found in Kennedy v. Columbia Lumber & Manufacturing Company, 299 S.C. 335, 384 S.E.2d 730 (1989) are limited to the residential housing arena or whether they have wider application.

Id. at 187, 666 S.E.2d at 250 (footnote omitted).

To provide a framework for understanding the ruling in Colleton Prep and assessing its potential impact, this article will review the development of the economic loss rule and its application in S.C. Supreme Court jurisprudence. The article will conclude by arguing that Colleton Prep did not "work[] a wholesale revision of the law of products liability," as the dissenting opinion states. Id. at 199, 666 S.E.2d at 257 (Pleicones, J., dissenting). Instead, based on the actual question answered, as reframed by the Court, the decision simply extended the existing Kennedy analytical framework beyond the residential housing context.

The economic loss rule

The economic loss rule grew out of the development of products liability jurisprudence and the erosion of the privity requirement in warranty law. First year law students no doubt still study the case of Henningsen v. Bloomfield Motors, Inc., in which the New Jersey Supreme Court held that an automobile manufacturer and a dealer were liable to the automobile purchaser's wife, on a theory of implied warranty, even in the absence of privity of contract. 161 A.2d 69, 84 (N.J. 1960). Other jurisdictions followed the New Jersey Supreme Court's lead and extended the implied warranty theory to other products. W. Page Keeton et al., Prosser and Keeton on the Law of Torts § 97 (5th ed. 1984). Courts struggled while applying contract rules to implied warranty cases involving personal injury, operating on the assumption that contract rules must apply to these "warranty" actions, although often no contract was involved. Id.

In response to the difficulties of attempting to apply contract rules to products liability cases in the absence of a contract, courts moved away from the implied warranty theory of recovery and adopted a theory of "strict liability" in tort. Based on the policy reasons used to justify "strict liability," courts considered tort theory, based on the dangerousness of conduct, more adaptable and more appropriate. Id. at § 98. However, as products liability law based in tort concepts developed, courts began to express a concern that tort law would "swallow" the law of contracts. California recognized the importance of limiting the use of tort theories in Seely v. White Motor Co., 403 P.2d 145 (Cal. 1965). The Seely court refused to allow a plaintiff to use a strict liability in tort theory to recover damages absent personal injury. Id. at 151-52. The court explained the rationale for limiting tort recovery in these situations:

The distinction that the law has drawn between tort recovery for physical injuries and warranty recovery for economic loss is not arbitrary and does not rest on the "luck" of one plaintiff in having an accident causing physical injury. The distinction rests, rather, on an understanding of the nature of the responsibility a manufacturer must undertake in distributing his products. He can appropriately be held liable for physical injuries caused by defects by requiring his goods to match a standard of safety defined in terms of conditions that create unreasonable risks of harm. He cannot be held for the level of performance of his products in the consumer's business unless he agrees that the product was designed to meet the consumer's demands. A consumer should not be charged at the will of the manufacturer with bearing the risk of physical injury when he buys a product on the market. He can, however, be fairly charged with the risk that the product will not match his economic expectations unless the manufacturer agrees that it will. Even in actions for negligence, a manufacturer's liability is limited to damages for physical injuries and there is no recovery for economic loss alone.

Id. at 151 (emphasis added). This was the initial expression of the economic loss rule, which many jurisdictions subsequently adopted. The rule, as generally stated, provides that no cause of action lies in tort when purely economic damage is caused by negligent breach of a contractual duty. This economic loss rule prevents recovery in negligence when the duty breached arises out of contract and the harm incurred is the result of failure of the purpose of the contract.

S.C. Supreme Court's application of the economic loss rule

Before Colleton Prep, the Supreme Court of South Carolina had analyzed the economic loss rule in several cases and had developed an application of the rule that led some to question whether the rule has any validity in South Carolina. See Benjamin Edward Nicholson, V, Unanswered Questions: The Economic Loss Rule in South Carolina, S.C. Law, Nov./Dec. 1996, at 27 (reviewing both federal and state applications of the rule in South Carolina courts, questioning whether the S.C. Supreme Court had "set a precedent" for rejecting the rule).

