Flagstaff Affordable Housing v. Design Alliance (2/12/10)

This is an examination and explanation of the economic-loss doctrine. It reverses a Division One opinion we blogged in March 2009.

Design Alliance designed apartments that Flagstaff Affordable Housing built. The design violated federal handicap-accessibility  requirements. FAH was required to remedy the problem at considerable expense so it sued Design Alliance.

Design Alliance moved to dismiss, arguing that the economic-loss rule barred the claim. That rule, as established by the First Division in  Carstens v. City of Phoenix, 206 Ariz. 123, says that there can be no recovery for economic loss absent personal injury or property damage. The trial court granted the motion. The Court of Appeals reversed, holding that the economic-loss rule does not apply to claims against design professionals. The Supreme Court reverses that, in an opinion meant to be a fairly definitive statement on the economic-loss rule.

Carstens had said that there is no tort recovery of economic loss absent physical harm. This opinion says that that’s what the rule is not. Tort plaintiffs who have no contract with the defendant can and often do seek to recover economic loss. The economic-loss doctrine is a creature of contract law: a contracting party is limited “to contractual remedies for the recovery of economic losses unaccompanied by physical injury to persons or other property.”

This was the law before the Court of Appeals mixed things up in Carstens. But the Supreme Court court seems aware that the real culprit was its opinion in the case that confused the Carstens court: Salt River (143 Ariz. 368). That case held that products liability plaintiffs, who could have both contract and tort claims, can’t get economic loss (assuming that the contract doesn’t permit it) unless there is physical harm caused suddenly and accidently by an unreasonably dangerous product (the “three-factor” test). The court tries to iron out one or two smaller problems with Salt River and then throws doubt on the three-factor test itself, apparently signaling a willingness to change it when an appropriate products case comes along.

In construction-defect cases, the court in effect says that building a building is a more contract-centric thing than buying a product and so allowing tort damages would not be appropriate. Therefore, “when a construction defect causes only damage to the building itself or other economic loss, common law contract remedies provide an adequate remedy.” Economic loss is recoverable only if the contract so provides. The three-factor test does not apply.

As to the Court of Appeals’ holding that the economic-loss rule isn’t involved in claims against design professionals, it is true that the architect owes common-law duties to the owner but they arise because there is a contract between them. There is no valid basis for dealing differently with architects than with other construction contractors.

It is at this point that the court seems to come closest to saying frankly that the very idea of an “economic-loss rule” is misleading. Its simply an aspect of the law of contract damages. To call it a “rule” makes more of it than there is and invites its misinterpretation as a piece of substantive law. That isn’t exactly what the court says, though it may not be a bad way to think about what the court means.

The opinion remands the case to the trial court. It announces an economic-loss rule different from the Carstens rule that the trial judge had; the new rule would allow economic loss if permitted by contract but the contract was not in the record on appeal.

This points up a potential source of confusion. Both this case and a number of Court of Appeals cases following Carstens indicate that the economic-loss rule applies to construction-defect cases. But this opinion means something different by “economic-loss rule;” it holds that the Carstens rule does not apply, overturning or making obsolete the CA cases.

One problem this opinion does not address – the facts did not present it – is the “other property” issue. The court repeatedly points out that the economic-loss rule does apply to claims of physical injury to persons or “other property” – i.e., property other than the product, building, etc. that was the subject of the contract. What “other property” means is not always easy to figure out.

A hat-tip to the court for trying in this and other decisions in the last year or so to address some real trouble-spots in our civil law. And also for citing in this one an oldie but a goodie, Hadley v. Baxendale, 9 Exch. 341, 156 Eng. Rep. 145 (1854), which you no doubt remember fondly from law school.

(link to opinion)