Virginia Real Estate, Land Use & Construction Law : Virginia Construction Lawyers & Attorneys : Bean Kinney & Korman Law Firm : VA Real Estate, Land Use & Zoning

A decision issued this month by the Supreme Court of Virginia, Kaltman v All American Pest, answers a question often debated by Virginia lawyers regarding the economic loss rule.  The case also may contain a hidden Trojan horse to contract defenses that everyone should pay attention to.

As we have discussed here on several occasions, the economic loss rule is a critical concept in Virginia construction law.  Stated simply, a party cannot sue under Virginia law for economic losses without establishing they have a contract.  Another case and its progeny, Richmond v. McDevitt Street, ruled that a plaintiff cannot sue in tort for a duty assumed solely by contract.

In Kaltman, a worker failed to properly clean his equipment after a commercial job.  The next day, he used the same equipment on a residential home, including on porous surfaces.  The result was a high-powered commercial pesticide was used on home despite it being inappropriate for residential use.  Despite multiple rounds of cleaning, the owners could not remove the pesticide smell from the home.  The owners claimed personal injuries and property damage from their home being rendered uninhabitable by the smell.

The defendants request that the trial court dismiss the case based on the economic loss rule barring tort claims.  The court agreed.  On appeal, the Supreme Court reversed and found that the owners could allege an independent tort duty to protect against personal injury and property damage.  While the court threw out the willful and wanton conduct allegations, it allowed both negligence and negligence per se to survive.

Why does it matter if you can sue in both contract and tort?  I can think of several strategic and practical reasons:

1. The tort claims may more easily trigger insurance coverage;
2. The tort claims may escape the net of contractual notice of claims provisions; and
3. The tort claims may escape the restrictions of limitations of liability clauses.
4. The tort claims may allow broader damages more easily than contract claims.

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Many plaintiffs attempt to allege fraud claims in construction cases.  These attempts generally fail in Virginia because a claimant must allege a basis for a fraud claim that arises outside the context of a contractual duty.  This theory was clearly established in the Richmond v. McDevitt Street Bovis case in 1998, but we still see it regularly playing out in Virginia state and federal courts. 

Fraud claims have a couple interesting features.  First, they must be pleaded with specificity and particularity.  Second, a host of case law establishes that the types of "representations" that can support a fraud claim are quite limited.  These first two features mean that a plaintiff can expect extensive aggressive motions practice attacking their offensive pleading and courts often throw out fraud cases.  Third, fraud claims have an elevated burden of proof.  Rather than proving fraud by a preponderance of evidence, the plaintiff must prove fraud by clear and convincing evidence.  Fourth, fraud claims allow recovery of punitive damages in egregious cases.  Fifth, fraud claims can also allow recovery of attorney's fees in some circumstances.

Why invite all this hassle and increased expense and effort into a case?  The reality is that recovery of punitive damages is extremely rare and punitive damages are capped in Virginia at $350,000.  The potential for attorney fee recovery is nice and may represent leverage in negotiations, but in my estimation this is not the driving issue.  The two biggest reasons in my mind are 1) attempting to gain the benefit of a discovery accrual trigger for statute of limitations, and 2) finding ways to circumvent the economic loss rule.

As we recently discussed, Virginia law has a hair trigger on when the limitations clock starts to run.  Unlike neighboring Maryland and DC, Virginia uses a damage trigger instead of starting from when a plaintiff knows they have a problem.  In construction cases, many elements of the project are covered up and defective work can take years to manifest in observable damages.

Fraud also may offer a way to sidestep the economic loss rule.  We have often discussed the economic loss rule which is critical to analyzing who can be sued for what.  In cases where a party is not in contract with the plaintiff, options are limited under Virginia law.  Fraud is one way to potentially get around that boundary, but it is a very narrow passage and subject to significant obstacles.

That being said, many plaintiffs seem to use the kitchen sink method of pleading and allege every cause of action that exists in Virginia.  This may not only be risky from a perspective of good faith pleading, it can be a strategic nightmare.  Why drive up litigation costs, invite hosts of well taken motions, and lost credibility in a case just to stretch to allege a claim that will ultimately fail?

