Fraud as an Exception to the Economic Loss Doctrine: Changing Trends in Colorado and Tennessee

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The Economic Loss Doctrine and its various analogues (e.g., the Independent Duty Rule and the Gist of the Action Doctrine) vary in form and application, but each is a judge-made rule serving one principle: If a party seeks the same economic losses for breach of contract and breach of a common law tort duty, courts must bar the tort claim to prevent a duplicative, windfall recovery. Most frequently, the Economic Loss Doctrine bars negligence claims. Its outer bounds begin with intentional torts, and most jurisdictions do not apply the Economic Loss Doctrine to fraud claims.

But two recent state-court decisions evidence a change in that trend: Both held that the Economic Loss Doctrine bars fraud claims because parties to a commercial contract — often sophisticated and represented by counsel — allocate risk, prescribe damages, and rely on the terms of the bargain. Economic losses flowing from fraud related to such a contract are not recoverable.

Practitioners ought to be aware of the status of a jurisdiction’s rule against the recovery duplicative economic losses and whether an argument can be made that fraud cannot be actionable as a result.

Dream Finders Homes LLC v. Weyerhauser NR, 2021 WL 5707117 (Colo. App. Dec. 2, 2021)

Dream Finders followed a series of cases in which Colorado appellate courts grappled with whether to except intentional torts from the Economic Loss Doctrine. It resolved the split unequivocally: Under Colorado law, the Economic Loss Doctrine bars claims of post-contractual fraud, so long as the traditional elements of the Economic Loss Doctrine are satisfied.

Weyerhaeuser, a designer and manufacturer of lumber products, sold wooden support joists to Dream Finders Homes. Dream Finders Homes purchased the joists from a retailer, whose terms of purchase included Weyerhaeuser’s warranty. Purchasers soon complained that the joists, which were coated with a fire-resistant protectant, emitted an irritating, chemical-like odor. Weyerhaeuser discontinued sales of the joists and promised to make repairs and replacements. Dream Finders Homes chose to remove the joists mechanically, the cost of which Weyerhaeuser paid.

Even though Weyerhaeuser removed the joists at its own cost, Dream Finders Homes filed suit for breach of express and implied warranties, negligent misrepresentation, and fraudulent concealment, among other claims. Dream Finders Homes claimed that Weyerhaeuser misrepresented the nature of the joists and claimed remediation costs and legal expenses. A jury found Weyerhaeuser liable for negligent misrepresentation and fraudulent concealment. Weyerhaeuser appealed, arguing that Colorado’s Economic Loss Doctrine must bar Dream Finders Homes’ claims for negligent misrepresentation and fraudulent concealment.

The Colorado Court of Appeals held that the Economic Loss Rule barred Dream Finders Homes’ tort claims, including fraudulent concealment. The court first articulated the principle underlying the Economic Loss Doctrine: “[C]ontracting parties should be held to the ‘terms of their bargain’ and should ‘confidently allocate risks and costs … without fear that unanticipated liability may arise in the future.” Otherwise, “a party that suffered only economic loss as a consequence of breach of contract” could assert a tort claim for the same damages.

Courts must determine if the Economic Loss Doctrine bars tort claims by first asking: Did the tortious conduct occur after contract execution? If so, courts then ask (1) whether the relief sought in tort is the same relief sought for breach of contract; (2) whether there is a common law duty of care; and (3) whether the common law duty differs from the contractual duty.

Addressing the first question, the court concluded that Weyerhaeuser and Dream Finders Homes dealt in a “network of contracts,” which is a “network of interrelated agreements between commercially sophisticated parties.” In other words, Weyerhaeuser and Dream Finders Homes entered a distribution agreement, a general terms agreement, stand-alone warranties, and invoices. No individual contract set out all the terms for sale of the joists. But, together, the contracts — as is the case in many complex construction transactions — made up the parties’ allocation of risks, duties, and remedies. When fraudulent conduct occurs after the network of contracts forms, the Economic Loss Doctrine can bar fraud. In this case, Weyerhaeuser’s misrepresentations and concealment occurred after the parties entered a contract. Dream Finders Homes’ purchase of the joists was, therefore, subject to the first contract.

