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TOWARDS A BROADER UNDERSTANDING OF PRIVITY EXCEPTIONS IN LAW: BESTOWING LIMITED RIGHTS ON INCIDENTAL THIRD-PARTY BENEFICIARIES IN CONSTRUCTION LITIGATION TO FULFILL PUBLIC POLICY OBJECTIVES

Cory H. Howard

ABSTRACT

This article explores the history and current adoption of the economic loss rules in a variety of jurisdictions across the United States. Of particular importance to construction law, the economic loss rule, as it is currently implemented in a number of jurisdictions, threatens to dole out inequitable results as a result of the doctrine’s anachronistic public policy justifications. As the construction industry evolves and project delivery methods become more complex, a modified view of the economic loss rule is imperative to ensure that strict contractual privity, once a non-negotiable requirement of the economic loss rule, does not threaten equitable considerations of the multitude of parties not in contractual privity with one another on large-scale construction projects. This article attempts to explain how a deeper understanding of the public policy that is currently used to justify a narrow interpretation of the rule can be used to expand its application and equity, with strengthening its policy considerations.

 Cory H. Howard is an attorney in Winston Salem, North Carolina. Mr. Howard is a 2014 graduate of the Wake Forest University School of Law and a 2011 graduate of the George Washington University. He would like to thank the editors and staff of the Gonzaga Law Review for their hard work in preparing this article for publication, as well as Sara Howard and Bailey, without whose support this article would not have been possible.

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TABLE OF CONTENTS

I. INTRODUCTION...... 189

II. THE ECONOMIC LOSS RULE ...... 191 A. What is the Economic Loss Rule? ...... 191 1. History of the Economic Loss Rule ...... 192 a. Foreseeability of Loss as Paramount in Actions for ...... 192 b. Application in Products Liability ...... 193 2. Current Incarnations of the Rule ...... 196 a. Traditional Interpretation of the Economic Loss Rule .... 197 b. The Modified Approach to the Economic Loss Rule ...... 198 i. Derivations From the Strict Privity Requirement ..... 198 ii. Actions Permitted in the Context of Contractual Privity ...... 199 iii. Substitutions for Privity ...... 200 B. Public Policy of the Economic Loss Rule ...... 203

III. THIRD-PARTY BENEFICIARIES AND THE EXTENSION OF THE ECONOMIC LOSS RULE ...... 204 A. Contract Law and Third-Party Beneficiaries ...... 204 1. The Public Policy Rationale of Recognizing the Rights of Third-Party Beneficiaries ...... 207 2. Recognizing the “Sufficient Nexus” of Third-Party Beneficiaries ...... 209 a. The Public Policy Rationale and Concerns of the Third-Party Beneficiary as Substantial Nexus Rule ...... 212

IV. THE ECONOMIC LOSS RULE AND CONSTRUCTION ...... 214 A. The Concept of “Public Policy” as a Judicial Impetus Towards “Fairness” ...... 214 B. Construction Project Delivery Methods Require a Modified View of the Economic Loss Rule ...... 215 1. Contract v. Tort: Does an Expanded Economic Loss Rule Erode the Foundation of Public Policy ...... 216

V. CONCLUSION ...... 219

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I. INTRODUCTION

While a quick review of throughout the United States may provide what appears to be a quick definition of the economic loss rule, pinning down a precise and all-encompassing definition of the rule is difficult, as the rule’s permutations make a complete, cross-jurisdictional approach almost impossible.1 For introductory purposes, the economic loss rule “prohibits recovery in tort for purely economic losses.”2 This stems from the premise that litigants in English common law systems must decide whether to attempt to recover damages in tort or in contract. Recovery in tort relies on the existence of a duty owed to the aggrieved party, while recovery under a breach of contract requires the existence of a valid contract, necessitating proof that the parties are in privity. Although recognizing that a breach of contract can give rise to both tort and contract claims,3 the economic loss rule generally bars aggrieved parties from collecting for purely economic losses in tort. However, the many permutations of the rule also determine what type of actions can be brought in contract law by barring suits for contractual damages where the parties have no contract.4 So, what happens when parties are left in the legal limbo that the economic loss rule creates? That is, what happens when parties who engage each other in a contractual situation, but are not in privity, sustain economic damages? This problem is of particular concern for the construction industry. For example, imagine that a property owner hires a developer to build a hotel: the owner then hires an architect to design the structure; the architect then hires an engineer to ensure stability of the design. In order to complete construction, the developer then hires a general contractor, who subsequently subcontracts out most, or all, of the trade work. This means that most tasks, from painting interior walls to the installation of exterior siding or the construction of a parking garage, are accomplished by a chain of parties, each of whom only has contractual privity with those directly above and below them. While trade specialization is essential for the complex construction

1. See Vincent R. Johnson, The Boundary-Line Function of the Economic Loss Rule, 66 WASH & LEE L. REV. 523, 526 (2009) (noting that there are many variations of the economic loss rule and is not considered a “settled” area of the law). 2. Long Trail House Condo. Ass’n v. Engelberth Constr. Inc., 59 A.3d 752, 755 (Vt. 2012) (quoting EBWS, LLC v. Britly Corp., 928 A.2d 497, 507 (Vt. 2007)). 3. See, e.g., Pinnex v. Toomey, 87 S.E.2d 893, 898 (N.C. 1955) (where the North Carolina Supreme Court held that “accompanying every contract is a common law duty to perform with ordinary care the thing agreed to be done, and that a negligent performance constitutes a tort as well as a breach of contract.”) 4. Tiara Condo. Ass’n v. Marsh & McLennan Cos., 110 So. 3d 339, 403 (Fla. 2013) (noting that the economic loss rule has been expanded over time to include a privity requirement for contract actions). HOWARD 1/13/2016 11:31 AM

190 GONZAGA LAW REVIEW Vol. 51:1 projects undertaken today, it creates serious judicial headaches when portions of the project fail to meet the owner’s expectations. Because of the economic loss rule’s requirements that (1) economic damages only be recovered in tort and (2) in order to recover in contract for economic damages, parties must have privity, or a suitable nexus to replace privity,5 construction litigation cases are often multi-party affairs that drag the negligent in with those who have adequately performed their job duties. Take for example the aforementioned project delivery scenario. If the concrete subcontractor, who was hired by the general contractor, failed to properly install steel reinforcements in the concrete, or failed to ensure the concrete was properly mixed or installed (if it was pre-cast), the owner would be forced to file a breach of contract claim against the developer, who in turn would be forced to file a claim against the general contractor, who would then be forced to file a claim against the concrete subcontractor.6 This article will show that the economic loss rule, especially as it is applied to construction litigation cases, should be interpreted in a different manner by courts, thus preserving judicial economy, preventing unjust results, and ensuring that the rule’s application is consistent with public policy. While some jurisdictions have developed specific statutory ways for select parties in construction defect cases to maintain causes of action without direct privity,7 something not possible with a narrow interpretation of the economic loss rule, these legislative fixes are not a panacea. Instead, courts should look to the rules regarding third-party beneficiaries in order to craft a privity exception to the economic loss rule that would avoid the circuitous litigation plaguing the construction industry. Part II of this article will explain the economic loss rule, including its historical progression and current forms. Part III of this article will explore the role of third-party beneficiaries in expounding the rule to construction law contracts. Part IV of the article will be dedicated to exploring how the public policy of the economic loss rule is upheld by selecting a broader interpretation (which leads to a more narrow application) of the economic loss rule in construction litigation.

5. Blake Construction Co. v. Alley, 353 S.E.2d 724, 727 (Va. 1987). 6. This scenario, and recommended legal strategy, was exactly what the Ohio Supreme Court faced in Corporex Dev. & Constr. Mgmt. v. Shook, Inc., 835 N.E.2d 701, 705 (Ohio 2005). 7. See, e.g., Greystone Homes, Inc. v. Midtec, Inc., 168 Cal. App. 4th 1194, 1213- 14 (Cal. Ct. App. 2008) (citing the Right to Repair Act, Cal. Civ. Code § 896 (2013) (permits recovery by homeowners for economic losses from the make of a defective product)). HOWARD 1/13/2016 11:31 AM

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II. THE ECONOMIC LOSS RULE

A. What is the Economic Loss Rule?

Generally, the economic loss rule is a legal doctrine that bars recovery in tort actions where a contractual relationship between the parties exists and the losses claimed are purely economic losses.8 It thus serves as a “fundamental boundary between contract law . . . and tort law,” enforcing expectancy interests where appropriate, and promoting policies to discourage physical harm to citizens.9 To understand the role of the economic loss rule, it is important to differentiate economic losses from their counterpart: losses from tortious conduct. Economic losses are a discrete category of damages under traditional common law, including, among other claims, “damages for inadequate value, costs of repair and replacement of the defective product or consequent loss of profits.”10 Several courts have elaborated on what constitutes an economic loss, noting that the term “includes the diminution of value of the product because it is inferior in quality and does not work for the general purposes for which it was manufactured and sold.”11 Economic losses are, therefore, distinct from personal loss, and the economic loss rule limits a tortfeasor’s legal liability for economic loss when there is no accompanying physical injury.12 Yet, it is important to note that economic loss is not a monolithic category of damages from which all products-based damages stem. Rather, there are three distinct kinds of economic losses: (1) “harm to the product itself,” (2) harm to a component part of a broader system, and (3) “[p]ure [e]conomic [l]oss [c]aused by [e]conomic [t]orts.”13 The idea that economic loss can be further broken down into discrete sub-categories is especially pertinent to the discussion of the rule’s influence in construction law. This is because construction projects traditionally produce damages that the

8. See Alejandre v. Bull, 153 P.3d 864, 868 (Wash. 2007) (“In short, the purpose of the economic loss rule is to bar recovery for alleged breach of tort duties where a contractual relationship exists and the losses are economic losses.”). 9. Tiara Condo. Ass’n v. Marsh & McLennan Cos., 110 So. 3d 339, 401 (Fla. 2013). 10. Robinson Helicopter Co. v. Dana Corp., 102 P.3d 268, 273 (Cal. 2004). 11. Casa Clara Condominium Ass’n v. Charley Toppino, 620 So. 2d 1244, 1246 (Fla. 1993) (quoting Margolis v. Jackson, 543 A.2d 1238, 1240 (Pa. 1988)). 12. See Pub. Serv. Enter. Group, Inc. v. Phila. Elect. Co., 722 F. Supp. 184, 193 (D.N.J. 1989) (noting that the economic loss rule places purely economic loss outside the scope of recover even if a direct result of the negligent act). 13. Danielle Sawaya, Note, Not Just for Products Liability: Applying the Economic Loss Rule Beyond Its Origins, 83 FORDHAM L. REV. 1073, 1079-81 (2014) (identifying three discrete categories of economic losses). HOWARD 1/13/2016 11:31 AM

192 GONZAGA LAW REVIEW Vol. 51:1 court categorizes as economic losses, although the damages are the result of disappointed economic expectations arising from a breakdown in quasi- contractual relationships. Focusing on the type of damages that arise, and looking specifically to the nature of the parties’ relationship that gave rise to the damages, sheds a better light on the inequitable results that occur under current incarnations of the economic loss rule. While the rule has been read broadly, courts have cautioned against assuming that the plaintiff is precluded from recovery in tort every time there is an economic loss.14 This is partially because there are a number of judicially and legislatively sculpted exceptions, allowing for recovery in tort for purely economic loss.15 Primarily, the economic loss rule serves as a boundary to dole out the appropriate measure of relief, thus protecting parties from claims for personal loss where there is no injury; it also provides for the institution of contractual reparations when a party has suffered “disappointed economic expectations”16 as a result of the breakdown in a bi-lateral or multi-lateral contractual relationship.

