Contracts Are King, But Don’t Forget Tort Law

The construction industry is unique in the extent to which business terms and legal obligations are memorialized in written contracts.  The extensive use of written agreements is driven by the complexity of designing and constructing projects, particularly when the project participants have potentially conflicting interests and incentives.  No other industry is awash in standard contract forms and terms like the construction industry.

It is understandable and appropriate for construction project participants to focus their attention on the important task of memorializing their agreements about known issues such as price, schedule and work scope, and to allocate the risk of potential unknown factors such as underground conditions and force majeure events.  In the event of a dispute, the contract is usually the determinant of who wins and losses.  However, the parties should not lose sight of the fact that their legal rights and remedies are not based solely on the agreements they may have signed.

In addition to agreement-based rights and obligations, “tort” law imposes all sorts of implied rights and obligations independent of what parties may have formally agreed to.  The foremost “tort” obligation is to use reasonable care so as to avoid damage to others.  The failure to use reasonable care is negligence.

Because of the dominance of formal contracts in the construction industry, courts historically were reluctant to recognize the applicability of tort remedies on construction projects.  This reluctance was reflected in the so-called “economic loss” doctrine, which prevented construction participants from suing for economic loss unless a contract existed between them.  The philosophy was that parties were expected to define their obligations in agreements that would be the sole determinants of their rights.

One party could not sue another outside of contract for negligence if the harm was merely economic.  Recently, however, courts have significantly limited the applicability of the economic loss doctrine to permit the pursuit of both contractual and negligence theories for economic losses.  This development has serious consequences by increasing the risk of claims outside the carefully negotiated contracts.  A recent court case outside the construction context is instructive.

In Kaste v. Land O’Lakes Purina Feed, a dairy sued its feed supplier for the death and health problems of its cows.  Despite the existence of a feed supply contract with a limitation of liability clause, the dairy sued for damages under both contract and negligence theories.  At trial, the dairy won about $90,000 for its breach of contract claims but won $750,000 in lost profits on its negligence claim.  The feed supplier appealed, arguing that the dairy should not have been awarded lost profit damages since the feed supply contract had a clause waiving such consequential damages.  However, the appeals court ruled that the language of the consequential damages limitation in the contract could reasonably be interpreted to relate only to the dairy’s contractual claims and not its negligence claims.  Therefore, the dairy’s judgment for lost profits was upheld.

While not in the construction context, Kaste is a good reminder that construction project participants must consider the extra-contractual risks and remedies under tort laws.  As the court in Kaste found, a waiver of consequential damages provision, depending upon its wording, may only protect against contractual claims, not negligence claims.  Notice and other procedures may be interpreted to relate to contractual claims unless the contract explicitly includes the full universe of claims—both contractual and non-contractual.

Subcontractors should be especially alert about the risk of direct tort claims from an owner.  In a recent California case, an owner sought to circumvent a consequential damages limitation in its prime contract by directly making a negligence claim against various subcontractors for delay.  The owner argued that it may have contractually limited its rights against the prime contractor, but these limitations did not apply to its direct negligence claims against the subcontractors.  Owners have employed a similar tack to avoid inadequate liquidated damages provisions or other limitations on their claims.

The issue of extra-contractual claims can also arise in the context of determining the scope of an arbitration clause.  If an arbitration clause is drafted narrowly to encompass claims arising under the contract, it may not be broad enough to include negligence claims related to the project as a whole.  Absent unusual situations, care should be taken to ensure that the arbitration scope broadly covers all claims that might arise, not just contractual claims.

A good contract will recognize and address the possibility that parties may resort to tort remedies.  That way, the contract will retain its primacy in governing the rights and obligations of construction project participants.

Originally published as “Op-ED: Contracts may be king, but don’t forget tort law” by the Daily Journal of Commerce on August 18, 2017.