Because Weyerhaeuser’s tortious conduct occurred after execution of the first contract, the court addressed each of the remaining factors. First, Dream Finders Homes sought the same relief for its tort- and contract-based claims: economic losses. Second, Weyerhaeuser owed Dream Finders two common law duties: not to conceal information fraudulently or negligently misrepresent information. Third, the court concluded that Weyerhaeuser’s common law tort duties were no different than its obligations under the network of contracts. Specifically, every party to a contract in Colorado has a duty of good faith and fair dealing. That duty imposes an obligation not to lie about, or conceal, material information.

As a result, Weyerhaeuser had the same duty to be truthful under the network of contracts and the common law. Where post-contractual fraud met the Hamon factors, Dream Finders Homes’ tort claims, including fraud, were barred by the Economic Loss Doctrine.

Commercial Painting Co. v. Weitz Co., 2022 WL 737468 (Tenn. Ct. App. Mar. 11, 2022)

Weitz Company (Weitz) agreed to be the general contractor for the construction of a retirement community. Weitz hired Commercial Painting to install drywall. Commercial Painting had an obligation to complete its work in accordance with Weitz’s project schedule.

The dispute arose when, after contract execution, Commercial Painting learned that Weitz misrepresented the extent to which the project schedule was already delayed. As a result, Weitz repeatedly condensed the project schedule. For Commercial Painting, this meant more work had to be completed in a shorter period of time. And Weitz ultimately refused change orders and payment for Commercial Painting’s extra work. Commercial Painting brought a claim for breach of contract and fraudulent concealment.

Under Tennessee law, the Economic Loss Doctrine is a “judicially created remedies principle that operates generally to preclude contracting parties from pursuing tort recovery for purely economic or commercial losses associated with the contractual relationship.” Commercial Painting was not the first Tennessee court to consider whether fraud must be an exception to the Economic Loss Doctrine. In Milan Supply Chain Sols. Inc. v. Navistar, Inc., a 2021 decision, the Tennessee Supreme Court surveyed how state courts across the country have dealt with this question, however limitedly:

  • First, very few jurisdictions always apply the Economic Loss Doctrine to bar fraud claims. Where jurisdictions have taken this approach, such cases are viewed as outmoded and have largely been abrogated, overruled, or called into question.
  • Second, most states never bar fraud claims under the Economic Loss Doctrine. The rationale is that fraud is among the least desirable behaviors, and it cannot be deterred if barred by the Economic Loss Doctrine.
  • Third, some jurisdictions bar fraud claims under the Economic Loss Doctrine, but only if the fraud is extraneous to, and not interwoven with, the parties’ contract.

The Tennessee Supreme Court adopted the third approach, barring fraud in limited circumstances: “[W]here a situation involves a contract between sophisticated commercial entities and the plaintiff seeks economic losses only, ‘the economic loss doctrine applies if the only misrepresentation[s] by the dishonest party concern the quality or character of the goods sold.'” Because Milan Supply Chain dealt not with a construction contract but with the sale of goods, the Commercial Painting court had to determine (1) if the limited exception adopted in Milan Supply Chain applies to construction contracts and, if so, (2) whether Weitz’s alleged fraud was barred.

Ultimately, the Commercial Painting court extended Milan Supply Chain‘s holding to the construction context. First, both parties were “sophisticated commercial business entities.” Second, the contract was signed only after heavy negotiation and investigation. Third, the misrepresentations — namely, whether the project schedule had already been delayed — “clearly involved the subject matter of the parties’ agreement.” Thus, Tennessee’s Economic Loss Doctrine barred Commercial Painting’s fraud claim.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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