1. History of the Economic Loss Rule

a. Foreseeability of Loss as Paramount in Actions for Breach of Contract

Determining a precise developmental timeline of the economic loss rule is difficult,17 but in its original form, state and federal courts used the rule in products liability cases.18 Before the evolution of the economic loss rule, damages resulting from a breach of contract, whether economic or non-

14. See Eastwood v. Horse Harbor Found., Inc., 241 P.3d 1256, 1261 (Wash. 2010) (cautioning that the economic loss rule is not an absolute bar to tort recovery by parties in contractual privity). 15. See Latino Food Marketers, LLC v. Ole Mexican Foods, Inc., No. 03-C-0190-C, 2004 U.S. Dist. LEXIS 5249, at *27-28 (W.D. Wis. Mar. 29, 2004) (holding that “the tort of intentional [is] not barred by the economic loss” rule, even though the parties were in contractual privity); Connecticut Mut. Life Ins. Co. v. New York & New Haven R.R. Co., 25 Conn. 265, 276 (1856) (noting that where the tort is an intentional tort, the economic loss rule will not bar recovery for economic damages); American Towers Owners Ass’n, Inc. v. CCI Mech., Inc., 930 P.2d 1182, 1190 n.11 (Utah 1996) (noting that in cases of intentional , such as fraud or intentional interference with contract, Utah law recognizes the recovery of purely economic damages in tort). 16. Sensenbrenner v. Rust, Orling & Neale Architects, Inc., 374 S.E.2d 55, 57 (Va. 1988); Stuart v. Coldwell Banker Com. Group, Inc., 745 P.2d 1284, 1291 (Wash. 1987). 17. See Moransais v. Heathman, 744 So. 2d 973, 979 (Fla. 1999) (“The exact origin of the economic loss rule is subject to some debate and its application and parameters are somewhat ill-defined.”). 18. Tiara Condo. Ass’n v. Marsh & McLennan Cos., 110 So.3d 399, 401 (Fla. 2013). HOWARD 1/13/2016 11:31 AM

2015/16 PRIVITY EXCEPTIONS IN CONTRACT LAW 193 economic, were governed by the concept of foreseeability, meaning that damages were only recoverable if they were foreseeable when the contract was executed.19 This is because prior to the expansion of the economic loss rule, damages resulting from contractual relationships were governed by the general rules of contract law.20 In Arizona, for example, damages in breach of contract claims were based on the Hadley21 rule, which made damages in breach of contract actions recoverable if they were foreseeable at the time of contract formation.22

b. Application in Products Liability

In its earlier incarnation, the economic loss rule was an effort by the courts to counter attempts to “apply tort remedies to traditional contract law damages,”23 or, in other terms, to reinforce the efforts to slowly obfuscate the boundaries between tort and contract law.24 In fact, some state legislatures, such as that of New Jersey, intended that the of the economic loss rule as part of the state’s Products Liability Act would explicitly demarcate the line dividing tort and contract remedies.25 By concretely establishing the economic loss rule in products liability, courts and legislatures in a variety of

19. See, e.g., RESTATEMENT (SECOND) OF CONTRACTS, §§ 351, 352 (AM. LAW INST. 1979) (establishing that every claim for damages based on actions sounding in contract have a foreseeability requirement); See also Giampapa v. Am. Family Mut. Ins. Co., 64 P.3d 230, 240 (Colo. 2003) (Holding that foreseeability is required because “contractual liability is determined by whether such liability was within the contemplation of the parties at the time of contracting.” Also holding that “all contract damages, whether general or special, economic or non-economic, are recoverable only if the damages were the foreseeable result of a breach at the time the contract was made.”). 20. Eddward P. Ballinger, Jr. & Samuel A. Thumma, The History, Evolution and Implications of Arizona’s Economic Loss Rule, 34 ARIZ. ST. L.J. 491, 492 (2002). 21. Hadley v. Baxendale, 156 Eng. Rep. 145 (1854). 22. See Ballinger & Thumma, supra note 20, at 492 (explaining the historical rules of recovery in Arizona contracts actions). 23. Tiara Condo Ass’n, 714 F.2d at 1256. 24. Sidney R. Barrett, Jr., Recovery of Economic Loss in Tort for Construction Defects: A Critical Analysis, 40 S.C. L. REV. 891, 894-95 (1989) (“the fundamental boundary between contract law, which is designed to enforce the expectancy interests of the parties, and tort law, which imposes a duty of reasonable care and thereby encourages citizens to avoid causing physical harm to others”). 25. Dean v. Barrett Homes, Inc., 8 A.3d 766, 767 (N.J. 2010) (explaining the legislative intent behind the passage of the state’s Products Liability Act); see also, Louisville Gas and Elec. Co. v. Cont’l Field Sys., Inc., 420 F. Supp. 2d 764, 769 (W.D. Ky. 2005) (explaining that the economic loss rule “pertains to and often limits its application to the sale of products [in order to] . . . preserve the distinction between the remedies available under the U.C.C. and those available in tort.”). HOWARD 1/13/2016 11:31 AM

194 GONZAGA LAW REVIEW Vol. 51:1 jurisdictions have provided a legal springboard for a more widespread adaption of the economic loss rules to other areas of law, including the negligence and contract regimes.26 Of course, some jurisdictions did not initially accept the rule’s application to the broader realm of non-products liability tort law.27 However, even in jurisdictions that were initially reticent to fully import the economic loss rule into broader tort and contract law, such as Hawaii, the widespread acceptance of the rule in the products liability forum enabled them to extend the rule’s applications to construction defect litigation.28 For example, the Washington Supreme Court expressly linked the expansion and wholesale adoption of the economic loss rule in tort and contract law to the intellectual foundation laid by the rule’s acceptance in products liability cases.29 In finding that the economic loss rule “bars recovery for alleged breach of tort duties where a contractual relationship exists and the losses are economic losses,”30 the Supreme Court of Washington likens the inquiry into the nature of the loss and manner in which it occurs to the fundamental approach established by products liability claims.31 Like New Jersey and Washington, New Mexico courts have relied on the bedrock public policy concerns underpinning the economic loss rule, such as the desire to “preserve the line between contract law and tort law,”32 as the compass guiding the rule’s application and expansion. In determining whether to increase the rule’s applicability, the New Mexico Supreme Court in

26. Dean, 8 A.3d at 773 (Federal courts applying New Jersey state law used the state Products Liability Act to justify the extension of the economic loss rule to “preclude tort- based recovery when a defective product is incorporated into another product which the defective product then damages.”). 27. After the Supreme Court’s decision in East River, the Hawaii Supreme Court refused to apply the economic loss rule in broader tort actions, such as in claims for negligent misrepresentation. See Ass’n of Apt. Owners v. Venture 15, Inc., 167 P.3d 225, 278-80 (Haw. 2007) (discussing the history of the economic loss rule’s evolution in Hawaii courts). 28. See, e.g., City Express, Inc. v. Express Partners, 959 P.2d 836, 839-40 (Haw. 1998) (revisiting the state supreme court’s earlier ruling on the application of the economic loss rule and finding that economic loss claims in construction litigation, where the parties were in privity, limits damages to contractual remedies and disallowing negligence actions to recover damages). 29. See Alejandre v. Bull, 153 P.3d 864, 868 (Wash. 2007) (linking the inquiry performed in applying the economic loss rule to tort/contract cases to the approach established by products liability claims). 30. Id. at 868. 31. Id. at 869. 32. In re Consol. Vista Hills Retaining Wall Litig., 893 P.2d 438, 446 (N.M. 1995). HOWARD 1/13/2016 11:31 AM

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Bhandari v. VHA Southwest Cmty. Health Corp.,33 used the “legal and policy considerations that motivated the New Mexico courts to adopt the economic loss rule in the products liability context”34 to determine whether such an application was warranted when service contracts were involved. The Bhandari court then explained that, just as New Mexico courts had adopted the economic loss rule to “allow commercial parties to freely contact and allocate the risk of defective products as they wish,”35 so too would a similar objective be achieved by applying the rule to service contracts.36 It is also important to recognize how the original application of the economic loss rule to products liability limits the rule’s expansion. A number of courts in Kentucky have repeatedly grappled with the question of whether to expand the economic loss rule’s application to areas outside of products liability and, if so, how. In Francis v. Armstrong Coal Reserves, Inc.,37 the Federal District Court for the Western District of Kentucky briefly explains the tumultuous history of the economic loss rule’s expansion in Kentucky’s jurisprudence.38 When faced with the decision of whether to expand the economic loss rule to mineral rights disputes, the district court is quick to note that the principles guiding the application of the rule to products liability are not compatible with the arguments advanced for expanding the rule to mineral rights.39 The Francis decision caps a string of earlier decisions in which the Kentucky Supreme Court limited the application of the economic loss rule to situations preserving the fundamental public policy concerns underpinning the economic loss rule’s original use, such as commercial parties allocating inherent transactional risks via contract, warranty, and insurance, rather than allowing tort law to perform these risk-allocation functions.40

