Defect Claims Get a Boost

HOA’s increasingly have exterior maintenance and repair responsibilities in non-condominium developments, and in that regard have the same type of financial responsibility that a condominium association would have over the common areas. When a developer’s defective construction increases those repair and maintenance expenditures, an association can quickly find itself without the funds necessary to make the repairs that the governing documents require. Faced with the prospect of a special assessment, many associations are successfully suing the developer for construction defects and forcing developers to provide the necessary funds to make repairs.

The success of construction defect suits has now become more likely since the Court of Appeals has knocked down a defense that developers and subcontractors have typically used – the economic loss rule. The economic loss doctrine is basically an analogy to products liability, an area of law that prohibits a purchaser from recovering against a manufacturer for negligence where damages are solely ‘economic’ in nature, meaning the price of the product itself. Boiled down, the rule does not require manufacturer to pay for damage to the product itself unless it agreed to do so in a contract. The rule doesn’t apply where the product harms a person or some other property besides itself. In that case, a manufacturer must still protect society from the physical harm or personal injury which may result from defective products. General contractors and subcontractors have been arguing that their “product” is the buildings themselves, and unless there is a contract or warranty, they cannot be sued when damage occurs to the building. As a practical matter, most warranties expire before something like a small leak develops into a major dry rot issue.

The application of the economic loss doctrine is based on three policies, (1) to maintain the fundamental distinction between tort law and contract law; (2) to protect commercial parties’ freedom to allocate economic risk by contract; and (3) to encourage the party best situated to assess the risk of economic loss, the commercial purchaser, to assume, allocate, or insure against that risk. In a condominium or townhome, those policies don’t make much sense. It is unlikely that a purchaser will inspect the siding or roofs, especially in other buildings, when that is the Association’s responsibility to maintain. Typically the unit insurance policies don’t cover that kind of loss either and so again, a purchaser is much less likely to investigate, negotiate or protect against construction defects where it is the Association’s job to take care of the exterior.

In Harris v. Suniga, 209 Or App 410 (December 6, 2006), the Oregon Court of Appeals struck down the economic loss doctrine in construction defect cases. The court reasoned that water damage resulting from construction defect was not harm to the product itself, but rather was damage to other property, namely the wood with which the building was constructed. The court held that deterioration to the physical structure of a building because of defective construction is property damage and not “economic loss.” The doctrine therefore does not bar a negligence claim by a subsequent purchaser against the builder to recover damages for the costs of repairing structural damage due to defects in construction.

Another argument by developers has been that their responsibility for construction ends when the home is sold by the first owners (who had a contract with the builder) to a subsequent unsuspecting buyer (who does not). The Court rejected the notion that a direct relationship was necessary to bring a negligence claim for defective construction. After Harris, there is no reason to believe that the principle would limit a direct claim against a subcontractor (who typically only has a contract with the general contractor and not the owner), where the subcontractors negligence caused damage to other portions of the building. This may be important where a developer forms a single purpose LLC, essentially to bear the risk of the development, and then leaves the entity without assets to stand behind its work.

On the heels of Harris, the Court of Appeals also issued an opinion in Bunnell v. Dalton Construction, Inc., 210 Or App 138 (December 27, 2006), another economic loss case based on home construction. In that case the plaintiffs had purchased the home from the prior owners that had built the home using a contractor. The new purchasers sued the original builder after discovering substantial damage caused by water leakage due to defectively installed siding. The court ruled that any property damage was recoverable even though the subsequent purchasers had no direct contract with the builder, since it was foreseeable that the house would be sold. Again, citing its own decision in Harris, the court restated that “deterioration to the physical structure of a building because of defective construction is property damage and not “economic loss,” and that the economic loss doctrine, as it has developed in Oregon, does not bar a negligence claim by a subsequent purchaser against the builder to recover damages for the costs of repairing structural damage due to defects in construction.” Bunnell at 142. The factual difference in Bunnell was that the purchasers actually knew that there was potential damage from siding defects and had negotiated a discount of the purchase price. The court disregarded that fact as somehow barring recovery in negligence.

The upshot is that in Oregon, the Court of Appeals has ended the analogy to products liability law for homes and condominiums. All persons are liable in negligence if their conduct unreasonably creates a foreseeable risk of harm to others. In the construction defect cases, that extends to protect the subsequent owners and the Associations that are charged with repairing the defects, and reaches to developers, subcontractors and anyone else that unreasonably causes harm to those that will occupy and maintain the development.

Thomas M. Johnson
Attorney at Law
tmj@vf2022.webuponstaging.com