Construction Law Advisory
Construction Defect Claims and Impact of Economic Loss Rule in Oregon
By Dean M. Phillips
[March 2007]
Why should contractors, subcontractors, insurance claims adjusters and real estate professionals know about the economic loss rule in Oregon? Because this important, but sometimes little-known rule, imposes liability on or relieves individuals and business entities from liability associated with construction defect claims. While the number of construction defect claims continues to climb, it is interesting to note that for Oregon contractors, a summary of the incurred loss and claim expense paid by insurance carriers has actually gone down since 1998. This interesting statistic is documented in the American Actuarial Consulting Group’s report to the Construction Claims Task Force Report to the 74th Oregon Legislature. In part, this may be due to the long “gestation” time for construction defects to manifest themselves but also this is likely due to the effect of the economic loss rule in Oregon.
In December 2006, the Oregon Court of Appeals issued two decisions that further clarify the effect and extent of the economic loss rule. Traditionally, this rule limits the ability of individuals to sue for negligent construction of residential homes and commercial facilities. In short, in Oregon (and most states have their own variation of this rule) a rule developed that a person or firm is not liable for negligent construction that causes only economic loss unless there is a special relationship between the plaintiff and defendant. But what defines “economic loss” and a “special relationship?”
In Bunnell v. Dalton Construction, Inc. (2006), purchasers of a residence costing approximately $500,000 discovered defects from a home inspection resulting from water intrusion alleging defective ventilation, windows, stone flashing and general lack of adequate weather protection. The purchasers negotiated a price reduction of approximately $2,500 for the cost of fixing the defects. After purchasing the home, they discovered the defects were more extensive than originally thought with an estimate of $17,500 as the cost to repair. The purchasers sued the contractor (who was not the seller to plaintiff/purchasers) claiming negligence. Because the plaintiffs were not a party to the original construction contract between the builder and prior owner, they claimed against the construction contractor based on negligence. The builder raised the defense that the plaintiff’s damages were only economic losses (because they were seeking only the cost of repairs) and therefore they should not be entitled to any compensation. The trial court agreed with this position, but the Court of Appeals reversed indicating that the water damage to the interior structure was property damage and not “economic loss.”
In the companion case of Harris v. Suniga (2006), the plaintiffs were trustees of a trust that owned an apartment complex in Salem, Oregon. The defendant was the builder. Again, these parties had no contractual relationship. Water damage issues of the same type as those raised in Bunnell were raised by plaintiff, and the same primary defense was raised by the defendant that plaintiff suffered only economic loss. In Harris, the cost of repairs was estimated at $376,000. At trial and on appeal, the plaintiffs claimed that the economic loss doctrine only applies to lost profits, loss of reputation or loss in value to intangibles (such as stock) and not to damage caused to physical structures. The trial court did not agree with the plaintiffs but the Court of Appeals did and reversed the trial court saying that damage to physical structures is not "economic loss."
As a result of these cases, the strength of the economic loss rule as a shield to limit liability for negligence in building has been significantly reduced.
Other cases under Oregon law have provided some clarity on whether there is a special relationship that will allow one to sue for negligence. Generally, such a special relationship will be established if you hire another to act as your expert representative to protect your interests during the design or construction of a project. This special relationship is generally established through a contractual relationship (written or verbal) such as an Owner/Architect or Owner/Engineer relationship. If a construction manager is given similar authority to make decisions and act on behalf of the other party, a construction manager could rise to the level of having this “special relationship.” Your relationship with your general contractor under a traditional construction contract does not create such a “special relationship” under existing Oregon law. Accordingly, it is normally impossible to sue your own general contractor for negligent construction in Oregon. Your only effective remedy is that for breach of contract as defined and limited by the terms of your contract. It is an open question as to whether a design-builder/owner relationship would give rise to this “special relationship.”
There are additional ways in which the parties can protect themselves from or allocate the risks associated with construction defects. First, one cannot overemphasize the importance of careful contract review and drafting. The contract remedy may be the only effective remedy one has for defective construction unless the parties’ relationship can be described as a “special relationship.” Second, if you are a contractor or developer, Oregon law allows you to limit liability through the use of recorded warranties under ORS 701.605. This statute allows you to avoid negligence claims by subsequent purchasers of buildings by binding subsequent purchasers to the terms of the recorded warranty for the 10-year time that claims can be brought for construction defects under Oregon law. Third, owners, contractors and subcontractors need to be aware of the right to cure construction defects under Oregon law. ORS 701.565 and following sections require owners to give notice of construction defects to contractors prior to bringing suit or filing claims in arbitration. Contractors and subcontractors have a corresponding obligation to notify subcontractors or sub-subcontractors. Under these statutes, contractors, subcontractors and sub-subcontractors have a right to cure or to pay damages in lieu of correction or to deny responsibility. If the procedure is not followed, no claim can be brought against the contractor or subcontractor. Finally, the parties can allocate the risks of construction defects through a well-coordinated insurance program.
If you have any questions about this article or the ways to effectively allocate the risks of construction defects through contract drafting, recorded warranties, notice of construction defects or construction insurance programs, please contact members of DWT’s construction practice group. These attorneys are listed here.
For more information, please contact:
This advisory is a publication of the real estate and land use department of Davis Wright Tremaine LLP. Our purpose in publishing this advisory is to inform our clients and friends of recent legal developments. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations. Attorney Advertising. Prior results do not guarantee a similar outcome.
Copyright © 2007, Davis Wright Tremaine LLP.
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