33. No. CIV 09-0932 JB/GBW, 2011 U.S. Dist. LEXIS 37750 (D.N.M. Mar. 30, 2011). 34. Id. at *58. 35. Id. at *59. 36. Id. at *59-60. 37. No. 4:11-CV-00077-JHM, 2012 U.S. Dist. LEXIS 30229 (W.D. Ky. Mar. 6, 2012). 38. Id. at *7. 39. Id. at *8-9 (noting that a recent Kentucky Supreme Court decision limited the rule’s application to the sale of a defective product, under the theory that the rule “[r]ecognizes that economic losses, in essence, deprive the purchaser of the benefit of his bargain and that such losses are best addressed by the parties’ contract and relevant provision of [the U.C.C.].”). 40. Ohio Cas. Ins. Co. v. Vermeer Mfg. Co., 298 F. Supp. 2d 575, 577-78 (W.D. Ky. 2004) (“The [economic loss rule] applies when parties engage in complex commercial endeavors, in order to preserve parties’ abilities to distribute risks via contract, warranty and insurance.”) (citations omitted). HOWARD 1/13/2016 11:31 AM

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Kentucky courts are not alone in limiting the application of the economic loss rule; Kansas courts have also struggled with defining the “uncertain contours”41 of the economic loss rule.42 In David v. Hett, the Kansas Supreme Court was tasked with parsing through the developmental history of the economic loss doctrine to determine whether it barred the negligence claims of homeowners against the contractor who built their home.43 In its decision to limit the application of the economic loss rule, the Kansas Supreme Court explained that the public policy objectives underlying the rule would not be achieved by its expansion to the case at hand.44 It noted that, unlike cases addressing contracts for goods or products liability, contracts for the building and sale of homes contain few protections for homeowners, as most damages are not discoverable until after the limited warranty period has ended.45 Although somewhat obfuscated, this logic exemplifies judicial recognition of the basic premise between tort law and contract law, with one designed to protect from societal harms and the other to enforce promises; the application of the economic loss rule to homeowners’ contracts would not further the public policy objective of keeping the two distinct. Since no contract between the parties could adequately allocate unforeseen risks that would not become evident until long after a warranty period ended, the principal recovery should be in tort, to protect consumers from defective housing, rather than to ensure contractual performance.

2. Current Incarnations of the Rule

A minority of jurisdictions have explicitly recognized three incarnations of the modern economic loss rule: (1) the products liability economic loss rule, (2) the contract economic loss rule, and (3) the negligence economic loss rule.46 Yet, the majority of jurisdictions recognize two prominent applications of the economic loss rule: (1) the contractual privity economic loss rule and (2) the

41. Wheeler Peak, LLC v. L.C.I.2, Inc., No. CIV 07-1117 JB/WDS, 2008 U.S. Dist. LEXIS 119820, at *16 (D.N.M. Oct. 29, 2008) (wherein the federal district court of New Mexico reiterated that “while the Supreme Court of New Mexico has endorsed the economic loss rule, the contours of the rule are uncertain.”). 42. See generally David v. Hett, 270 P.3d 1102, 1105 (Kan. 2011) (For a history of the doctrine evolution in Kansas). 43. Id. at 1103. 44. Id. at 1114 (“The rationale of these cases [cases not expanding the economic loss rule] is easily applied to residential construction contracts such as the one at issue in this case.”). 45. Id. at 1114. 46. Woodson v. Martin, 663 So. 2d 1327, 1331 (Fla. Dist. Ct. App. 1995) (noting that Florida state law currently recognizes three distinct economic loss rules). HOWARD 1/13/2016 11:31 AM

2015/16 PRIVITY EXCEPTIONS IN CONTRACT LAW 197 products liability economic loss rule.47 The “contractual privity” economic loss rule bars tort recovery when the damages arises from a contractual relationship,48 while the products liability economic loss rule bars a tort action to recover damages when a purchased product itself is damaged and the resulting damages are purely economic in nature.49 Since the negligence economic loss rule and the contract economic loss rule operate in fundamentally the same way, for purposes of this article, the economic loss rule will be considered to have two primary applications: (1) the “contractual privity” rule and (2) the products liability rule.

a. Traditional Interpretation of the Economic Loss Rule

In the jurisdictions that follow the traditional, majority view of the economic loss rule, “details matter.”50 As the Texas Court of Appeals has enunciated, in Barzoukas v. Found. Design, Ltd. when speaking as to the details of the contract,

It matters who contracted with whom to do what. . .what the contract said . . . what they contracts and what they do not cover. It matters what kind of damages are requested. It matters whether the requested damages are attributed to activities covered by the contracts . . . It matters what kinds of claims are asserted and against whom they are asserted.51

However, courts have noted that focusing on the type of harm when determining whether the economic loss rule applies has made application of the rule outside of the products liability realm difficult.52 As a result, the establishment of contractual privity between the parties has served as a bedrock principle in courts’ decisions as to whether the economic loss rule will bar

47. Saxon Fin. Group, Inc. v. Rath, 2010 U.S. Dist. LEXIS 111818, at *13-14 (noting the two different applications of the economic loss rule that Florida recognizes). 48. Allen v. Stephan Co., 784 So. 2d 456, 457 (Fla. Dist. Ct. App. 2000) (the economic loss rule bars recovery in tort where the act “complained of relates to the performance of the contract.”). 49. Indem. Ins. Co. of N. Am. v. Am. Aviation, Inc., 891 So. 2d 532, 536-38 (Fla. 2004) (noting that the economic loss rule applies “when there is a defect in the product that causes damage to the product, but causes no personal injury or damage to other property.”). 50. Barzoukas v. Found. Design, Ltd., 363 S.W.3d 829, 834 (Tex. Ct. App. 2012). 51. Id. at 834. 52. Grynberg v. Questar Pipeline Co., 70 P.3d 1, 11 (Utah 2003) (“Focusing on the character of the harm, however, made it difficult to apply the economic loss doctrine beyond the realm of products liability, where torts such as fraud and conversion exist to remedy purely economic losses in non-contractual settings.”). HOWARD 1/13/2016 11:31 AM

198 GONZAGA LAW REVIEW Vol. 51:1 recovery of certain damages.53 In fact, the concept that contractual privity between parties was necessary in order to implement the economic loss rule was so strongly held in traditional interpretations of the rule that some courts have referred to it as the ‘contractual privity economic loss rule.’54 Courts at all levels in Virginia, for example, have issued decisions demonstrating the strength of the privity requirement for parties seeking solely economic losses. For example, in Blake Const. Co. v. Alley,55 a case in which a general contractor sued an architect for damages resulting from the architect’s negligent performance of its contract with the owner, the Virginia Supreme Court held that the contractor could not sustain a cause of action for economic loss because the architect’s contract was with the project’s owner, not the general contractor.56

b. The Modified Approach to the Economic Loss Rule

i. Derivations From the Strict Privity Requirement

In a non- setting, where courts consider the economic loss rule in contracts actions, privity has always been a key requirement to barring negligence actions for recovery of economic damages.57 However, courts have been open to deviating from the strict privity requirement to find that the economic loss rule bars tort recovery for purely economic damages.58 For example, in Digicorp, Inc. v. Ameritech Corp., the Wisconsin Supreme Court extended the holding in Daanen & Janssen v.Cedarapids, Inc., that “the economic loss doctrine bars one party in the distributive chain from recovering economic losses in tort from another party in that chain.”59 Wisconsin has also adopted a modified view of the economic loss rule, with its state Supreme Court barring recovery by a purchaser from a manufacturer for tort damages

53. Vesta Constr. & Design, L.L.C. v. Lotspeich & Assoc., 974 So. 2d 1176, 1180 (Fla. Dist. Ct. App. 2008) (noting that because the plaintiff had no contractual privity with the defendant, the economic loss rule cannot be applied to bar a negligence action). 54. Ass’n of Apt. Owners v. Ventures 15, Inc., 167 P.3d 225, 266 (Haw. 2007) (calling contractual privity “predicate for the application of the economic loss rule.”). 55. 353 S.E.2d 724 (Va. 1987). 56. Id. at 727. 57. Id. at 726 (holding without injury to person or property, the action purely for economic loss requires privity of contract). 58. See Affiliated FM Ins. Co. v. LTK Consulting Servs., Inc., 234 P.3d 521, 525 n.1 (Wash. 2010) (noting that other jurisdictions have applied the economic loss rule in the absence of contractual privity). 59. 662 N.W.2d 652, 666 (Wisc. 2003) (citing Daanen & Janssen v. Cedarapids, Inc., 573 N.W.2d 842 (Wis. 1998). HOWARD 1/13/2016 11:31 AM

2015/16 PRIVITY EXCEPTIONS IN CONTRACT LAW 199 when the losses were purely economic, yet there was not contractual privity between the parties.60 Similarly, the Vermont Supreme Court has given a lengthy explanation of a local derivative of the economic loss rule. In Long Trail House Condo. Ass’n v. Engelberth Constr., Inc.,61 the Vermont court stated on no uncertain terms that “[p]rivity, or lack thereof, is not the determining factor, nor are we persuaded that the rule’s application turns on whether the parties had the opportunity to allocate risks.”62 Vermont courts have held that the absence of privity can be overcome by a showing of an independent that is separate from contractual relationships.63 If such a duty exists, and economic damages are sustained, the economic loss rule will bar recovery for all damages not sounding in contract.64 These adaptations of the economic loss rule are important; the Vermont-based independent obligation analysis is particularly significant, as it illustrates that cognizable duties, which reach further than contractual duties, are a controlling factor in the implementation of the economic loss rule. Such a view is essential to justifying the public policy permitting parties who owe duties to each to be bound by the economic loss rule even in the absence of contractual privity.

ii. Tort Actions Permitted in the Context of Contractual Privity

While exploring the furthest reaches of tort law in the context of contractual relationships will not advance the thesis of this article, it is important to demonstrate the fluidity of the economic loss rule. As discussed earlier in this article, several courts have recognized that the economic loss rule does not act as a blanket ban on recovering in tort, even while contractual obligations generally bar the recovery of tort damages. In fact, courts in California have recognized that a contractual obligation may create a legal duty that, if breached, will support an action in tort.65 In Eads v. Marks,66 the plaintiff’s parents entered into a contract for the delivery of milk, which, on one occasion, was done negligently, resulting in the physical injury of the

60. Daanen & Janssen, 573 N.W.2d at 850. 61. Long Trail House Condo. Ass’n v. Engelberth Constr., Inc., 59 A.3d 752 (Vt. 2012). 62. Id. at 753. 63. Springfield Hydroelectric Co. v. Copp, 779 A.2d 67, 71-72 (Vt. 2001) (noting that “the underlying analysis [of the economic loss rule] turns on whether there is a duty of care independent of any contractual obligations.”). 64. Id. at 69. 65. North Am. Chemical Co. v. Superior Ct., 59 Cal. App. 4th 764, 774 (1997). 66. Eads v. Marks, 249 P.2d 257, 261 (Cal. 1952). HOWARD 1/13/2016 11:31 AM

