North Carolina Muddies the Water on the Economic Loss Doctrine

Construction and Procurement Law News, Q4 2021

Authored Article, Firm Alert

Author(s)

A pair of recent rulings involving the economic loss doctrine from North Carolina serve as a timely reminder to carefully consider the extent of contractual remedies in negotiation of construction agreements – lest a later breach of contract remedy prove insufficient, and further recovery barred by the economic loss doctrine. In some states, the doctrine bars recovery of purely economic loss (delay damages, for example) where there is a contractual relationship in the chain of alleged wrong-doers. The rule is murky at best, but can be a surprise to you and your lawyers.

In December 2020, the North Carolina Supreme Court released its decision in Crescent University City Venture, LLC v. Trussway Manufacturing, Inc., 376 N.C. 54 (2020), clarifying the application of North Carolina’s economic loss rule in the commercial construction context. The decision emphasizes the need for owners negotiating commercial construction contracts to expressly allocate all risk of possible loss in the contractual documents – even losses related to subcontractor performance. 

The Crescent case involved a series of lawsuits by an owner/real estate developer, Crescent University City Venture LLC (“Crescent”), against its general contractor, AP Atlantic, Inc. (“AP Atlantic”) and its parent company, related to wooden truss failures in a series of student apartments.  AP Atlantic was hired to construct the apartment buildings, subcontracting with Madison Construction Group, Inc. (“Madison”) for framing work. Madison then executed a purchase order with Trussway Manufacturing, Inc. (“Trussway”) to fabricate and supply the wooden trusses at issue.

Following student occupation of the apartments and in particular a party in which a large number of people congregated in an upstairs apartment unit, the lower unit’s ceiling began to crack and sag. Crescent hired an engineering firm, which advised that the Trussway floor trusses were defective and that the defects were systemic and pervasive throughout all apartment buildings.  

Litigation ensued, and Crescent (in addition to filing a breach of contract action against AP Atlantic) eventually filed a negligence action against Trussway—alleging that Trussway was negligent in manufacturing and fabricating the trusses. Trussway moved for summary judgment, arguing that North Carolina’s economic loss rule barred Crescent’s claim because Crescent failed to prove breach of any duty other than Trussway’s contractual obligations to Madison. The North Carolina Business Court agreed and granted summary judgment in favor of Trussway.

The North Carolina Supreme Court affirmed the decision of the Business Court, and clarified that the correct inquiry for determination of whether the economic loss rule applies is whether the “subject matter of a contract has, in its operation or mere existence, caused injury to itself or failed to perform as bargained for”—thereby resulting in damage. The Supreme Court found the economic loss rule applicable, even though Crescent had no contractual relationship with Trussway (and therefore the only path of recovery against Trussway was through a negligence claim). The Supreme Court noted that Crescent had fully negotiated its risk relating to truss failures via its contract with AP Atlantic.

In so doing, the Supreme Court clarified prior holdings regarding the economic loss doctrine in North Carolina, noting that 1) the application of the economic loss rule does not hinge on the existence of contract between the plaintiff and the defendant and 2) public policy considerations may exist in the residential homeowner market that necessitate different results.

Following the Crescent opinion, a separate opinion issued from the Eastern District of North Carolina further qualified and narrowed the application of the economic loss doctrine. In New Dunn Hotel, LLC v. K2M Design, Inc., the court allowed an economic loss claim brought against an architectural firm by an owner of a commercial construction project to survive, holding that it was not barred by the existence of a contractual remedy. The New Dunn Hotel case involved a design dispute between an owner of a hotel building (New Dunn Hotel, LLC), its operator/lessee (510 Spring Branch, LLC), and the architectural firm contracted with the operator/lessee. The architectural firm failed to comply with its contractual duties, causing significant losses to both owner New Dunn and operator 510, who together sued the architectural firm. The Eastern District Court found that owner New Dunn’s negligence claims against the architectural firm were not barred by the economic loss rule, because New Dunn and the architectural firm lacked a contract and “never allocated risk of loss by contract.” The Eastern District Court stressed the limitations of the Crescent opinion, narrowing it to apply only where the “injury complained of concerns solely the subject matter of a valid contract between the developer and the general contractor.”

These recent North Carolina opinions highlight the importance of careful negotiation of risk and remedies in construction agreements between owners and contractors. For owners, it is especially critical to understand the extent of potential contractual remedies in the event of a design or construction defect – including consideration of warranty provisions and insurance coverage. For contractors, it is critical to ensure appropriately negotiated limitations of liability and consequential damages waivers in every agreement. As North Carolina courts have recently demonstrated, in many states, it is far from a sure bet – and in fact an extremely risky bet – to depend or allege tort recovery for economic losses.