Is your construction contract worth the paper it’s printed on?

By Steven W. Keane

Several recent Wisconsin appellate decisions have held that those providing mostly services to construction projects may face greater liability than those considered to be providing a product.

The court decisions involve the application of the economic-loss rule. Under this rule, suing parties that have sustained only economic losses (unrelated to any bodily injury or property damage) for the failure of a product to live up to expectations generally are limited to recovery in contract.

This rule may determine the amount of risk your business faces on construction projects. For example, when a project is significantly delayed by the conduct of a general contractor, a construction manager, a subcontractor or a design professional, the owner may attempt to recover economic losses caused by late project completion. When the owner asserts a breach of contract claim, your attorney may be able to defend against the recovery of economic losses by using your negotiated damage limitations or perhaps a no-damage-for-delay clause. But to circumvent these contractual limitations and attempt to recover greater damages, the owner’s attorney might attempt to also assert noncontractual tort claims, such as negligence.

The purpose of the economic-loss rule is to prevent this from happening and to preserve the distinction between contract and tort law by holding parties to the terms of their negotiated contracts. If the rule applies, a court will likely dismiss the owner’s tort claims seeking to recover economic losses.

But Wisconsin’s appellate courts have decided (at least for now) that the policies behind the rule only apply to construction contracts involving the provision of a product and not to contracts for predominately construction-related services.

A look at recent appellate decisions highlights how critical application of the economic-loss rule can be to your defense. In 1325 North Van Buren LLC vs. T-3 Group Ltd., the Wisconsin Court of Appeals refused to apply the rule to bar tort claims arising out of a contract to renovate an old Milwaukee building and turn it into condominiums. T-3 contracted as a construction manager to provide services and to hire subcontractors to perform the renovation work, but it failed to complete the project on schedule.

The court considered the contract to be for the provision of services, in part because the project involved renovation, and the final product was already in existence at the time of the contract. As a result, the court declined to extend the protections of the rule to dismiss the owner’s claims against T-3 for negligence and misrepresentation, likely exposing T-3 to greater liabilities at trial. In short, the court allowed T-3 to be hit with both barrels: tort claims and breach-of-contract claims.

More recently, the Wisconsin Supreme Court applied the economic-loss rule to protect a general contractor from tort claims. In Linden vs. Cascade Stone Co. Inc. et. al, a homeowner sued the general contractor for defective work by its subcontractors and delay in the completion of the construction of a home, alleging both claims for negligence and breach of contract.

While much of the allegedly defective work was performed by subcontractors, the court held that the terms of the general contract with the owners (not the various subcontracts) would control whether the rule would be available as a defense. While the performance of the general contract clearly involved a mixture of both goods and services, the court concluded that the general contract was predominately for a product (a custom-built house). As a result, the court held that the rule required the dismissal of the homeowner’s tort claim for negligence, and the owner was limited to contractual remedies.

Wisconsin courts will undoubtedly continue to develop law on the application of the economic-loss rule to construction disputes. For now, it appears that courts are willing to potentially treat construction managers differently than general contractors despite both likely having carefully negotiated contracts and the reality that there may not be huge differences between the two project-delivery methods. Risk managers for construction firms must stay on top of developments in these areas and consult with legal professionals if necessary.