HOWARD 1/13/2016 11:31 AM TOWARDS A BROADER UNDERSTANDING OF PRIVITY EXCEPTIONS IN CONTRACT 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 guarantee 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. 187 HOWARD 1/13/2016 11:31 AM 188 GONZAGA LAW REVIEW Vol. 51:1 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 Breach of Contract .......................................................... 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. Tort 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 CONTRACTS .......... 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 HOWARD 1/13/2016 11:31 AM 2015/16 PRIVITY EXCEPTIONS IN CONTRACT LAW 189 I. INTRODUCTION While a quick review of common law 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