Links to recent fraud posts by Heidi Meinzer:

Broken Promises Won't Get You a Fraud in the Inducement Claim

Broken Promises, Part 2

Construction Law Musings Reply: Fraud and Construction Contracts: Like Oil and Water?

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The Virginia Supreme Court recently gave us yet another example of a breach of contract case that couldn’t rise to a fraud in the inducement claim in Station #2, LLC v. Lynch, et al., Record No. 091410.

In Station #2, the Lynches owned a three-story building in the City of Roanoke. They sold the top two floors to 237 Granby LLC in order to convert the floors to condos. The Lynches then leased the ground floor to Station #2 so it could operate a restaurant with live music and other entertainment. The lease between the Lynches and Station #2 required Station #2 to install soundproofing material in the void space between Station #2’s ceiling and the lower level of 237 Granby’s condos. 237 Granby’s agent agreed to allow Station #2 access to the void space, but the company hired by the agent to renovate and develop the condos closed off the void space before Station #2 could soundproof.

After repeated noise ordinance citations, the City of Norfolk ordered Station #2 to stop all musical performances, causing a steep decline in the restaurant’s business. Station #2 threatened to withhold rent until it was allowed access to install the soundproofing, and the Lynches responded by locking Station #2 out of the building.

Station #2 filed suit, alleging among other things breach of contract and fraud in the inducement against 237 Granby’s agent and statutory conspiracy against the agent and the Lynches. The thrust of these claims was 237 Granby’s refusal to honor the agreement to allow access to the void space. The defendants filed a demurrer based on the economic loss rule and an interesting statute of frauds argument.

Regarding the fraud claim, the Court reiterated that fraud requires a false representation of a material fact, and that mere failure to perform a promise is insufficient unless the promisor had no intention of performing at the time he made the promise. Unfortunately for Station #2, its complaint did not allege that 237 Granby’s agent had no intent to perform at the time it promised to allow access to the void space. Instead, the complaint merely claimed that the agent and the Lynches agreed to prevent Station #2 from soundproofing the void space. The only duty alleged – providing access to the void space – was a mere contractual duty that could not give rise to fraud in the inducement. In resolving this issue, the Court unfortunately sidestepped the more interesting question – whether a person who fraudulently induces someone into entering into a contract can be liable for fraud in the inducement if that person is not a party to the ultimate contract.

Regarding Station #2’s statutory conspiracy count, the Court refused to allow mere breach of contract to constitute an “unlawful act” that could form the underpinning for a conspiracy. Had Station #2 sufficiently alleged fraud in the inducement, it may have been able to also proceed with its statutory conspiracy claim.

Regarding the statute of frauds, the defendants claimed that installing soundproofing in the void space was the equivalent of creating a party wall, i.e. accessing and occupying real property. According to the defendants, Station #2 was required to have an easement, and the agreement for an easement would have had to have been in writing. The Court rejected this argument, pointing out that Station #2 did not need continuing access to and use of the void space. Instead, Station #2 needed only permission – a license – to enter the void space and install the soundproofing, and that permission could be given orally.

Stay posted until next time when we contrast Station #2 with a recent Circuit Court opinion that reached the opposite conclusion and allowed a fraud in the inducement claim to go forward.
 

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I spent this weekend thinking about the significant victory for Virginia home owners in the Chinese drywall litigation that was tried as part of the pending class action in New Orleans.  It may have mattered quite a bit that this ruling was issued in New Orleans as opposed to Virginia. 

I run the risk of delving into legal complexity, but it is necessary here to understand these issues.  We have talked about the economic loss rule several times here, in particular as it relates to products liability cases, and implications of classifying damages in such cases.  Those interested in design and construction issues in Virginia absolutely need to understand the economic loss rule.  The contours of this rule define who can whom and for what.  This rule is heavily briefed, argued, and litigated and can mean the difference between a big payday and a big goose egg.