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Plaintiff’s child.67 A strict interpretation of the contractual privity economic loss rule would have barred recovery. However, the Eads court held that the contractual relationship was significant only in establishing a legal duty, the breach of which gives rise to an action in tort, not contract.68 As a result, where a cause of action arises as the result of negligent performance of contractual duties, the action may sound in tort, as it is considered the more serious of the causes of action.69 This exclusion is a drastic departure from the general principle that the economic loss rule forecloses tort claims when the duty was created because of a contractual relationship.70 Such is just another example of how malleable the rule has become, depending on which jurisdiction is interpreting the rule.

iii. Substitutions for Privity

Central to this article is the concept that the economic loss rule can be modified to permit recovery for economic damages where the parties lack privity. While a strict interpretation of the economic loss rule has traditionally required privity between parties before recovering in contract, several jurisdictions, including Ohio, California, and New York have carved out a sufficient nexus exception.71 This exception permits contractual recovery despite the absence of a direct contractual relationship if there is a “sufficient nexus between the parties.”72 This nexus “usually exist[s] only when the plaintiff is a member of a limited class whose reliance is specially foreseen.”73 The determination of whether a sufficient nexus exists between parties not in privity so as to substantiate a contract claim is a question of law for the court.74 In Pennsylvania, a trial court hearing a negligent misrepresentation claim needed to decide whether two parties, one who ordered steel bars and one who manufactured them, bore a sufficient nexus to each other so as to overcome the

67. N. Am. Chem. Co., 59 Cal. App. 4th at 775. 68. Eads, 249 P.2d at 260-61. 69. See Distefano v. Hall, 32 Cal. Rptr. 770 (1963). 70. Sharyland Water Supply Corp. v. City of Alton, 354 S.W.3d 407 (Tex. 2011). 71. Floor Craft Floor Covering, Inc. v. Parma Cmty. Gen. Hosp. Ass’n, 560 N.E.2d 206 (Ohio 1990); Widett v. U.S. Fid. & Guar. Co., 815 F.2d 885 (2d. Cir. 1987); White v. Guarente, 372 N.E.2d 315 (N.Y. 1977). 72. Floor Craft Floor Covering, 560 N.E.2d at 211 (noting that Ohio recognized a privity exception to the economic loss rule). 73. Laurent v. Flood Data Servs., Inc., 766 N.E.2d 221 (Ohio Ct. App. 2001). 74. Id. (holding that the question of whether a sufficient nexus existed was a question of law for the court, rather than a question of fact for the jury). HOWARD 1/13/2016 11:31 AM

2015/16 PRIVITY EXCEPTIONS IN CONTRACT LAW 201 privity requirement, even when a third-party distributor separated them.75 In dismissing the negligent misrepresentation claim, the trial court held that there was not a sufficient nexus between the parties, even if it could be proved that the steel rod manufacturer’s certifications about the quality of the product were for the benefit of a third-party.76 The trial court based its dismissal on public policy arguments designed to protect the manufacturer from claims brought by a lengthy and unforeseeable string of third parties down the distribution line.77 While the Teledyne court’s analysis stems from a negligent misrepresentation claim, its analysis shows us how strictly the rule can be interpreted. The substantial nexus exception to the privity requirement has generally not proven to be helpful in the construction law context. In fact, when required to decide whether there was a sufficient nexus between a subcontractor, who was hired by the general contractor, and an architect, who was hired by the owner, the New York appellate court held that a sufficient nexus did not exist and dismissed the claim, citing the economic loss rule’s privity requirement.78 Ohio courts, however, have developed a more nuanced rule to determine whether design professionals and subcontractors can be considered to be in sufficient nexus in a negligent misrepresentation claim. As one Ohio court noted, courts should “look to the degree of control the design professional exerted over the project and the amount of interaction between the design professional and the third party”79 when seeking to determine whether a sufficient nexus exists. In State Plaza Assocs v. Hillsboro Assocs.,80 we see the court’s of these factors. Ultimately, the court concluded that even though the engineer directed contractors to relocate pipes, add storm drains, and build a water retention feature, the engineer had no authority to actually direct the contractor, making the engineer’s control over the project too remote to be considered a sufficient nexus to the plaintiff.81 The Supreme Court of

75. Teledyne Techs v. Freedom Forge Corp., 2002 WL 748898, at *19-20 (Pa. Ct. Common Pl. 2002) (explaining the factual circumstances that gave rise to the claims and determining whether a negligent misrepresentation could be heard despite a lack of privity between the plaintiff and defendant). 76. Id. 77. See id. 78. See, e.g., Underhill Constr. Corp. v. New York Tel. Co., 56 A.D.2d 760 (1977) (finding that where the architect who contracted with the owner and subcontractor who contracted with the general contractor did not have sufficient nexus to overcome the privity requirement of the economic loss rule). 79. State Plaza Assocs. v. Hillsboro Assocs., No. 96CA898, 1998 Ohio App. LEXIS 297, at *13 (Ohio Ct. App. Jun. 29, 1998). 80. Id. 81. See id. at *19-20 (court’s factual discussion of its reasoning that a sufficient nexus did not exist between engineer and a subcontractor on the project). HOWARD 1/13/2016 11:31 AM

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Florida was presented with a similar question in A.R. Moyer, Inc. v. Graham, where the court was forced to consider whether the architect and general contractor, who were not in privity with each other, shared a substantial nexus so as to overcome the privity requirement of the economic loss rule.82 In finding that the two parties shared a substantial nexus, the state Supreme Court clarified its reasoning, recognizing that “[t]he power of the architect to stop the work alone is tantamount to a power of economic life or death over the contractor. It is only just that such authority, exercised in such a relationship, carry commensurate legal responsibility.”83 By examining these cases, we see a distinct trend emerging in “substantial nexus” jurisprudence, with the determination of whether a substantial nexus exists involving a determination of the power that one party wields over another.84 While this may be a useful tool for achieving the public policy goals elucidated by the Teledyne court, it seems that judicial adoption of the substantial nexus approach deviates from traditional conceptions of the word nexus. Nexus, according to Merriam-Webster, has two primary meanings: (1) a causal link, or (2) a connected group or series.85 In the context of judicial use, substantial, according to the same source, means important or essential.86 Although the two together may seem oxymoronic, they should be interpreted to mean an important causal link, or an essentially-connected group or series. Using power to delineate important causal links or essentially-connected groups may speak more about Western conceptions of the legal system than the effectiveness of current jurisprudence. Therefore, another measuring stick to determine whether parties not in privity share a substantial nexus to each other may be useful. Namely, this author would suggest that courts consider approaching the question by categorizing the parties that are intricately or systemically linked together via a construction project as third-party beneficiaries of each other’s contracts.

82. A.R. Moyer, Inc. v. Graham, 285 So. 2d 397, 401 (Fla. 1973). 83. Id. 84. This viewpoint was reaffirmed by Mosser Constr., Inv. v. W. Waterproofing Co., No. L-05-1164, 2006 Ohio App. LEXIS 3546, at *8-10 (Ohio Ct. App. July 14, 2006) (holding that the Clevecon, Inc. v. Northeast Ohio Reg’l Sewer Dist., 628 N.E.2d 143 (Ohio Ct. App. 1993), court’s power analysis was determinative in establishing whether a sufficient nexus existed between parties so as to overcome the privity requirement). 85. MERRIAM-WEBSTER’S COLLEGIATE DICTIONARY 836 (11th ed. 2003). 86. Id. at 1245. HOWARD 1/13/2016 11:31 AM

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B. Public Policy of the Economic Loss Rule

Although the story of the evolution of the economic loss rule is an indirect glimpse of the public policy supporting the rules’ adoption, there are several other public policy justifications for the rule’s widespread adoption. Especially in its earliest products liability format, one of the primary reasons for the implementation of the economic loss rule was that was the appropriate forum in which to resolve claims for purely economic loss.87 This ensures the protection of commercial interests, shielding sellers from unknown and potentially unlimited liability to buyers by preventing buyers from making an end-run around limitations of liability recognized by the UCC.88 This policy justification for the economic loss rule implicitly recognizes that commercial damages, i.e. purely economic damages, should be relegated to contract law and not be introduced in the realm of torts, as there is already a well-established body of contract law that is designed to handle such disputes.89 This distinction is a manifestation of the public policy underpinning the economic loss rule: there is a schism in English common law systems between contract law and tort law, with each protecting a different societal interest.90 Although various jurisdictions have crafted public policy arguments for the imposition of the economic loss rule in different scenarios, generally, courts have accepted that the economic loss rule is a judicial recognition “that contract law and tort law each protect distinct interests.”91 In fact, the American Law Institute has suggested that one of the guiding principles behind the economic loss rule is that it “reflects the resolution of liability for purely economic loss

87. Indianapolis-Marion Cnty. Pub. Library v. Charlier Clark & Linard, P.C., 929 N.E.2d 722, 729 (Ind. 2010) (summarizing the American Law Institutes’ primary justifications for adopting the economic loss rule). 88. See Reed v. Cent. Soya Co., 621 N.E.2d 1069, 1075 (Ind. 1993). 89. Miller v. U.S. Steel Corp., 902 F.2d 573, 574 (7th Cir. 1990) (“It would be better to call [an economic loss] a ‘commercial loss,’ not only because personal injuries and especially property losses are economic losses . . . but also, and more important, because tort law is a superfluous and inapt tool for resolving purely commercial disputes.”). 90. Tort law is said to protect society’s members from harm, while contract law is intended to further society’s desire to see promised performances take place. See Detroit Edison Co. v. Nabco, Inc., 35 F.3d 236, 239 (6th Cir. 1994). 91. Carstens v. City of Phoenix, 75 P.3d 1081, 1084 (Ariz. Ct. App. 2003), overruled in part by Flagstaff Affordable Hous. L.P. v. Design Alliance, Inc., 223 P.3d 664 (Ariz. 2010). HOWARD 1/13/2016 11:31 AM

204 GONZAGA LAW REVIEW Vol. 51:1 caused by negligence is more appropriately determined by commercial rather than tort law.”92 Another justification for the adoption and implementation of the economic loss rule is that it creates a firm deadline for liability, avoiding the creation of liability that has the potential to be so uncertain in time, class, or amount that it exposes a defendant to a disproportionate amount of risk for the task that he undertook.93 For example, in City of Chicago v. Beretta U.S.A. Corp., the economic loss rule played a pivotal role in the state Supreme Court’s decision to uphold a trial court’s grant of a motion to dismiss the city’s public nuisance claim against gun manufacturers whose products had been used to commit crimes throughout the municipality.94 In this case, the court found that the justification for employing the economic loss rule to bar claims for purely economic damages resulting from private nuisance created potential inequitable results from continuing damages.95 The economic loss rule, the court reasoned, protects defendants from “virtually endless” damages for purely economic loss, which would create “virtually uninsurable risks” vastly exceeding the defendants’ proportional culpability.96 Therefore, where potential economic damages result from a course of conduct, rather than a single action, the economic loss rule has been employed to shield defendants from perpetual and unquantifiable claims for economic damages.

