What You Need to Know about the Economic Loss Rule (Part 1 of 2)
June 16, 2014
By Christopher J. Charles, Esq. &
David Degnan, Esq.
Whether you’re a real estate broker, contractor, lender, or attorney, most real estate professionals will encounter litigation at some point in their career. As a result, it’s important to understand what claims and damages are recoverable concerning real estate-related disputes. This article begins a two-part series that examines how the Economic Loss Rule limits certain real-estate related claims.
I. The Economic Loss Rule Prevents Recovery in Tort and In Contract for Purely Economic Loss Without Showing Separate Injury or Property Damage
The economic loss doctrine is a common law rule that limits contracting parties to only their contractual remedies in the absence of a separate physical injury or property damage. The doctrine has historically been limited to construction defect and product liability cases. Some argue, however, that the rule could be extended to claims against REALTORS®.
In Flagstaff, 223 Ariz. 320, the Supreme Court held that the property owner could not recover tort damages arising from the faulty work by an architect that caused structural damage without any resulting physical injury to persons or other property. Id, 223 Ariz. at 329, 223 P.3d at 673.
The Supreme Court confirmed that tort damages are recoverable only where there is separate injury. For example, in a construction defect case, “if a fireplace collapses, the purchaser can sue in contract for the costs of remedying the structural defects and sue in tort for damages to personal property or personal injury caused by the collapse. Each claim will stand or fall on its own.” Flagstaff, 223 Ariz. at 324, 233 P.2d at 668 (emphasis added and citations omitted).
II. The Economic Loss Rule Still Allows For Recovery in Tort and In Contract . . . Sometimes.
The economic loss rule (“ELR”) is riddled with exceptions. ELR does not apply in the following circumstances: (1) the claim relates to the inducement; (2) cases other than product liability or construction defect; (3) a statute creates independent liability; and (4) the policies of tort law favor allowing for the claim to proceed.
1. The Economic Loss Rule Does Not Apply Where Defendants Were Induced Into A Contract Based On False, Fraudulent, or Misleading Representations.
The ELR does not extend to claims involving the contract’s inducement. In Wilson v. GMAC Mortgage, LLC, the Court explained that “[w]hen fraudulent conduct infects contract negotiations, the presumption that the parties engaged in an equal negotiation evaporates.” Wilson v. GMAC Mortgage, LLC, No. 2011 U.S. Dist. LEXIS 104331, *5, 2011 WL 4101668 (D. Ariz. Sept. 14, 2011) (citing Giles v. General Motors Acceptance Corp., 494 F.3d 865, 880 (9th Cir 2007). As a result, that Court declined to apply the ELR in a fraudulent inducement case, because doing so would “release a party from liability for even intentionally fraudulent behavior.” Id.
2. Independent Statutory Liability Precludes the ELR’s Application.
The ELR does not apply to claims for independent statutory liability. The “economic loss rule is a judicially created limitation on common law remedies. It is not a substantive restraint on the power of the Legislature to create new remedies.” Shaw v. CTVT Motors, Inc., 232 Ariz. 20, 33 (App. 2013) (Edward P. Ballinger,  Jr. & Samuel A. Thumma, The History, Evolution and Implications of Arizona’s Economic Loss Rule, 34 Ariz. St. L.J. 491, 502 (2002) (“observing that . . . courts in other jurisdictions recognize that statutory claims are not barred by the economic loss rule if a contrary result would be inconsistent with the legislative purpose in enacting the statute”). As a result, the Shaw court held that Arizona’s economic loss rule does not apply to private causes of action under the Consumer Fraud Act.
Additionally, the ELR arguably does not apply to professional negligence / malpractice claims that are grounded in Title 32 of the Arizona Revised Statutes.
3. The ELR May be Limited to Product Liability and Construction Defect Cases.
In Salt River Project, 143 Ariz. 368 (1984), the Court applied the ELR to product liability case. Years later, in Flagstaff, the Court extended the ELR to construction defect case (construction defect cases are essentially product liability cases – the “product” is the structure). Following Flagstaff, in Cook v. Orkin, the Court applied the ELR to termite contractors in a construction defect context. Cook v. Orkin, 227 Ariz. 331, 258 P.3d 149 (App. 2011). Of course, Cook addressed the damage to the structure as a result of the contractor’s failure to adequately remove the termites over the course of many years.
By contrast, some courts have declined to apply the ELR outside the construction defect and product liability context. B2B CFO Partners, LLC v. Kaufman, 856 F. Supp. 2d 1084, 1096 (D. Ariz. 2012) (explaining that the economic loss rule’s application is limited to product liability and construction defect cases.); Firetrace USA, LLC v. Jesclard, 800 F.Supp.2d 1042, 1051-52 (D. Ariz. 2011) (declining to apply the economic loss rule to bar tort claims in an employment case.).
Some argue, however, that the ELR should be extended to other types of claims, including non-disclosure claims and broker negligence/professional liability claims. Next month’s article will examine whether the courts will extend the ELR’s protections that far.
For more Laying Down the Law articles, click here.
Christopher Charles is an experienced real estate lawyer and a former “Broker Hotline Attorney” for the Arizona Association of REALTORS® (the “AAR”). He has an “AV Preeminent” rating by the Martindale-Hubbell Peer Review Ratings system, which connotes the highest possible rating in both legal ability and ethical standards.
He is a Partner with the law firm Davis Miles McGuire Gardner, PLLC where he serves as the chair of the Real Estate Practice Group. Mr. Charles is an Arbitrator and Mediator for the AAR regarding real estate disputes; he serves on the State Bar of Arizona’s Civil Jury Instructions Committee where he helped draft the Agency Instructions and the Residential Landlord/Tenant Eviction Jury Instructions.
Mr. Charles is a licensed real estate instructor and he teaches continuing education classes at the Arizona School of Real Estate and Business. For a list of upcoming speaking engagements, please visit www.davismiles.com. He can be reached at firstname.lastname@example.org
Christopher’s company website: www.tbl-law.com
David Degnan is a real estate and construction lawyer at Davis Miles McGuire Gardner. Mr. Degnan may be reached at email@example.com.
 Flagstaff Affordable Housing Ltd Partnership v. Design Alliance, Inc., 223 Ariz. 320, 322, 223 P.3d 664, 666 (Ariz. 2010).