It is clear in the Chinese drywall case that the home owners purchased a single unitary home from various builders and that one part of the home (the drywall) damaged others (piping, wiring, HVAC, et c).  There is a strong argument these cases fall under the clear mandate of the seminal Virginia case on this topic, Sensenbrenner v. Rust, Orling & Neale.  At least as to the home repair issues, the Sensenbrenner case would potentially eliminate all of the negligence based property damage theories of recovery for home repairs.

The remaining theories of recovery against remote manufacturers would be for breach of UCC warranties.  The next layer of analysis would be to evaluate whether the repair costs claimed are direct damages or whether they were consequential damages requiring privity of contract that are thus barred.  The products cases in Virginia have stuck to the statutory measure of direct damages which is the difference of the value of the product as warranted versus as delivered.

Reading the court's opinion issued last week in the drywall case, the court never discussed any of these issues.  The court discusses Virginia law, property damage, and recoverable measures of damages for property damages at length.  The economic loss rule is never mentioned, nor is the Sensenbrenner case, nor is the UCC line of cases on direct versus consequential damages.  Reviewing the cases and our previous posts, this case may have turned out very differently if tried in a Virginia court.

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Virginia law continues to apply a strict division between contract claims and tort claims.  This rule holds true in the context of professional malpractice claims as well.  Many states apply legal rules where professional malpractice claims arise from negligence or both negligence and contract.  This is not the case - from 1976 forward, the Supreme Court of Virginia stated in Oleyar v. Kerr that a claim for professional malpractice, while sounding in tort, was actually a claim for breach of contract with a contract statute of limitations.

The nature of professional services does present a somewhat different posture for the economic loss rule than simple contracts cases.  A licensed professional is regulated by the Commonwealth and required to meet express professional services prior to licensure.  Many of the statutes and regulations that govern professionals expressly provide that in addition to duties assumed pursuant to contract, the law imposes duties towards the safety of the general public on the licensed professional.

Despite these license implications, Virginia again applies the economic loss rule in the context of professional services.  In Gerald M. Moore & Son, Inc. v. Drewry, the Supreme Court of Virginia considered a case where the plaintiff had a contract with an engineering corporation.  In its claim for economic losses, the plaintiff sued both the engineering corporation and the individual engineer for negligence.  The Supreme Court of Virginia ruled that in the absence of privity, a party could not be held liable for damages caused by negligent performance of a contract and that the same rule applies to professional engineers.

See our previous economic loss rule posts.

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As we watch Chinese drywall litigation erupt nationally, we see the rapid fallout: insurance companies denying coverage; suppliers going bankrupt; homeowners filing suit against all the parties in the food chain.  We have seen this story before.  In Virginia, the applicable could translate to some very harsh results even if owner plaintiffs can prove the drywall was defective and caused damages.

Why is that?  We have learned that Virginia requires a contract to recover "economic losses".  We have also discussed that this requirement extends to products liability cases for recovery of "consequential damages" despite a statute in the Uniform Commercial Code that appears to eliminate lack of privity as a defense.  We now need to see how these definitions play out in actual context.

For home owners, the owner may want to recover the cost of repair to their home associated with defective products.  Virginia courts appear to agree that owners purchase real estate from builder/sellers rather than goods and have no UCC remedies against manufacturers and sellers of goods.  Under the Sensenbrenner case, the owner's remedy for economic repairs sounds in breach of contract against the builder.  If the builder goes bankrupt, the owner may be completely out of luck.  If there are express warranties on products that were assigned to the owner, they may have an express warranty claim; however, it is quite rare that all those t's are actually crossed.

On the builder side, if a builder is sued by the owners, they might try to drag in all the contractors, subcontractors, suppliers and manufacturers to pass through the claimed repairs of the owners.  Virginia again applies conservative principles, even on products cases, and forces people to stick to the chain of privity.  On products cases in particular, in Pulte v. Parex, the Supreme Court of Virginia stated that a builder's attempt to pass through a home owner's damages were consequential damages and, "fit into this definition like a hand in a glove."  The Court applied a conservative analysis in blocking the builder's claims for breach of express and implied warranties, indemnification, and contribution.  (Disclosure - I represented the manufacturer in this case, so if there is any apparent bias here, guilty as charged).

