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Economic Loss Doctrine Does Not Preclude Professional Negligence Action against Architect by Project Owner for Damages Imposed Under Fair Housing Act

by: J. Kent Holland, Jr., Esq

J. Kent Holland’s Website

Property owner’s suit against an architect alleging professional negligence and seeking purely economic damages was not barred by the economic loss doctrine. As a result of a Fair Housing Act complaint filed by HUD claiming that the design and construction of apartments violated the FHA, the owner was required to incur expense in remedying the design deficiencies. The owner then filed suit against the architect to recover its economic damages in responding the FHA violations. The architect filed a motion to dismiss the complaint on the basis of the eight year statute of repose. The trial court granted the motion but this was reversed on appeal, with the court holding that the statute applies on to breach of contract and not to tort actions such as negligence. The court concluded that the design professional’s duty to use ordinary skill, care and diligence arises out of tort — not contract, and that the economic loss doctrine does not foreclose a cause of action for professional negligence even though the claim seeks only economic damages.

In Flagstaff Affordable Housing Ltd. v. Design Alliance, Inc., 221 Az. 433. 212 P.3d 125 (Ariz. Appl. Div 1) (2009), the plaintiff, Flagstaff Affordable Housing (“Owner”) entered into a contract with Design Alliance (“Architect”) for the design of apartments in Flagstaff, Arizona. Construction of the apartments was completed in accord with the design. No design defects were alleged. Subsequently, the U.S. Department of Housing and Urban Development (“HUD”) filed a complaint against the Owner for housing discrimination, claiming that the design and construction violated the Fair Housing Act (“FHA”). The owner incurred costs in correcting the issues identified by HUD as design deficiencies.

Owner then filed a complaint against the Architect for breach of contract and negligence — and seeking to recover the costs it incurred as a result of the design changes necessitated by the FHA suit. No personal injury or property damage was alleged to have occurred. The suit was strictly to recover purely economic damages. In response, the architect filed a motion to dismiss the complaint on the basis that the 8 year period under the Arizona statute of repose had lapsed, and also that the economic loss doctrine precluded the professional negligence claim. Owner agreed to withdraw its breach of contract claim but it pursued the negligence count — arguing that the economic loss doctrine did not apply to professional negligence claims. The trial court granted the motion to dismiss, but this was reversed on appeal.

In analyzing the merits of the case, the appellate court began by explaining the concept of the economic loss doctrine. It explained as follows:

The economic loss doctrine precludes an aggrieved party from recovering economic damages in tort unless accompanied by physical harm-either in the form of personal injury or property damage…. The doctrine is a creature of judicial origin, its purpose grounded in the judicial hallmarks of distinction and clarity. ‘The purpose of the “economic los rule” is to maintain the distinction between those claims properly brought under contract theory and those which fall within tort principles.’ [citation omitted]. ‘The economic loss rule thus “serves to distinguish between tort, or duty-based recovery, and contract, or promise-based recovery, and clarifies that economic losses cannot be recovered under a tort theory.’ [citation omitted].

The court went on to state that in Arizona, the economic loss doctrine has been applied in two categories of disputes: construction defects and products liability. The court stated that because there was no construction defect involved in the case at bar, the Arizona cases pertaining to the economic loss doctrine are inapplicable here. According to the court:

Here, Owner alleges Architect negligently fell below the standard of care for architects by failing to design the apartments in accordance with the Fair Housing Act. If proven, this would amount to a tort claim for breach of duties imposed by law upon Architect: namely, to act with the ordinary skill, care, and diligence of other design professionals in the architectural field. [citation omitted]. Because Architect’s professional duties arise independently of any contract, the purpose of the economic loss doctrine-maintaining a distinction between tort and contract actions-is not implicated.

The court further stated that application of the economic loss doctrine here would have the effect of eroding an implied duty of care that the architect has “to use ordinary skill, care, and diligence.” The court then cited a number of state statutes concerning the practice of architecture and concluded that application of the economic loss doctrine to limit claims of professional design negligence would be inconsistent with public policy as established by the state statutes.

