• Landmark Case Clarifies Economic Loss Doctrine in Wisconsin
  • September 12, 2006 | Author: David J. Hanus
  • Law Firm: Hinshaw & Culbertson LLP - Milwaukee Office
  • The Wisconsin Supreme Court recently refined the boundary between the laws of contract and tort, holding that the economic loss doctrine precluded recovery on negligence claims related to an alleged breach of a construction contract. 1325 North Van Buren, LLC v. T-3 Group, Ltd., No. 2004AP325 (Wis. July 11, 2006). The highly anticipated decision was not only a victory for contractors like the particular defendant who was represented by Hinshaw & Culbertson LLP’s Milwaukee office, but also has implications for any parties entering into mixed contracts for products and services.

    The case arose out of a March 2001 contract wherein T-3 Group (“T-3”), a construction manager, agreed to convert a warehouse owned by 1325 North Van Buren (“1325”) into a 42-unit condominium complex. Besides furnishing the necessary materials for renovation and construction, T-3 was to provide management services, including the hiring and supervision of subcontractors, and to ensure that the project was completed on time and within budget. Nearly all of the approximately $6 million contract price was allocated to construction costs. Seven months after work began, 1325 terminated T-3 for alleged nonperformance and filed suit against it for breach of contract, negligence and negligent misrepresentation, seeking a total $20 million in damages.

    Although the trial court dismissed 1325’s negligence claims under the economic loss doctrine, the court of appeals reversed. According to that court, the doctrine was inapplicable because T-3 had contracted to provide “construction administration and management services,” and Wisconsin courts have long held that the doctrine covers only contracts primarily or predominantly for products. To support its conclusion, the court of appeals stressed that the actual construction work on the warehouse was performed by subcontractors, not by T-3. In the court’s view, the roughly $6 million allocated to construction was used by T-3 to pay the subcontractors it hired as construction manager, not to pay T-3 for any product it was personally building. Characterizing T-3 as a mere “conduit through which the money flowed,” the court held that the contract was actually one for services, not for a product, and reinstated 1325’s negligence claims.

    The court of appeals’ ruling raised eyebrows in Wisconsin’s legal and construction communities with its suggestion that parties to certain commercial contracts could choose to seek damages for alleged breaches in tort, rather that through the contractual remedies they bargained for. So-called “construction manager/constructor” or “design-build” contracts similar to the one between 1325 and T-3 are widely used, and the decision caused concern that such agreements could no longer be worth the paper they were printed on.

    Unlike the court of appeals, the supreme court held that the contract between 1325 and T-3 was for both products and services and applied the economic loss doctrine to bar 1325’s negligence claims. While its decision was based partly on the language of the contract, the court also considered the agreement in the totality of the circumstances and concluded that the 1325/T-3 dispute was “tailor made for the application of traditional contract law,” not for tort.

    According to the court, the contract “clearly discusse[d] both services and products to be furnished.”  For one thing, the parties used a standard “construction manager/constructor” form that bound T-3 to provide labor and materials and to assume financial responsibility for the project. Furthermore, the contract defined the “project” T-3 was to oversee as the “total construction” and the “work” T-3 was to perform as “construction and services” (emphasis added). To the court, this language proved that T-3 was not hired only to provide construction management services, but was obligated to deliver the condominium complex regardless of whether its own personnel performed the actual construction work. The fact that T-3 assumed the financial risk of completing the project on budget further showed that is was not the mere cash “conduit” the appellate court thought it was.

    Having determined that the 1325/T-3 contract was mixed, the court concluded that it was also primarily for a product. To reach that conclusion, the court applied a “predominant purpose test,” viewing the agreement in the totality of the circumstances, including such factors as the contractual language and the parties’ understanding of the contract and objective in making it. The court found that the “plain language” of the contract described “the project” as the conversion of the warehouse into condominiums. It also noted that, during the bidding process, 1325 awarded the project based on overall contract price. Furthermore, at lease one 1325 employee believed that T-3 was contractually obligated to deliver a fully completed building. As a result, the court held that 1325’s predominant purpose in entering into the contract was to have the complex built, not just to have the work supervised.

    The court also held that application of the economic loss doctrine to the 1325/T-3 contract was consistent with principles underlying its use in tort actions between commercial parties. The doctrine maintains a fundamental distinction between contract and tort law, the court explained, and the property damage 1325 suffered consisted only of defects within the subject matter of the contract. Furthermore, the doctrine protects parties’ freedom to allocate financial risk by contract, and the bargained-for nature of the contract, the sophistication of the parties, and the fact that they agreed on warranties, available remedies, and allocation of risk all “weigh[ed] heavily” for application of the doctrine.