What are the takeaways from this series of cases?

• Construction products liability cases face significant legal hurdles under Virginia law
• The basic requirement for privity of contract appears intact on Virginia products cases relative to attempts to pass through repair cost claims
• You should assume that you need to stick to the chain of privity to recover unless you get lucky
• A bankruptcy can cripple your ability to get to the responsible party

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We have seen waves of claimed problems with construction products over the last several decades: PVC plumbing fixtures and materials; fire retardant treated (FRT) plywood; exterior insulation and finish systems (EIFS).  We are on the front edge of another eruption with Chinese drywall, and indeed we have heard the first rumblings that the drywall problems may extended to materials manufactured in the United States.  It seems like the construction industry has become the Land of Misfit Toys from my favorite old school TV special, Rudolph the Red-Nosed Reindeer.  

Construction products liability cases present a very messy interaction between tort, contract, traditional economic loss principles, and the Uniform Commercial Code (UCC).  We have previously discussed Virginia's economic loss rule which basically provides that in order to recover economic losses, you need to have a contract with the party you are suing.  To understand the interplay, we need to get a little more technical than we usually do here on the blog. 

The UCC states at Section 8.2-318, "Lack of privity ... shall be no defense in any action brought against the manfuacturer or seller of goods to recover damages for breach of warranty, express or implied, or for negligence [.]"  That should end the issue on products cases as the statute is clear, right?

Wrong.  The Supreme Court of Virginia found in the Beard Plumbing case that with regards to claims for consequential damages, the consequential damage statute was more specific and controlled over the general "anti-privity" statute.  The consequential damage allowed recovery of losses known by the seller "at the time of contracting ".  Thus, the court ruled that to recover consequential damages under the UCC, the claimant still has to demonstrate privity of contract despite the UCC anti-privity statute.

Next time, we will talk about what are direct versus consequential damages, in particular as it relates to privity and economic loss.  Teaser: if the plaintiff is stuck with the direct damages as precisely defined in the UCC, the plaintiff is one unhappy camper on a construction case.

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The economic loss rule defines that most basic of questions: who can sue whom and for what claims.  Virginia still sticks to an extremely Conservative judicial model and this philosophical thread is readily apparent in cases dealing with this question.  The Virginia economic loss rule provides that in order to sue a party for "economic losses", the plaintiff generally needs to have a contract with the defendant.

The rule is simply stated in isolation, but proves to be a source of continuing debate, especially in construction litigation.  The seminal Virginia case, Sensenbrenner v. Rust, Orling & Neale, sets the groundwork with its definition of "economic losses".  In the Sensenbrenner case, the plaintiffs purchased a home with an indoor pool from a builder.  The plaintiffs claimed that the pool was negligently designed and built on fill, settled, and caused leaking from broken pipes.  This water in turn was alleged to have caused the bottom of the pool and the foundation of the house to crack.

The court discussed the differences between contract and tort.  While tort law easily handles legally imposed duties, tort law "is not designed, however, to compensate parties for losses suffered as a breach of duties assumed only by agreement."  The court found that the plaintiffs entered into a single contract for construction of a home with a pool.  When one part of the home damaged another, the plaintiffs suffered nothing more than "disappointed economic expectations."  Thus, their remedy sounded in contract.  They had no contract with the architect or pool installation subcontractor, so their claims failed as a matter of law.

When all the parties are still standing, the economic loss rule basically forces parties to stick to the food chain for their remedies.  This naturally means that risk allocation provisions really have teeth under Virginia law because courts will often block plaintiffs from slipping away from these clauses by restating their contract claims in tort.  In today's quite risky economy, the economic loss rule means that a bankruptcy at some point in the contract chain of privity can often let a whole chain of potentially liable parties off the hook.

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