III. THIRD-PARTY BENEFICIARIES AND THE EXTENSION OF THE ECONOMIC LOSS RULE

A. Contract Law and Third-Party Beneficiaries

Generally, contracts are considered to be “executed for the benefit of the parties thereto and not third person,”97 a policy requiring privity of contract in

92. Indianapolis-Marion Cnty. Pub. Library v. Charlier Clark & Linard, P.C., 929 N.E.2d 722, 728-29 (Ind. Sup. Ct. 2010) (citing RESTATEMENT (THIRD) OF ECONOMIC TORTS AND RELATED WRONGS § 8 (AM. LAW INST., Council Draft No. 2, 2007)). 93. Charlier Clark, 929 N.E.2d at 730 (“A second justification for the economic loss rule is that ‘[l]iability should not be imposed when it creates a potential for liability that is so uncertain in time, class, or amount that [a defendant should not] fairly or practically be expected to account for the potential liability when undertaking the conduct that gives rise to’ it.”). 94. City of Chicago v. Beretta U.S.A. Corp., 821 N.E.2d 1099 (Ill. 2004). 95. Id. at 1140. 96. Id. 97. Oman Constr. Co. v. Tennessee Cent. Ry. C., 370 S.W.2d 563, 572 (Tenn. 1963). HOWARD 1/13/2016 11:31 AM

2015/16 PRIVITY EXCEPTIONS IN CONTRACT LAW 205 order to enforce contractual provisions.98 However, courts have created an exception to the privity requirement and will allow third-party beneficiaries, who are not privy to a contract, to enforce an action for breach of the contract.99 There are two broad categories of third-party beneficiaries: the intended beneficiary and the incidental beneficiary, only one of which is imbued with the standing required to enforce a contract to which they are not a party.100 In order for a third-party beneficiary to avail themselves of the privity exception and enforce the contract, the third-party must be an intended beneficiary, as incidental beneficiaries do not have standing to enforce a contract to which they are not a signatory.101 Most, if not all, common law recognizes two discrete categories of intended third-party beneficiaries who can enforce a contract to which they are not privy: (1) a donee beneficiary and (2) a creditor beneficiary.102 The primary difference between the two categories of beneficiaries that can enforce the contract is in the nature of the obligation. If the performance is rendered purely out of charity, the recipient is a donee

98. Windham at Carmel Mountain Ranch Ass’n v. Superior Court, 135 Cal. Rptr. 2d 834, 842 (Cal. Ct. App. 2003) (citing Hatchwell v. Blue Shield of California, 244 Cal. Rptr. 259, 253 (Cal. Ct. App. 1988) (for the proposition that “someone who is not a party to a contract has no standing to enforce the contract or to recover extra-contract damages for wrongful withholding of benefits to the contracting party.”)). 99. See, e.g., L.A.C. v. Ward Parkway Shopping Ctr. Co., L.P., 75 S.W.3d 247, 260 (Mo. 2002) (“A third-party beneficiary is one who is not privy to a contract or its considerations but who may nonetheless maintain a cause of action for breach of the contract.”); Evans v. Sirius Computer Solutions, Inc., No. 12-CV-46-AA, 2012 U.S. Dist. LEXIS 61552, at *5 (D. Or. 2012) (denying standing to bring a breach of contract claim where the plaintiff was neither a party to the contract, nor a third-party beneficiary); Shay v. Aldrich, 790 N.W.2d 629, 638 (Mich. 2010) (noting that Michigan law allows for third-party beneficiaries to enforce a contract, even though they lack direct privity). 100. Ennen v. Integon Indem. Corp., 268 P.3d 277, 283-84 (Alaska 2012) (recognizing a distinction between incidental and intended third-party beneficiaries, both in legal classification and corresponding rights); Forcier v. Cardello, 173 B.R. 973, 985 (D.R.I. 1994) (noting that Rhode Island law recognizes a difference in the character and legal rights of intended and incidental beneficiaries). 101. Glass v. United States, 258 F.3d 1349, 1354 (Fed. Cir. 2001) (noting that in order to “avail oneself of the third-party beneficiary exception” a plaintiff must be able to show that it is intended beneficiary, that is “that the contract not only reflects the express or implied intention to benefit the party, but that it reflects an intention to benefit the party directly”); L.A.C. v. Ward Parkway Shopping Ctr. Co., L.P., 75 S.W.3d 247, 260 (Mo. 2002) (Recognizing that only intended beneficiaries may recover on a contract to which they are not a party. Unlike federal law, however, the intended third-party beneficiary does not have to prove that the primary object of the contract was to benefit the third party, only that the third-party is in fact the primary beneficiary). 102. MCI Telecomms. Corp. v. Tex. Utils. Elec. Co., 995 S.W.2d 647, 651 (Tex. 1999) (enumerating the two classes of third-party beneficiaries that are able to enforce a contract). HOWARD 1/13/2016 11:31 AM

206 GONZAGA LAW REVIEW Vol. 51:1 beneficiary, whereas if the performance is rendered to satisfy some legal obligation, the recipient is a creditor beneficiary.103 While the legal status of third-party beneficiaries has become somewhat better defined,104 the development of their unique legal status was not a forgone conclusion in earlier eras of contract law, nor is the public policy behind contractual enforcement by third-party beneficiaries without critics.105 The legal standing of third-party beneficiaries to enforce contracts can be traced back to the mid-nineteenth century landmark decision of Lawrence v. Fox.106 In Fox, the promisor, Fox, borrowed $300 from Holly, the promisee, who owed the money to Lawrence.107 Fox then agreed to pay Lawrence on Holly’s behalf.108 When Fox’s default brought the case to the court’s attention, the court found that Lawrence was a third-party beneficiary of Fox’s promise to pay Holly’s debt; notably, the court failed to cite specific legal rationale for finding so, making only a broad assertion of “manifest justice” inherent in enforcing the contract.109 Professor Powers speculates that the real concern driving the decision was judicial economy, as it was easier to hear one case instead of having all parties sue one another in separate actions; Professor Powers still believes that this policy underpins the expansion of the legal doctrine today.110 However, judicial economy is not the only public policy that courts have relied on to make contract remedies available to third-party

103. Lesieur v. Fryar, 325 S.W.3d 242, 252 (Tex. App. 2010) (noting the distinguishing characteristics of each class of third-party beneficiary). 104. Orna S. Paglin, Criteria for Recognition of Third Party Beneficiaries Rights, 24 NEW. ENG. L. REV. 63, 64-65 (1989) (Explaining that benchmarks and criteria for determining intent to benefit are still vague. Since the intent to benefit is the determining factor under the Restatement (Second) of Contracts test to determine whether a third-party is an intended beneficiary, it would be disingenuous for this article to assert that common law has corrected all ambiguities that exist in contract law with regards to third-party beneficiaries.). 105. Melvin Aron Eisenberg, Third-Party Beneficiaries, 92 COLUM. L. REV. 1358, 1370, 1374 (1992) (In earlier eras, especially in the last part of the nineteenth century, third- party beneficiary rights were subsumed by decisions that limited the rights of third-parties and that some critics see the enforcement of contracts by third-parties to run counter to fundamental principles of contract law.). 106. Lawrence v. Fox, 20 N.Y. 268 (1859); see also Jean Fleming Powers, Expanded Liability and the Intent Requirement in Third Party Beneficiary Contracts, 1993 UTAH L. REV. 67, 68 (1993) (postulating the roots of the doctrine of third-party beneficiaries to the Lawrence case). 107. Powers, supra note 106, at 68-69. 108. Id. at 69. 109. Id. at 69; Lawrence, 20 N.Y. at 275. 110. Powers, supra note 106, at 69-70 (“modern courts have articulated multiplicity of actions as a reason for the expansion of liability.”). HOWARD 1/13/2016 11:31 AM

2015/16 PRIVITY EXCEPTIONS IN CONTRACT LAW 207 beneficiaries.111 The concept of fairness played an important role in the rule’s original development and continued expansion.112 The Delaware Supreme Court explicitly linked the concept of fairness to the doctrine of third-party beneficiary actions when it stated, “the reason for the [third-party beneficiary] doctrine is that it is just and practical to permit the person for whose benefit the contract is made to enforce it against one whose duty it is to pay.”113

1. The Public Policy Rationale of Recognizing the Rights of Third-Party Beneficiaries

One of the motivating public policy concerns in the application of the third-party beneficiary rule is contractual fairness, requiring that the beneficiary, when attempting to “take advantage of a contract made for him by another, [ ] make it subject to all legal defenses and inherent equities arising out of the contract as between the parties thereto and [ ] bear the burdens thereof.”114 This rationale, embodied in the New Jersey Superior Court’s decision in Naimo v. La Fianze, is a reflection of Professor Corbin’s treatment of the application of the statute of limitations and discovery rule to third-party beneficiaries seeking to enforce a contract:

the right of the creditor came to him by a sort of ‘unexpected grace’ and without consideration from him. If the statute should bar his remedy by a like accident because of his ignorance he would still be in exactly as good a position as his own contract originally put him in. The law giveth and the law taketh away. The ‘unexpected grace’ is nullified by the unexpected limitation.115

The superior court’s decision in Naimo is an explicit manifestation of the judicial acceptance of the general rule, as stated in WILLISTON ON CONTRACTS, that a party seeking to enforce a contract on the basis that he is an intended third-party beneficiary bears not only the benefit of the contract, but any burden

