Arizona Supreme Court Has the Final Word—Again—on Economic Loss Doctrine

by Snell & Wilmer

Last week, in Sullivan v. Pulte Home Corp., No. CV-12-0419-PR, Arizona’s highest court took on a lingering question about the scope of economic loss doctrine since its landmark decision of Flagstaff Affordable Hous. Ltd. P’ship v. Design Alliance, Inc., 223 Ariz. 320, 321, 223 P.3d 664 (2010). Flagstaff held that the economic loss doctrine limits contracting parties to their contractual claims and remedies and bars tort claims like negligence seeking the same remedies. Sullivan was short and simple: non-contracting parties may bring negligence claims for construction defects because such claims are not barred by the economic loss doctrine. The Supreme Court said this outcome was consistent with its reasoning in Flagstaff

The facts of the Sullivan case are equally simple. Pulte Homes built a new home and sold it in 2000. The original buyer re-sold the home to the Sullivans in 2003. The Sullivans said they discovered retaining wall defects six years later in 2009. The Sullivans filed suit in 2010 because Pulte denied it could be responsible for defects in a ten-year-old home. The Sullivans claimed damages for consumer fraud, fraudulent concealment, negligence, negligent non-disclosure, negligence per se, negligent misrepresentation and breach of implied warranty.

The trial court dismissed the lawsuit because the Sullivans never dealt with or contracted directly with Pulte Homes (i.e. the Sullivans had no contractual privity with Pulte Homes). Since Pulte Homes never made representations to the Sullivans, there could be no fraud or misrepresentation claim. As subsequent buyers in the chain of ownership and occupancy, the Sullivans did have a claim for breach of implied warranty, but this contract-based claim was untimely and barred by Arizona’s eight-year Statute of Repose, A.R.S. § 12-552. The trial court decided, moreover, that the Sullivans’ negligence claims for construction defect were for the same economic damages claimed in contract. The negligence claims were, therefore, barred by the economic loss doctrine. The Sullivans left the trial court empty-handed and appealed.

The Arizona Court of Appeals disagreed with the trial court on the negligence claims. The appellate judges said the lack of contractual privity between Pulte Homes and the Sullivans still allowed the Sullivans to pursue their tort claims for construction defects, even though their implied warranty claim was barred. The appellate court reasoned that if the Sullivans could show that they filed their negligence claim within two years of discovering the retaining wall defects, the Sullivans had a timely tort claim against Pulte Homes for defects in the retaining wall.  Arizona’s eight-year Statute of Repose did not bar this non-contract, tort claim. 

Both the Sullivans and Pulte Homes petitioned the Arizona Supreme Court for review.  In addition, the Arizona Builders’ Alliance, the Home Builders Association of Central Arizona, the Southern Arizona Home Builders Association and the American Council of Engineering Companies of Arizona filed Amicus (“friend of the court”) Briefs.  These associations argued that the appellate court’s ruling was commercially irreconcilable with expectations of builders, homeowners, homebuyers, engineers and architects in the construction industry. These construction associations further argued that tort claims having no time limitation at all would wreak havoc on their construction insurance. Their insurers, after all, issue policies dictating a determinable beginning and end to coverage for defect claims. These insurers would hardly assume such an open-ended risk for defects identified by any number of homebuyers in the indeterminable future. The associations argued that homebuilders will be forced to become their own insurers and will be bankrupted by stale defect claims.

Nevertheless, in the Arizona Supreme Court’s evaluation of Sullivan, the justices concurred with the appellate court by concluding that because “the economic loss doctrine does not bar the homeowner’s negligence claims to recover damages resulting from construction defects … [w]e agree with the court of appeals that the Sullivans’ negligence claims are not barred by Arizona’s economic loss doctrine.”  The end result from Sullivan is, therefore, that homebuilders may now be subject to contract and tort claims for construction defects as follows: (1) a breach of implied warranty based on defects in original construction but no more than eight years after the home is sold; and (2) construction defect tort claims by claimants not in contractual privity with the homebuilder as long as the claims are filed two years after a homeowner discovers the defects.  

A dilemma from the Arizona Supreme Court’s decision in Sullivan is that the entire Arizona construction industry is left wondering how long developers, contractors, subcontractors and design professionals on both residential and commercial projects will be subject to construction defect claims based in tort. We know from Arizona’s discovery rule that claimants must file tort claims within two years of the time the claimant discovered or reasonably should have discovered the defects. But does Sullivan mean to establish that the two-year discovery period restarts when a new owner moves in to a home? How many years after the builder finishes a home does it have to plan on defending defect claims—10, 20, 30 years? Does Sullivan mean that experts will now be the determining factor in fighting expensive battles over when construction defects were actually discovered or reasonably discoverable by the homeowner? Should homebuilders and other construction industry professional affected by this ruling consider assuming contractual duties to subsequent homebuyers to try and subject all defect claims on the home to the eight-year Statute of Repose?      

To be sure, developers, contractors, subcontractors and design professionals need to be on guard about the potential consequences of Sullivan v. Pulte Homes in Arizona. At the very least, these construction industry professionals should be thinking of ways to restructure construction and buyer-seller agreements to include contractual limitation periods or waivers and assignments of rights to claim construction defects, all to try and better define contractual obligations and duties of reasonable care assumed by all parties in the chain of ownership and occupancy. 

It is likely that, as parties continue to challenge the timeliness and validity of construction defects in Arizona, judges, juries and arbitrators will respect the well-reasoned, negotiated and written agreements for construction and sale of residential and commercial properties.  It makes sense to revisit your contracts with Sullivan in mind. It may also be wise to consider an action plan to lobby the Legislature for a specific limitations period to govern all construction defect claims on Arizona projects.

Written by:

Snell & Wilmer

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