Kennedy v. Columbia Lumber and Mfg. Co., Inc., 299 S.C. 335, 384 S.E.2d 730 (1989) was the first S.C. Supreme Court economic loss rule decision and has been the leading case discussing the rule. In Kennedy, the S.C. Supreme Court stated the economic loss rule as follows: "[T]here is no tort liability for a product defect if the damage suffered by the plaintiff is only to the product itself. In other words, tort liability only lies where the damage done is to other property or is personal injury." Id. at 341, 384 S.E.2d at 734. In discussing the rule, the Court expressed its concern that a strict application of the economic loss rule would undermine South Carolina's policy of protecting purchasers of new homes and refocused the inquiry "on activity, not consequence." Id. at 342-45, 384 S.E.2d at 734-37. The Court held that if the activities that allegedly led to the plaintiff's damages violated a legally imposed duty, not just a contractually imposed duty, the economic loss rule did not apply to bar a claim in tort. Id. at 347, 384 S.E.2d at 737.

In Kennedy, the Court held that residential homebuilders had a duty to build in accordance with applicable building codes, in accordance with applicable industry standards and in a manner that did not pose a serious risk of physical harm. Id. at 346, 384 S.E.2d at 737-38. The existence of this duty, which was separate and apart from the contractual duty, is what gave rise to liability in tort rather than just contract when a homeowner complained of poor workmanship.

In Kershaw County Bd. of Educ. v. U.S. Gypsum Co., 302 S.C. 390, 396 S.E.2d 369 (1990), the S.C. Supreme Court questioned whether the protections afforded by Kennedy should be extended to commercial entities. In Kershaw County, the plaintiff school district sought "money damages for the costs of inspection, testing, and the removal of the hazardous asbestos material from [its] school buildings." Id. at 392, 396 S.E.2d at 370. The district asserted both negligence and warranty claims. Id. The defendant manufacturer asserted the economic loss rule as a defense to the negligence claim upon which the district had recovered. Id. at 393, 396 S.E.2d at 371. The Court summarized the basic economic loss rule, noted its refusal to apply the rule to residential home building in Kennedy and further noted that it had not "yet been presented with the question of whether the rule should be so rejected in all contexts, including the commercial arena à" Id. The Court did not reach that question. Instead, it disposed of the case on the fact that the district had pleaded and proved "other property damage," not just damage to the asbestos products themselves. Id. at 393-94, 396 S.E.2d at 371.

Beachwalk Villas Condo. Ass'n, Inc. v. Martin, 305 S.C. 144, 406 S.E.2d 372 (1991), gave the Court its next opportunity to address the economic loss doctrine in light of Kennedy. The Court extended Kennedy to architects "in connection with home construction projects," again tying the exception to the particular policy concerns arising from home ownership-in this case, a condominium. Id. at 147, 406 S.E.2d at 374. The Court once more pointed to an independent legal duty owed to homebuyers, existing apart from any contractual duty, because of the "practical difficulties" facing homebuyers in correcting deficiencies in the construction of homes and the particular relationship between the alleged tortfeasor and the homebuyer. Id. at 146, 406 S.E.2d. at 374.

In Tommy L. Griffin Plumbing & Heating Co. v. Jordan, Jones & Goulding, Inc., 320 S.C. 49, 463 S.E.2d 85 (1995), the S.C. Supreme Court applied the rule in Kennedy to an engineering firm. Griffin, a subcontractor on a building project for Charleston County, alleged that the defendant engineering firm, which served as a design professional and supervised the project for the county, had caused it to suffer monetary losses as a result of the engineering firm's alleged wrongful acts, including improper delay of the project, false demands on Griffin not included in its contract and erroneous interpretation of Griffin's contractual obligations. Id. at 51-52, 463 S.E.2d at 86-87.

Once more, the Court focused on the nature of the relationship between the parties and whether the Court recognized any distinct legal duties arising from that relationship. In finding a sufficient "special relationship" between the subcontractor and the design professional in Griffin, the Court looked for guidance in those cases in which persons, such as attorneys and accountants, held themselves out to be professionals possessing special training or skill upon which others might rely in making judgments about how they should act or carry on their business and the plaintiff's resulting loss from relying upon that professional judgment. Id. at 55, 463 S.E.2d at 88-89 (citing Lloyd v. Walters, 276 S.C. 223, 277 S.E.2d 888 (1981) (attorneys); Georganne Apparel v. Todd, 303 S.C. 87, 399 S.E.2d 16 (Ct. App. 1990) (accountants)). The Court reiterated the analytical method it applied in Kennedy:

In our view, the Kennedy application of the "economic loss" rule maintains the dividing line between tort and contract while recognizing the realities of modern tort law. Purely "economic loss" may be recoverable under a variety of tort theories. The question, thus, is not whether the damages are physical or economic. Rather the question of whether the plaintiff may maintain an action in tort for purely economic loss turns on the determination of the source of the duty plaintiff claims the defendant owed. A breach of duty which arises under the provisions of a contract between the parties must be redressed under contract, and a tort action will not lie. A breach of duty arising independently of any contract duties between the parties, however, may support a tort action.

