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OPINION: In construction, be careful what you contract for

The Wisconsin Court of Appeals recently reaffirmed the application of the economic-loss doctrine as a bar to negligence claims caused by certain defects in construction. Kmart Corporation v. Herzog Roofing, Inc., No. 2017AP1041, (Wis. App. 3rd Dist., Oct. 30, 2018). The decision clarified the broad application of the economic-loss doctrine to bar economic damages that are foreseeable under a contract, incorporating contract terms in its analysis.

Brian Zimmerman

Brian Zimmerman

In 2004, Kmart contracted with a commercial roofing contractor, Herzog Roofing, Inc., to install a synthetic-rubber roofing membrane called EPDM on one of its stores. Ten years later, the roof collapsed. Kmart filed suit against Herzog claiming negligence per se, negligence, and breach of contract. Kmart argued that Herzog breached its contract and acted negligently by failing to obtain a permit and failing to inform Kmart that the roof needed to be inspected before installation. Kmart claimed that the inspection that would accompany a permit would have revealed the structural condition of the roof and alerted Kmart to the need for structural repairs. Kmart’s damages exceeded $1.8 million for contents, fixtures, merchandise, clean-up costs, costs to shore up walls adjacent to the collapse, and other damages.

On Herzog’s motion for summary judgment, Kmart’s breach-of-contract claim was dismissed as barred by the statute of limitations. The trial court also dismissed the negligence claims as being barred under the economic-loss doctrine. Kmart appealed the decision.

On appeal, Kmart conceded its tort claims fell within the general scope of the economic-loss doctrine, but argued that the doctrine should not apply because (1) Kmart was not alleging the roofing material was defective; and (2) its damages fell under the “other property” exception to the economic-loss doctrine.

Predominant purpose and economic-loss doctrine

The economic-loss doctrine bars tort remedies when commercially sophisticated parties have bargained for contractual limitations to liability in contracts for goods. The first test in determining whether the economic-loss doctrine applies is to identify whether a contract is for goods, services, or both. When a contract is for both, courts examine the “predominant purpose” of the contract according to the totality of circumstances. Among the considered factors for this test are the primary objective of the contract, the contract language, the nature of the business, and the cost of goods as compared with the cost of services. If the predominant purpose of the contract is for the sale of goods, the economic-loss doctrine applies to bar a negligence claim.

The contract between Kmart and Herzog was for goods and services—both the EPDM roofing membrane material and its installation. Herzog argued that the contract’s primary purpose was for a product. Herzog claimed that the contract’s scope of work, as defined by Kmart, included particular specifications revolving around the product Kmart chose—the EPDM roofing. Herzog offered in further support of its position that the material costs exceeded the labor costs by nearly fifty percent of the total contract price.

Andrea Jahimiak

Andrea Jahimiak

Kmart did not directly discuss the predominant-factor test, conceding that the economic-loss doctrine applied to the contract. Nevertheless, Kmart argued that its claims were not barred by the economic-loss doctrine and that it could recover under tort law because Kmart’s claim arose out of the service component of the contract—failure to obtain construction permits and not the failure of the roofing membrane itself. The appellate court disagreed and held that either contract law or tort law applies to mixed contracts, not both. In so finding, the court reinforced that the choice is not at the discretion of either party in a piecemeal fashion; rather it is determined by the predominant purpose of the parties’ negotiated contract as a whole.

Exception to economic-loss doctrine – ‘other property’

Kmart also argued that the “other property” exception to the economic-loss doctrine applied, allowing tort claims when a product defect causes damage to “other property.” This exception is analyzed using two tests: integrated systems and disappointed expectations. If a defective product is part of an integrated system and it causes damage to other parts of the same system, the damage is not to “other property.” The appellate court found that parts of Kmart’s damages were “other property.” Under the disappointed expectations test, however the “other property” exception does not survive if the damage was reasonably foreseeable. The disappointed expectations test is objective and generally concerns whether a reasonable purchaser of a product in the plaintiff’s position should have foreseen the risk and anticipated the need for protection through the contract. The court of appeals found that Kmart’s damages were foreseeable and that the parties’ contract anticipated the need for protection from such foreseeable damages. The court explained that a reasonable purchaser of roofing materials would foresee that the failure of the roofing materials would result in damages equivalent to those incurred by Kmart. The court further found it was foreseeable that failing to obtain a building permit could result in a roof collapse and cause the type of damages suffered by Kmart.

The court found that Kmart’s contract anticipated all of the damages it incurred, including damage to “other property,” because the contract’s boilerplate provisions made Herzog liable for damages caused by “any action, omission or operation under the Contract.” This protective contractual liability language reinforced for the Court that the parties anticipated the sort of damages Kmart sought to recover using their controlling contract-remedy provision. As a result, the “other property” exception was inapplicable.

Effect of the decision

This court of appeals’ decision has reinforced the bright-line separation of contract and tort law by further expanding the types of damages that are deemed foreseeable. Particularly, when a party incorporates broad liability or obligations for damages resulting from acts, omissions or contract breach, property damages will be foreseeable, and thus, tort claims will be barred from them under the economic-loss doctrine.

The reasoning of the court and its reliance on contract provisions leaves unresolved what sort of damages will be treated as “unforeseen.” Under this court’s rationale, arguably any property damage would arise from “any action, omission or operation” of a mixed contract for construction goods and services.

Brian Zimmerman is an attorney and shareholder at Hurtado Zimmerman specializing in construction and real estate law. Andrea Jahimiak is an attorney at the same firm specializing in construction accounting, collections and the resolution of disputes concerning real property.

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