Image courtesy of Flickr (Licensed) by © Mark Fischer
Image courtesy of Flickr (Licensed) by © Mark Fischer

Supreme Court of Texas:  The Economic Loss Rule bars general contractor’s negligence and negligent misrepresentation claims against design professionals.

It is not uncommon for an owner to hire architects and engineers to design the owner’s project.  The owner then seeks bids from multiple general contractors and contracts with the general contractor to build the project.  No contract exists between the architect and the general contractor so they are referred to as “contractual strangers.”

Can then a general contractor recover damages against the design professional in negligence if, after construction commences, many costly errors are discovered in the engineer’s work?  On June 20, 2014, Texas Supreme Court answered in LAN/STV vs. Martin K. Eby Construction Company, Inc., that they could not.

The Economic Loss Rule

In legal parlance, the “Economic Loss Rule” is a common law rule that restricts the recovery by a party to a contract, from another party in negligence, for purely economic (money) losses to the subject of the contract.  The underlying theory is that a contract that settles responsibility for an economic loss would best serve the interest of the parties to a risky situation and is preferable to judicial assignment of liability after the harm is done.

Martin Eby’s Claims

The Dallas Area Rapid Transportation Authority (“DART”) contracted with LAN/STV to prepare plans, drawings and specifications to build a light rail line.  LAN/STV agreed with DART to be responsible for the quality and accuracy of the services it furnished and to be liable to DART for all damages to DART for the negligent performance of the services furnished.  DART used LAN/STV’s plans to solicit competitive bids to construct the project.  Martin K. Eby Construction Company (“Eby”) submitted the low bid and was awarded the contract.  Eby and LAN/STV had no contract with each other, they were “contractual strangers.”

After Eby commenced construction it discovered that 80% of LAN/STV’s drawings required change that caused losses to Eby totaling nearly $14 million.  Eby sued DART for breach of contract and LAN/STV for negligence and negligent misrepresentation.  Eby settled with DART for $4.7 million and continued its lawsuit against LAN/STV.  At trial, Eby was awarded judgment for $2.25 million against LAN/STV.  Both parties appealed and the court of appeals affirmed.

Reversal by the Texas Supreme Court

In reversing and rendering judgment that Eby take nothing from LAN/STV, the supreme court removed any confusion about whether architects should be treated differently for the negligent performance of professional services.  Justice Hecht explained that,

though there remains the possibility that a contractor may not do so, we think the availability of contractual remedies must preclude tort recovery in the situation generally, because, as stated above, “Clarity allows parties to do business on a surer footing.

Applying the economic loss rule to the facts in Eby, the Court explain that DART was contractually responsible to Eby for providing accurate plans for the job.  Eby agreed with DART to specified remedies for disputes and settled its claims for $4.7 million.

Does the Court’s opinion overlook the realities of public contracts?

One of the principals underlying the economic loss rules is that the parties are in the best position to protect themselves through bargaining with the owner and that they can insist on protection from the owner who will get protection from the architect.  However, in the realm of public contracting, such free market bargaining does not exist.  In fact, contractors must all bid upon the same fixed terms provided by the public entity.  If the public contract is silent concerning responsibility for defective plans and specifications, then under Texas common law (established in 1907 by the Texas Supreme Court in Lonergan v. San Antonio Loan & Trust  Co.), the risk and liability resulting from defective design documents rests upon the general contractor.  Until this common law liability for design defects is shifted to public owners, public contractors will invariably continue to bear a disproportionate amount of risk for defects over which they have no control.