Id. at 54-55, 463 S.E.2d at 88.

These cases set the stage for the S.C. Supreme Court's decision in Colleton Preparatory Academy.

Colleton Preparatory Academy

In Colleton Preparatory Academy, the Supreme Court of South Carolina reviewed its holdings in Kennedy, Kershaw County, Griffin and Beachwalk Villas, among others, and reiterated the rule in Kennedy that "changed the focus of the inquiry from the consequences of the alleged tortfeasor's actions to whether or not the alleged tortfeasor acted in a way that violated a legal duty aside from his contractual duties." 379 S.C. at 189, 666 S.E.2d at 251. Although the Court explained that the "policy considerations noted in Kennedy [were] arguably not present in the commercial construction arena," it determined that the "analytical framework" applied in Kennedy was "universal." Id. at 190, 666 S.E.2d at 252. It thus held that the "serious threat of physical harm" exception set forth in Kennedy would be applicable in the commercial construction context. Id. at 191, 666 S.E.2d at 252. In response to the certified question, as posed by the district court ("Can the user of a defective product recover in tort when only the product itself has been injured and when the product either violated generally accepted industry standards or posed a serious risk of bodily harm?"), the S.C. Supreme Court answered "`no,' if there is merely a breach of industry standards without an accompanying breach of a legal duty owed, and `yes,' if there is a breach of duty accompanied by a clear, serious and unreasonable risk of bodily injury or death." Id. at 194, 666 S.E.2d at 254.

Although the language of its ruling was broad, the Court was careful to note that "focusing on whether or not the actor violated a non-contractual duty does not eviscerate the economic loss doctrine; it only determines its applicability to the case presented." Id. at 190, 666 S.E.2d at 252. Moreover, the Court emphasized that "the traditional lines between tort and contract are not blurred by our decision because tort liability for purely economic losses only attaches where there is a breach of these legal duties beyond the contractual duties." Id. at 191, 666 S.E.2d at 252. Further, the Court clearly rebutted the possibility that its ruling might "raise concerns that manufacturers would essentially become insurers against every remote threat of harm" by stating, "This is not our intent, and we emphasize that the exception applies to serious threats with recovery calculated as the costs to repair or remove the dangerous product." Id. at 193, 666 S.E.2d at 253 (emphasis in original).

Colleton Prep thus cannot and should not be read as resulting in a wholesale reworking of products liability law. Although the Court used broad language, the question actually addressed, as the Court reframed it, was a limited one: whether the Kennedy analytical framework would apply in the commercial construction context. This conclusion is strengthened by the fact that the S.C. Supreme Court has fairly recently affirmed the principle that actual damages are a critical element in a case alleging product defect. In Wilson v. Style Crest Products, Inc., the Court addressed whether consumers (mobile home owners) who had not suffered any personal injuries or physical damage to their homes could bring warranty and fraudulent concealment claims for their alleged "economic loss" or "diminution in value" stemming from their purchase of allegedly defective "soil anchor systems" for their homes. 367 S.C. 653, 656-57, 627 S.E.2d 733, 735-36 (2006). In addressing whether "the Homeowners must prove an actual injury to person or property to bring their warranty and fraudulent concealment claims," the S.C. Supreme Court agreed with a line of cases from other jurisdictions rejecting the "no-injury approach to product litigation." Id. at 657, 627 S.E. 2d at 736.

Seen in light of the S.C. Supreme Court's holding in Wilson, Colleton Prep did not eliminate the economic loss rule from South Carolina jurisprudence. It simply gave commercial plaintiffs a starting point for arguing that the rule does not apply to a particular set of facts in the construction law context.

Susan M. Glenn and Paula M. Burlison practice in the Columbia office of Nelson Mullins Riley & Scarborough, LLP.