111. Patience A. Crowder, More Than Merely Incidental: Third-Party Beneficiary Rights in Urban Redevelopment Contracts, 17 GEO. J. POVERTY LAW & POL’Y 287, 301 (2010) (noting that courts have considered the concept of fairness in deciding whether to expand the use of the third-party beneficiary rule). 112. Id. 113. Id. (citing Wilmington Hous. Auth. v. Fidelity & Deposit Co. of Md., 47 A.2d 524, 527 (Del. 1946)). 114. Naimo v. La Fianze, 369 A.2d 987, 992 (N.J. Super. Ct. Ch. Div. 1976). 115. 4 CORBIN ON CONTRACTS § 820 (1951); see also RESTATEMENT (FIRST) OF CONTRACTS §136 cmt. on subsec. (1) (1952). HOWARD 1/13/2016 11:31 AM

208 GONZAGA LAW REVIEW Vol. 51:1 as well.116 New Jersey’s Superior Courts are not alone in their recognition of this principle, as the Circuit Court for the District of Columbia has also held third-party beneficiaries to the same limitations that bind the contracting parties.117 This trend is a reflection of a confluence of two important, yet competing, theories of contract law, and the result recognizes that allowing a third-party beneficiary to disaffirm distasteful provisions while reaping favorable rewards is equitably offensive and contrary to the bargained-for intent of the parties.118 This underlying notion of contractual fairness is evident in the Third Circuit Court of Appeal’s opinion in E.I. Dupont de Nemours & Co. v. Rhone Poulenc Fiber & Resin Intermediates, S.A.S.119 In Dupont, the Court of Appeals was faced with the issue of whether a forum selection clause in a contract would bind an intended third-party beneficiary if the beneficiary sued to enforce other provisions in the contract.120 In holding that the beneficiary was bound by the forum selection clause, the court noted that finding otherwise would be “inconsistent with the law of contracts, which has long recognized that third-party beneficiary status does not permit the avoidance of contractual provisions otherwise enforceable.”121 The language of this holding is another manifestation of the basic principle of fairness between the parties, as the Appellate Court refused to allow a party to reap the benefits of a contract to which they were not a signatory while simultaneously disaffirming any resulting contractual obligations they felt burdensome or offensive.

th 116. 13 WILLISTON ON CONTRACTS § 309 cmt. b (4 ed. 2013) (“Third party beneficiaries must take their contracts as they find them—the good with the bad.”). 117. Cafeteria & Rest. Workers Union, Local 473 v. McElroy, 284 F.2d 173, 180 (D.C. Cir. 1960) (holding that contractually imposed limitations that bind the original contracting parties bind third-party beneficiaries as well). 118. Larry A. DiMatteo, The Norms of Contract: The Fairness Inquiry and the “Law of Satisfaction”- A Nonunified Theory, 24 HOFSTRA L. REV. 349, 362, 368-75 (1995) (Professor DiMatteo’s article attempts to identify normative underpinnings of contract law as employed by judges and legal experts in the United States. Two competing, yet influential schools of normative thought are: (1) the Restatement’s objective approach to contract formation and (2) the relaxing of formal contract law with equity and the migration of contract law from a distinct field to tort.) 119. E.I. Dupont de Nemours & Co. v. Rhone Poulenc Fiber & Resin Intermediates, S.A.S., 269 F.3d 187 (3rd Cir. 2001). 120. Id. at 195. 121. Id. at 196. HOWARD 1/13/2016 11:31 AM

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2. Recognizing the “Sufficient Nexus” of Third-Party Beneficiaries

The legal theory of third-party beneficiaries, therefore, presents construction law jurisprudence with a legal abstraction that can be implemented to curb inefficiencies in construction litigation. In Part II, this article explored the concept that the economic loss rule requires privity of contract to recover damages based on disappointed economic expectations, except in cases where parties not in privity could prove a substantial nexus to each other. This jurisprudence, especially as seen in Florida, New York, and Ohio, can form the basis for streamlining construction litigation and eradicating costly inefficiencies. The introduction of the article and Section IV have and will continue to explore how construction projects, with their multi-tiered systems of arranging contractual obligations and duties, give rise to situations where parties working on the same project are not in privity, yet can be the proximate cause of each other’s damages. Under the current “substantial nexus” jurisprudence, unless the plaintiff can prove a relation of power by the defendant, such contractual claims would be barred by the economic loss rule.122 However, judicial determinations of power not only waste judicial resources by creating dramatic litigation efficiencies, they also misunderstand the very nature of the substantial nexus. As discussed earlier, a plain text reading of the term “substantial nexus” would require only an important causal link or an essential connection between the parties. However, parties involved in litigation over a construction project should only need to show that they were linked together by an underlying commercial transaction, such that they are working alongside one another for the same purpose: the construction of a particular project. This unity of commercial interest is what binds two particular parties, whether they be an architect and a waterproofing subcontractor, a truss manufacturer and a structural engineer, or an acoustic engineer and a general contractor. But for the web of contractual obligations emanating from both the owner and the general contractor, a given set of subcontractors, design professionals, and tradesman might never cross paths. It would seem that the courts’ presently-misguided focus on power relations seeks to uphold one of the essential tenants of contract law: preventing the strong from using their commercial power to unfairly victimize the weak.123 If the parties are proportionally equal, without one exerting too much power or influence over the project so as to place him in a position to exploit a weaker party, the courts otherwise do not care about the interactions between parties not in privity. However, this eliminates judicial

122. Supra Part II. 123. Supra Part III. HOWARD 1/13/2016 11:31 AM

210 GONZAGA LAW REVIEW Vol. 51:1 recourse for parties not in privity. Since they are not bound by contract, their claims for disappointed economic expectations are barred under contract law, and since their claims for damages stem from disappointed economic expectations, they are barred from seeking remedies under tort law. Instead, what traditionally follows is a convoluted series of claims, cross-claims, counter-claims, and third-party (or even fourth or fifth party claims) that turn construction litigation cases into needlessly complex, multiparty affairs. Instead of concentrating on power relations between parties to determine whether a substantial nexus exists, courts should create a common law rule that parties bound by a contract either with the general contractor or the owner are incidental third-party beneficiaries of other contracts related to the same construction project. To be considered an intended beneficiary to a contract, a party must show: “(1) the existence of a valid and binding contract between other parties; (2) that the contract was intended for its benefit; and (3) that the benefit to it is sufficiently immediate, rather than incidental, to indicate the assumption by the contracting parties of a duty to compensate it if the benefit is lost.”124 Generally, the intent of the parties in privity is the primary focus of judicial determination of third-party rights.125 Parties in construction projects would almost certainly not qualify as intended third-party beneficiaries under the elements propounded by most courts. However, “if the benefits of a contract are merely incidental to the performance of the promise, and the third party is neither a donee nor a creditor beneficiary, then the third party is an incidental beneficiary.”126 For example, in the context of construction law, a subcontractor would be able to prove the existence of a binding contract between the owner and general contractor and that the benefit to himself was immediate, as he would be hired to perform a particular job. Because of the broad definition of an incidental beneficiary, most tradesman, design professionals, and other parties involved in a construction project are incidental beneficiaries to the contracts of others. Traditionally, in contract law, incidental beneficiaries to a contract acquire no rights against the promisor or promisee of the contract that it is trying to enforce.127 However, in the construction litigation context, the incidental beneficiary would not acquire rights to enforce the contract; a subcontractor, for example, would not seek to enforce the provisions of a contract between the

124. West Chelsea Bldgs., LLC. v. United States, 109 Fed. Cl. 5, 17 (2013). 125. Owner-Operator Indep. Drivers Ass’n v. Concord EFS, 59 S.W.3d 63, 70 (Tenn. 2001). 126. Yuchnitz v. PCA Health Plan of Tex., No. 03-99-00130-CV, 2000 Tex. App. LEXIS 65, at *9 (Tex. Ct. App. Jan. 6, 2000). 127. RESTATEMENT (FIRST) OF CONTRACTS §147 (1932); Matternes v. City of Winston- Salem, 209 S.E.2d 481, 487 (N.C. 1974). HOWARD 1/13/2016 11:31 AM

2015/16 PRIVITY EXCEPTIONS IN CONTRACT LAW 211 general contractor and the owner or between the owner and a design professional.128 Instead, the subcontractor seeks to enforce only the rights to which it is entitled by virtue of its own contractual relationships with certain parties, merely offering up its status as an incidental third-party beneficiary as a way to recognize the validity of a chain of contracts. Because of this approach, courts could benefit from adopting a modified third-party beneficiary rule. Such a rule would read:

Modified Third-party Beneficiary rule: An incidental beneficiary, who is in privity with either the promisor or promisee of another contract, is considered to be in substantial nexus with the promisor or promise against whom it has a potential claim for damages, arising from disappointed economic expectations, therefore allowing recovery in contract without necessitating proof of privity.

Such a rule recognizes the nature of construction relationships, acknowledging that parties are often incidental third-party beneficiaries of contracts of others working on the project, and bestowing on them certain rights and obligations, thus streamlining the often unduly burdensome construction litigation. The relaxing of strict privity requirements, as would occur through the adoption of a modified incidental third-party beneficiary rule, is not uncommon. For example, North Carolina courts have relaxed the privity requirements pertaining to warranty claims in cases where the public health is at risk.129 Poorly built structures, such as those that are often at the center of multi-party construction lawsuits, pose a great risk to the public.130 The legal basis for both privity relaxations are the same: the court is more concerned with the nature of the suit, the relationship between the parties, and the type of damages than it is with factual particulars.131 Eliminating the privity

128. See Premix-Marbelite Mfg. Corp. v. SKW Chem., Inc., 145 F. Supp. 2d 1348, 1359 (S.D. Fla. 2001). 129. Tedder v. Pepsi-Cola Bottling Co., 154 S.E.2d 337, 339 (N.C. 1967) (“[O]ur Court has heretofore relaxed the privity rule in certain cases involving food and drink because of their importance to health.”); Richard W. Cooper Agency, Inc. v. Irwin Yacht & Marine Corp., 264 S.E.2d 768, 771 (N.C. Ct. App. 1980) . 130. Supra Part IV. 131. Kinlaw v. Long Mfg. N.C., Inc., 259 S.E.2d 552, 557 (N.C. 1979) (Wherein the court implies that in the elimination of previously formal steps in maintaining an action for breach of warranty (such as by bringing an action only for breach of warranty against the next link in a chain of distribution), judicial focus is on the contractual nature of the relationship between the manufacturer and the buyer. The court reinforces this notion by employing phrases such as “[p]laintiff here purchased both goods and a promise . . . the performance of which was expressly guaranteed within the limits and upon the terms HOWARD 1/13/2016 11:31 AM

