Changes in Texas' Interpretation of the Economic Loss Rule

This past summer the Texas Supreme Court handed down two decisions regarding the economic loss rule. The decisions, on their face, look to be completely inconsistent with each other – one holding that a subcontractor can be sued for negligence in a breach of a contract action, and the other holding the subcontractor cannot.  However, while the results of the two cases may have been different, the Supreme Court’s reasoning for their decision was absolutely consistent.

Generally, the economic loss rule precludes recovery in tort for economic losses resulting from a party’s failure to perform under a contract when the harm suffered consists only of the economic loss from the respective contract. In other words, when the complaining party has not suffered personal injury or property damage, it cannot sue for monetary damages arising out of a breach of contract.

LAN/STV v. Martin K. Eby Const. Co.

This past June, in LAN/STV v. Martin K. Eby Const. Co., (“LAN/STV”) the Texas Supreme Court held Eby, the general contractor, was precluded from recovering in tort for the monetary costs it incurred from delays and increased performance costs because of LAN/STV’s faulty architectural designs for the extension of the DART light rail system in Dallas. The Supreme Court disagreed with the appellate court’s assertion that the out of pocket expenses Eby suffered to compensate for LAN/STV’s misrepresentation in its designs was independent from the injury that is subject of the contract itself. The Court found that, in fact, the economic loss rule applied to the case's underlying facts, which worked to bar a general contractor from recovering delay damages from an owner's architect. The Court reasoned that LAN/STV, as architects, should not be treated any differently than any other party agreeing to be part of a construction project. Although there is a basis for the contractor's reliance on the architect's plans, the contractor’s increased performance costs only affected the profit it intended to collect under its contract with DART. To protect themselves, the parties should have distributed the risk of economic loss via the contract. Therefore, the Court held that the economic loss rule must be applied to the case and accordingly ruled that Eby take nothing from LAN/STV.

Chapman Custom Homes, Inc. v. Dallas Plumbing Co.

Two months later, in Chapman Custom Homes, Inc. v. Dallas Plumbing Co., the Texas Supreme Court ruled the economic loss rule did not bar a homeowner from suing a subcontractor for negligent performance of its contract when the plumber’s negligence caused flooding of the completed house.  In Chapman, plumbing leaks caused extensive damage to a newly-completed, custom-built house. The homeowner and general contractor, together, sued the plumbing subcontractor for breach of contract and negligence. They alleged the plumbing subcontractor failed to properly join the water system to the hot water heater, which resulted in flooding of the house. The trial court granted the plumbing subcontractor’s motion for summary judgment as to all claims and the court of appeals affirmed. The court of appeals ruled that (1) the owner could not recover contract damages because it was not in privity with the subcontractor, (2) the general contractor, although a party to the plumbing subcontract, did not own the property and therefore did not suffer compensable damages, (3) the pleadings asserted only breach of contractual duties, so that dismissal of the negligence action was proper, and (4) the economic loss rule barred the negligence claim because the property damage was an economic loss arising from the “subject matter of the contract itself,” citing Jim Walter Homes, Inc. v. Reed, 711 S.W.2d 617, 618 (Tex. 1986).

The Texas Supreme Court reversed, ruling that the subcontractor may be liable in negligence because it breached an implied duty to undertake its services in a workmanlike manner. The Court asserted the court of appeals erred in applying the economic loss rule because, although as a general matter, the ELR [Economic Loss Rule] “precludes recovery in tort for economic losses resulting from a party’s failure to perform under a contract when the harm consists only of the economic loss of a contractual expectancy,” a party cannot avoid tort liability to the world simply by entering into a contract.  The Court reasoned that if this were the case the economic loss rule would swallow all claims that arose between contractual and commercial strangers.  The Court explained that a party may still incur tort liability from the negligent performance of a contractual obligation when the defendant breaches a duty that is “independent of the contractual undertaking and the harm suffered is not merely the economic loss of a contractual benefit.” The ELR did not apply the homeowner’s claim because “the plumber’s duty not to flood or otherwise damage the house is independent of any obligation undertaken in its plumbing subcontract with the builder, and the damages allegedly caused by the breach of that duty extend beyond the economic loss of any anticipated benefit under the plumbing contract.”

Comparing LAN/STV  and Chapman

So the remaining question is why is the owner in Chapman owed an implied duty of workmanlike conduct from the subcontractor, but the general contractor was not protected from the architect’s negligent misrepresentation in LAN/STV? While the Chapman court does not attempt to give an explicit answer to this, the distinction no doubt lies in the nature of the injury suffered. The contractor in LAN/STV suffered increased performance costs, affecting the profit it intended to reap under the contract. By contrast, the plumber’s negligence in Chapman resulted in physical damage to the house. While the plumber’s acts arose out of a contract obligation, that fact did not absolve him from tort liability. The cost of performance is the “subject” (or subject matter) of the prime contract in LAN/STV. On the other hand, physical damage to the Chapman house, although the foreseeable consequence of poor workmanship by a plumber, was not the “subject” of the plumbing contract. Otherwise stated, while the Court had previously imposed upon all service contracts a duty to perform in a workmanlike manner, breach of that duty results in tort liability only if the injury is not “economic loss to the subject of a contract itself.”