07 August 2013

Economic loss rule does not bar tort claims of construction lender's subsidiary

The Colorado Court of Appeals held last week that the economic loss rule does not bar residential construction defect claims against a construction professional, even when the homeowner is a corporate subsidiary of a construction lender, rather than a natural person.

Colorado has a long history of protecting homeowners from defective construction. Thirty years ago, in May 1983, the Colorado Supreme Court announced its seminal decision in Cosmopolitan Homes v. Weller, which recognized that builders have an independent duty to avoid negligence when building someone’s home. The court reasoned that that builders are in the best position to determine the structural condition of a home, that an ordinary homebuyer is seldom qualified to evaluate a house's construction, and that a house is typically a family’s largest investment. Although the court would later adopt the economic loss rule—which provides that a party suffering only economic loss from the breach of a contractual duty may not assert a tort claim—the court has consistently held that a builder’s duty to avoid negligence exists independent of any contract. Because of this, the economic loss rule does not shield builders from tort liability for negligent work and construction defects.

The August 2013 case of Mid Valley Real Estate Solutions V, LLC v. Hepworth-Pawlak Geotechnical, Inc., 2013 COA 119, however, presented an interesting question: Can the subsidiary of a construction lender sue in tort over construction defects in a house it acquired after the developer defaulted on a construction loan? On the one hand, the public policy concerns that underlie a builder’s independent duty to avoid defects seem less compelling when the homeowner is a sophisticated corporation. On the other hand, there is little reason to excuse a builder’s negligence merely because a business may have temporarily owned a house that was originally intended for sale to a family.

The court noted the tension between the economic loss rule and the independent duty recognized in Cosmopolitan Homes, but it ultimately sided with the owner and allowed the negligence claim to proceed. Among other reasons, the court based its decision on the fact that limiting negligence claims to natural persons would grant the defendants a windfall based solely on the fortuity of who happened to hold title to a house when a defect manifested; the court explained:

as years pass, some houses will be foreclosed on by mortgage lenders, who, in turn, will sell the houses to new owners. If only natural persons who both owned and occupied such a house could enforce the builder’s duty, the dispositive factor would be the fortuity of who owned the house when the defect ripened, rather than the builder’s negligence and its consequences to that owner. This approach, in turn, would lead to the anomaly of a negligence duty becoming unenforceable upon sale of a home to a commercial or non-occupant owner, only to have enforceability resurrected upon acquisition by a traditional home owner.

Judge Webb wrote the majority opinion, and Judge Russell concurred. Judge Jones wrote a special concurrence urging the supreme court to revisit the issue and clarify whether recognition of a homebuilder’s duty to act without negligence is truly consistent with the economic loss rule, or whether it should simply be treated as an exception to the rule.

The full text of the court’s opinion is available on the court's website at