212 GONZAGA LAW REVIEW Vol. 51:1 requirement by replacing it with a privity exception in construction litigation allows those involved in construction projects the chance to quickly identify and remedy any potential defects, and to sue for damages without traveling the circuitous litigation route that the economic loss rule currently requires.132 This is just a logical extension of the court’s rationale in Premix-Marbelite Mfg. Co. v. SKW Chem., Inc., where the court held that the economic loss rule applies “when the actions complained of relate directly to the subject matter of the parties’ agreement, or are interwoven with the agreement.”133 If courts acknowledge that all actions are interwoven with all agreements, they will find that all parties working on a construction site are incidental third-party beneficiaries of one another’s contracts, thus creating the substantial nexus necessary to eliminate the privity requirement in the economic loss rule.

a. The Public Policy Rationale and Concerns of the Third-Party Beneficiary as Substantial Nexus Rule

One of the primary motivations for instating the third-party beneficiary rule in construction contracts would be to achieve the same goal jurists originally had in adopting the third-party beneficiary rule in general: judicial economy.134 Much as permitting intended third-party beneficiaries to bring an action under a contract to which they are not in privity, instituting the incidental third-party beneficiary rule in construction law cases would permit courts to hear fewer cases, with fewer parties, thus drastically reducing the need for contribution and indemnification suits by intermediary parties. The second public policy objective underlining the widespread adoption of the traditional third-party beneficiary rule is fairness.135 This is achieved by giving intended third-party beneficiaries the rights, duties, and obligations that would, if not for a mere technicality, be available to them under contract law. Similarly, the adoption of the modified, third-party beneficiary rule to construction law cases would imbue fairness to parties working on a construction site. Were it not for the increasingly complex project delivery methods that the construction industry deploys, parties working on a construction project would have a firm grasp on specified in the warranty.” These words are littered with words paramount to contract law, not tort law.). 132. In fact, a similar dedication to the preservation of judicial resources was the driving force behind the Supreme Court of Ohio’s decision to streamline the complicated litigation path of a consumer against a product manufacturer for breach of warranty where there are several other intermediary parties in the chain of distribution. See Rogers v. Toni Home Permanent Co., 147 N.E.2d 612, 615-16 (Ohio 1958). 133. Premix-Marbelite, 145 F. Supp. 2d at 1359. 134. See Eisenberg, supra note 105 at 1374. 135. Supra Section III(A)(1). HOWARD 1/13/2016 11:31 AM

2015/16 PRIVITY EXCEPTIONS IN CONTRACT LAW 213 their legal rights, recourses, and obligations. Instituting limited legal rights for incidental beneficiaries to a construction contract would ensure that complex layers of subcontractors, design professionals, developers, and owners are able to bring suit quickly and against the party responsible for their damages, without instituting broad, scattershot actions against uninvolved parties, merely to ensure that there is an unbroken chain of privity. There is no doubt that such a rule would worry construction professionals, construction law attorneys, and jurists. The Teledyne court promulgated one of the first concerns with such a broad rule, fearing that such an interpretation would lead to open-ended liability for parties, with one party being liable in contract to another party several places removed on the chain of distribution.136 However, designating parties who can trace their contractual relationship back to a general contractor or owner in some way, as incidental third-party beneficiaries of another party’s contract ensure that the chain of liability is a known quantity. Courts have used reasonable and foreseeable reliance as a guide to determine what constitutes a substantial nexus, but ultimately, they require more than that.137 But foreseeability and reasonability are exactly the benchmarks that will ensure that a modified third-party beneficiary rule would not lead to indeterminable liability. While not every subcontractor or design professional may personally or professionally know each other on the job site, they generally coordinate their efforts, participate in meetings, and work together during the construction of a given project. It is always foreseeable and reasonable that a subcontractor would rely on the drawings produced by an engineer or architect, and the design professional should always be able to reasonably and foreseeably rely on the general contractor or subcontractor construct the project as planned. Unlike product liability suits, the kind of which was at issue in the Teledyne case, distribution of drawings by design professionals on a construction site and work performed by a subcontractor have intended and known beneficiaries. A subcontractor should be concerned that the project owner would sue him for failure to build in a workmanlike manner, just as a design professional should be liable to a subcontractor for faulty design work leading to damages suffered by the subcontractor. There is a finite and knowable audience for the work performed by every party on a construction site, thus distinguishing parties to a construction contract from those in the sale and distribution of tangible goods.

136. See Teledyne, 2002 WL 748898, at *19-20 (Pa. Ct. Common Pl. 2002) (wherein the court notes that a laxer interpretation of the substantial nexus rule would lead to open- ended liability). 137. Cedar Dev., Inc. v. Exch. Place Title Agency, Inc., 778 N.E.2d 136, 140 (Ohio Ct. App. 2002) (noting that while reliance was both reasonable and foreseeable, ultimately the court found that the reliance did not constitute a substantial nexus). HOWARD 1/13/2016 11:31 AM

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Additionally, the limited scope of rights that this rule would bestow on incidental third-party beneficiaries should allay any slippery-slope public policy arguments. Generally, unlike intended beneficiaries, incidental third- party beneficiaries acquire no contractual rights, such as the right to enforce a contract.138 The modified third-party beneficiary rule would not attempt to dramatically change our legal system’s separation between incidental and intended beneficiaries; instead, it merely attempts to grant limited rights to specific incidental beneficiaries. Parties in a construction project that are deemed incidental beneficiaries will not be able to enforce the contracts of any other party working on the project. The modified rule merely recognizes that they share a substantial nexus to another party’s contract with the general contract/project manager or owner. The modified rule is passive acceptance of the fact that a single commercial transaction ties a large amount of parties together in such a way that the successful discharge of one party’s duties are essential and important to the successful discharge of another party’s duties. Such an interpretation precludes arguments that the modified rule would permit for “run-away” liability with a multitude of parties claiming benefits pursuant to the contracts of others.

IV. THE ECONOMIC LOSS RULE AND CONSTRUCTION CONTRACTS

A. The Concept of “Public Policy” as a Judicial Impetus Towards “Fairness”

Under the black letter law recited by our appellate courts lays an equally important stratum of legal principles, generally referred to as equity, or public policy, which serve as a source of structural support and guidance for the law recited by our appellate courts.139 Courts and legal scholars can use public policy as a benchmark, both to evaluate the efficacy of a particular law and to incorporate manifest rules of fairness into black letter law to reflect positive, instead of normative, realities.140 In the case of contract law, for example, the

138. See generally Willard v. Claborn, 419 S.W.2d 168, 170 (Tenn. 1967) (If on the other hand, the benefit flowing to the third party is not intended, but is merely incidental, the third party acquires no right to enforce the contract.). 139. Larry A. DiMatteo, Equity’s Modification of Contract: An Analysis of the Twentieth Century’s Equitable Reformation of Contract Law, 33 NEW ENG. L. REV. 265, 333 (1999) (“[P]ublic policy, like equity, is the name for a precise set of legal standards which lie at the bedrock of the legal system.”). 140. See Shingleton v. Bussey, 223 So. 2d 713, 715 (Fla. 1969), superseded by statute, FLA. STAT. § 627.4136 (1992) (formerly FLA. STAT. § 627.7262), as recognized in Progressive Exp. Ins. Co. v. Scoma, 975 So. 2d 461 (Fla. Dist. Ct. App. 2007) (“Public HOWARD 1/13/2016 11:31 AM

2015/16 PRIVITY EXCEPTIONS IN CONTRACT LAW 215 decision to alter legal standards on ‘public policy’ is generally grounded in “community ideas of fairness and justice.”141 While such an argument reflects a strongly deontological viewpoint,142 it also recognizes the consequentialist nature of public policy, as fairness, especially in contract law, is usually regarded as the optimal outcome for all parties involved.143 If public policy can be used as a tool to modify judicial or statutory constructs, the question of its significance to contract law remains, especially when considering how contract law relates to the construction industry.

B. Construction Project Delivery Methods Require a Modified View of the Economic Loss Rule

Over the past several decades, the structure of a construction project, the number of actors, the complexity of the delivery system, and technological innovation, have turned construction projects from predictable affairs to more complicated endeavors.144 Owners, developers, builders, and designers have an ever-increasing number of project delivery methods that they can use to successfully complete a construction project. The traditional model is the Design-Bid-Build project delivery system, in which the owner’s design experts, including architect(s) and engineer(s), design the project,, and then bids are policy is a molding device available to the judicial process by which changing realities and the attending manifested rules of fair play may be incorporated into our corpus juris.”). 141. DiMatteo, supra note 139, at 333. 142. There are two basic viewpoints in considering whether policy choices should be made. Michael B. Dorff, Why Welfare Depends on Fairness: A Reply to Kaplow and Shavell, 75 S. CAL. L. REV. 847, 851 (2002) (Noting that there has been an intellectual clash between the two philosophies since the 19th century. The first camp, consequentialists, believe that “public policy choices should be made by examining the likely outcome of such choices [and that] one outcome should be preferred over a second if the first will result in a better outcome.”) However, deontologists advocate for the adoption of a particular policy only after it has passed inspection under a given set of principles, which tend to include some incarnation of fairness. See id.; see also EYAL ZAMIR AND BARAK MEDINA, LAW, ECONOMICS, AND MORALITY 42 (2010) (noting that there is an explicit fairness requirement of deontology). 143. Nancy S. Kim, Evolving Business and Social Norms and Interpretation Rules: The Need for a Dynamic Approach to Contract Disputes, 84 NEB. L. REV. 506, 515 (2005) (while noting that fairness may not be the impetus for most parties entrance into a contractual relationship, fairness or equity tends to be an expected good). Using this logic, a policy which therefore promotes the greatest amount of fairness will ultimately benefit the most people, making a deontological viewpoint a consequentialist motivator. 144. Robert A. Rubin & Linda M. Thomas-Mobley, FUNDAMENTALS OF CONSTRUCTION LAW 171, 188 (2001) (explaining that while the design-bid-build, the previously predominate project delivery system, was predictable, evolution within the construction industry drives and will continue to drive delivery system changes). HOWARD 1/13/2016 11:31 AM

216 GONZAGA LAW REVIEW Vol. 51:1 solicited from construction firms, one of which becomes the project’s general contractor.145 This delivery system creates privity of contract with the owner and the design professionals, and the owner and the general contractor, although there is still lack of privity between the design professionals and the general contractor.146 However, a number of different project delivery systems have been developed in recent years, including Design Build, Multiple Prime, Construction Management-Agency, and Construction Management-At-Risk.147