Having determined that the architect had a duty to the project owner independent of the contract, the court proceeded to find that the state statute of repose did not apply to bar the negligence action since the statute on its face stated that it applied to actions “based in contract.” The statute of repose statute provides, in pertinent part, as follows:

[N]o action… based in contract may be instituted or maintained against a person who… performs or furnishes the design… or construction… of an improvement to real property more than eight years after substantial completion of the improvement to the real property.

The court concluded: “Because we are addressing a professional negligence action rather than a contract action, no violence is inflicted on the statute of repose by allowing a professional negligence claim to proceed despite the expiration of potential contract claims.” For these reasons, the court held that the negligence action against the architect is not barred by either the economic loss doctrine or the statute of repose.

Comment: In order to hold against the architect in this case the appellate court had to get around both the economic loss doctrine and the statute of repose. It got around both by finding that the action against the architect arose independent of the contract between the project owner and architect – that at common law the architect owed a duty to care with regard to performance of its design in a manner consistent with the standard of care applicable to the performance of professional services. As understood by this court, “Because Architect’s professional duties arise independently of any contract, the purpose of the economic loss doctrine-maintaining a distinction between tort and contract actions—is not implicated.” What this holding fails to appreciate is that unless the architect had a contract to perform services for the owner, it would have no duty whatsoever with regard to design services. It is the contract that creates the duty to provide the services. Once that duty has been contractually created, then and only then does a duty exist to perform the services consistent with the generally accepted standard of care.

The court has created a common law duty of care where no such would otherwise exist in the absence of the contract. Having created this duty independent of the contract, the court then proceeded to find that the state statute of repose would not apply because the complaint is independent of the contract and therefore not within the parameters of the statute of repose. But this is surely contrary to the intent of the drafters of the statute of repose — who when drafting it would have logically understood that any action against a design professional would have to arise under its under contract and would not have an independent basis outside the contract.

The court cited a number of other states that have also refused to apply the economic loss doctrine to protect design firms against actions for purely economic damages. The cited cases include Moransais v. Heatherman, 744 So. 2d 973 (Fla. 1999); Robinson Redevelopment Co. v. Anderson, 547 N.Y.S. 2d 458 (1989); Business Men’s Assurance Co. of America v. Graham, 891 S.W. 2d 438 (Mo. Ct. App. 1994); Magnolia Construction Co., Inc. v. Mississippi Gulf S. Engineers Inc., 518 So.2d 1194 (Miss. 1988); and E. Steel Constructors, Inc. v. City of Salem, 209 W.Va. 392, 549 S.E.2d 266 (2001).

In the opinion of this commentator, the holding of the court in this Arizona case is contrary to the principle of honoring the intent of the contract. It also fails to honor the intent of the statute of repose which plainly assumed that any action against a person who performs design or construction would necessarily arise under a contract. One remedy to correct the ill affects of this court’s decision and others like it, might be to revise the state statutes of repose to clarify that the statute applies to any cause of action against a person who performs design or construction where that individual or firm was under a contract to perform such services. In other words, if there is a contract for the services, it would make no difference whether, in the opinion of a court, there might be a duty independent of that contract. The statute would apply in any event. Since that is already the intent of the statute, however, one would not think it really needs any further clarification to explain that intent<

NOTE: This article originally was published in “ConstructionRisk.com Report”, Vol. 11, No. 5 and appears here with permission. Kent Holland is the publisher of “ConstructionRisk.com Report” and principal of ConstructionRisk, LLC. They provide insurance risk management services and construction risk management services, including but not limited to, advice to insurance underwriters; guidance to those procuring insurance; change order and claim preparation, analysis and defense; contract preparation; contract review and contract negotiation.

Kent Holland is a risk management consultant for the environmental and design professional liability unit of Arch Insurance Group, and he is Of Counsel with the law firm of Wickwire Gavin, P.C., with a practice emphasizing construction law.

NOTE: The comments presented are general in nature, and are not intended to be a legal review or legal opinion. Neither a/e ProNet, Kent Holland, or any organization with whom Mr. Holland may are hereby providing legal services. Any opinions stated herein are solely those of Mr. Holland and are not to be attributed to any other party or organization. The information provided herein is for general educational purposes to assist the insured in understanding potential issues concerning the insurability of certain identified risks that may result from the allocation of risks under the contractual agreement. The insured should seek the advice of legal counsel familiar with construction law and contracts in the jurisdictions where this contract will be executed and performed.