1. Contract v. Tort: Does an Expanded Economic Loss Rule Erode the Foundation of Public Policy

Such a public policy rationale is expounded on in Rotonda Condominium Unit Owners Assoc. v. Rotonda Associates,148 a Virginia court case in which the court was concerned with determining what damages were recoverable in an action brought by the condominium owners association against the developer for structural defects in the building’s construction.149 In Rotonda, the Virginia Supreme Court distinguishes the public policy rationales behind the state’s economic loss rule in the context of the damages sought. In determining that the property owners association could not bring suit, the court held that “[s]uch economic losses [damages for structural deficiencies without personal injury] are not recoverable in tort; they are purely the result of disappointed economic expectations. The law of contract provides the sole redress for such claims.”150 This quote succinctly illustrates one of the fundamental problems with the position for which this article advocates: it could allow parties that are not in privity to recover for economic losses through tort damages for disappointed economic expectations, thus violating public policy. However, there are two primary rationales indicating that, awarding damages for economic loss in non-contractual settings does not violate the

145. Flour Enters. v. United States, 64 Fed. Cl. 461, 482 (2005) (explaining the segmented delivery strategy of “design-bid-build.”). 146. Bedwell Co. v. Camden Cty. Improvement Auth., Civ. No. 14-1531 (JEI), 2014 U.S. Dist. LEXIS 95510, (D.N.J. July 14, 2014) (noting that there privity between the owner and design professionals and owner and contractor, but not between the contractor and design professionals). 147. Rubin & Thomas-Mobley, supra note 144, at 187. 148. Rotonda Condo. Unit Owners Ass’n. v. Rotonda Assoc., 380 S.E.2d 876 (Va. 1989). 149. Metro Panel Sys. v. Sordonia Skanska Constr. Co., 56 Va. Cir. 399, 403-04 (2001). 150. Rotonda Condo. Unit Owners Ass’n v. Rotonda Assoc., 380 S.E.2d 876, 879 (Va. 1989) (citing Sensenbrenner v. Rust, Orling & Neale, 374 S.E.2d 55, 58 (Va. 1988)). HOWARD 1/13/2016 11:31 AM

2015/16 PRIVITY EXCEPTIONS IN CONTRACT LAW 217 public policy supporting the economic loss rule. First, the determining factor behind the adoption of the economic loss rule should be the positions of the party.151 Unlike what some courts have emphasized, it is the nature of the transaction, not the existence of privity, which is essential. As the construction industry evolves, project delivery methods become more complex, and trades become increasingly specialized, privity between all parties will never be achieved. However, all parties are related to each other in commerce, with all of them seeking to complete a given construction project successfully. It is the unification in commercial interests that makes all parties incidental third-party beneficiaries of all contracts related to the project, thus establishing the sufficient nexus required to override the formality of the economic loss rule’s contractual privity focus. Requiring privity is therefore anachronistic; while it ensures the distribution of appropriate damage categories and achieves particular public policy objectives, it ignores the notion that parties not in direct contract have the same commercial goals and expectations. As it stands, strict interpretations of the contractual privity requirement actually distribute rewards inequitably, reduce overall fairness and therefore are, from both a deontological and consequential standpoint, less desirable for public policy than the widespread adoption of a modified approach to the economic loss rule. The second reason a modified economic loss rule does not violate central public policy tenants of tort and contract law rests in the type of damages typically sought in construction disputes. In several jurisdictions, the strict requirement of the broader conception of the economic loss rule, barring parties from seeking tort damages in contractual relationships, is relaxed when there is an independent duty free of contractual obligations.152 Most states have enacted extensive statutory protections for occupants of residential and commercial buildings to ensure that all buildings within the jurisdiction can be used without the occupant having to fear for their safety.153 In fact, the Standard Building

151. See supra Part III (noting that the modified economic loss rule should be adopted by courts in construction cases). 152. Springfield Hydroelectric Co. v. Copp, 779 A.2d 67, 71 (Vt. 2001) (noting that courts have permitted for recovery of economic loss in a tort setting where there is a special relationship between the tortfeasor and plaintiff that gave rise to a duty of care beyond the contractual obligations). 153. South Carolina, for example has enacted sixteen statutes that regulate the construction industry including the Horizontal Property Act, the Residential Landlord and Tenant Act, the Residential Property Condition Disclosure Act, the Dwellings Unfit for Human Habitation Act, and the Hotels, Motels, Restaurants and Boarding Houses Act. In addition, the state has assigned more than 10 agencies to regulate design and construction professionals including, the Department of Labor, Licensing and Regulation, the Board of Professional Engineers and Land Surveyors, and the Contractors Licensing Board. This is HOWARD 1/13/2016 11:31 AM

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Code, in its preface, states that its creation is to “protect the public’s life, health and welfare in the built environment.”154 In addition to these industry guidelines, most political subdivisions in South Carolina have adopted localized building codes.155 While focusing on South Carolina is merely a demonstrative tool, most states have adopted one of three types of building codes, and many localities have adopted additional regulatory schemes as well.156 Together, this complex web of international, state, and local building codes, as well as state regulation over licensing of construction professionals, creates an intricate and non-delegable duty on all in the construction industry to ensure that their work protects the life and safety of any potential building inhabitants.157 This is why the courts recognize implied warranties, such as the warranty of workmanlike construction and the of habitability.158 Although courts have considered the question of relaxing the economic loss rule to permit the recovery of economic damages in a tort action, courts have recognized strict adherence to the guidelines of the economic loss rule can actually undermine public policy objectives in cases where

why violation of a building code in North Carolina is considered negligence per se. Olympic Prods. Co. v. Roof Sys., Inc., 363 S.E.2d 367, 371 (N.C. App. 1988). 154. Brief for Appellant at 12, Long Grove at Seaside Farms, LLC v. Long Grove Prop. Owners’ Ass’n, N. 2015-UP-377, 2015 S.C. App. Unpub. LEXIS 457 (July 29, 2015) (No. 2009-CP-10-6746), available at http://ctrack.sccourts.org/public/caseView.do?cs IID=52668 (quoting Preface, 1997 STANDARD BUILDING CODE) [hereinafter Long Grove Brief]. 155. See generally SOUTH CAROLINA BUILDING CODE (2006 INTERNATIONAL CODE COUNCIL, INC.); COUNTY OF CHARLESTON, S.C. ORDINANCES FOR BUILDINGS AND BUILDING REGULATIONS, CH. 4 SECT. 101-18; INTERNATIONAL BUILDING CODE; see also Long Grove Brief, supra note 154. 156. ALAN JEFFERIS & DAVID A. MADSEN, ARCHITECTURAL DRAFTING AND DESIGN 114 (5th ed. 2005) (noting that building codes have been adopted throughout most of the United States); STEVEN R. WINKEL, ET AL., RESIDENTIAL BUILDING CODES ILLUSTRATED: A GUIDE TO UNDERSTANDING THE 2009 INTERNATIONAL RESIDENTIAL CODE 5 (2010) (noting that most states have adopted one of three categories of building codes, or have developed their own, while many municipalities have adopted uniform codes with little adaptation). 157. See Taylor v. Stevens Cnty, 759 P.2d 447, 450 (Wash. 1988) (even the inspection of buildings and issuance of building codes, without additional layers of obligations owed by construction professions, has been viewed by courts as a public duty to ensure the safety of possible inhabitants). 158. Speight v. Walters Dev. Co., 744 N.W.2d 108, 110 (Iowa 2008) (explaining that the implied warranty of workmanlike quality was developed to protect homeowners from latent defects in the home); Davencourt at Pilgrims Landing Homeowners Ass’n v. Davencourt at Pilgrims Landing, LC, 221 P.3d 234, 252 (Utah 2009) (noting that the implied warranty of habitability has been recognized by other jurisdictions to ensure that a new residence provides “inhabitants with a reasonably safe place to live, without fear of injury to person, health, safety, or property.”). HOWARD 1/13/2016 11:31 AM

2015/16 PRIVITY EXCEPTIONS IN CONTRACT LAW 219 independent duties related to life/safety dominate. Given the intricate layer of duties owed by construction professionals, allowing a broader reading of the economic loss rule, or suspending the economic loss rule’s restrictive parameters, is in line with earlier courts’ decisions and furthers not only the public policy considerations of construction law, but the economic loss rule as well.159

V. CONCLUSION

The current regime within which construction litigation operates is plagued by glaring inefficiencies. Specifically, the economic loss rule, or at least the variation requiring privity of contract between two parties in order to sustain claims for economic damages, has produced a complicated series of claims, cross-claims, counter-claims and claims from third, fourth, and fifth parties. These claims often stem from how intertwined the responsibilities and outcomes of the parties working on construction projects are, since flawed drawings or construction by one design professional or subcontractor often causes damages for others involved in the project. Similarly, delivery methods for construction projects are becoming increasingly complex, placing layers of parties above and below increasingly-specialized tradesman and others involved in the process, making it very difficult for an aggrieved party to bring an action against a culpable party. Instead, the economic loss rule requires a convoluted series of suits that drains judicial resources and increases net unfairness. A number of jurisdictions across the country have recognized numerous exceptions to the economic loss rule. One exception that can prove particularly helpful in solving the current dilemma in construction litigation is the substantial nexus exception. Instead of requiring parties seeking economic damages to be in privity of contract, the substantial nexus exception will waive the privity requirement and permit for the recovery of economic damages when the parties share a substantial nexus. This exception lends itself to construction litigation via the recognition of a modified form of the third-party beneficiary rule. Courts can explicitly establish a baseline as to what parties are in substantial nexus to each other by recognizing that all parties providing services on a construction project are incidental third-party beneficiaries to the

159. See Springfield Hydroelectric Co. v. Copp, 779 A.2d 67, 72 (Vt. 2001) (citing Vermont Plastics, Inc. v. Brine, Inc., 824 F. Supp. 444, 450 (D. Vt. 1993) aff’d, 79 F.3d 272 (2d Cir. 1996) (The objectives of the economic loss rule would be circumvented in situations in which the rule forbade recovery of “third party recovery in negligence for purely economic losses suffered as a result of reliance upon negligently rendered professional services.”)). HOWARD 1/13/2016 11:31 AM

220 GONZAGA LAW REVIEW Vol. 51:1 contracts of others involved in the project. Modifying the third-party beneficiary rule by granting limited rights to incidental beneficiaries will eliminate unreliable and misguided tests currently used by courts to determine if parties involved in the same construction project share a substantial nexus. Modification of the rule would also allow all parties to understand their legal rights at the time of contracting. This preserves courts’ resources and maximizes fairness for all parties involved, thus fulfilling the public policy objectives of the third-party beneficiary rule and the economic loss rule, while also preventing negative public policy outcomes.