New Jersey’s Answer to the Economic Loss Rule: Striking a Balance Between Public Policy Considerations in Contract and Tort Law

Dennis Shlionsky
Monday, August 24, 2015

I.         A Brief Introduction 

            For nearly forty decades, courts have struggled to determine whether to award purely economic loss to a party that fails to show an actual physical injury or property damage.  The struggle focuses around the application of the economic loss rule. As a judicially made doctrine developed to charter the bounds between the idiosyncrasies of contract and tort law, the economic loss rule has generated a legion of scholarly literature, as well as fuels fervent debate regarding its application.

            The black letter economic loss rule is ostensibly straightforward: absent contractual rights and privity, a party may not recover economic damages in tort absent a showing of a personal injury or property damage.[1]  Although the rule can be stated with some clarity, its application has proven difficult, resulting in a myriad of exceptions.

            What has happened in New Jersey, more or less, centers around a few cases that purport to define the rule’s outer bounds and, accordingly, guide lower courts in the doctrine’s application.  At base, Garden State courts agree that where contractual privity exists, the terms provide for sole recourse absent a showing of personal injury or property damage.[2]

            Informed minds, however, may disagree that contracts for goods and service provide the same level of protection.  For example, when the contract involved pertains to the sale of services, the U.C.C. provides no remedy.[3]  In any event, since 1985 New Jersey courts have appeared to permit a “foreseeable plaintiff” to recover purely economic losses in tort even where the loss was not a consequence of any event causing personal injury or property damage.[4]

            Recent unpublished decisions, however, have created significant uncertainty in the law regarding the proper application of the rule, particularly in the construction law arena.  As such, this article reconciles the law’s current state in New Jersey by exploring meaningful distinctions in recent case law, as well as countervailing policy decisions.

    II.         Exploring Scope, Purpose, and Public Policy Considerations

            At base, the spirit of the rule strikes an equitable balance between countervailing legal principles and public policy[5] considerations, as well as social objectives that exist in tort and contract law.  As such, the interplay between tort and contract law in New Jersey has undergone significant changes over the last several decades.

            In any event, the dilemma posed by the economic loss doctrine involves the balancing of beneficial public policies.[6] On the one hand, a robust economic loss defense appears justified when weighing countervailing policy objectives as well as divergent tort and contract principles[7]: (a) implemented as a general rule limiting damages to foreseeable consequences;[8] (b) gives an incentive to sophisticated contracting parties to protect themselves against potential liability;[9] (c) enables parties to allocate risk effectively by imposing liability solely under contract, (d) enforces the reasonable expectations of the parties, and (e) maintains predictability in the industry. In other words, to those that endorse efficiency and predictability, the rule’s strict application is necessary to protect the parties’ expectations through enforcement of contractual terms.[10]

            Equally compelling, however, are justifications for eliminating the rule, all the more because such justifications often align with modern tort doctrine.  As a primary matter, permitting purely economic recovery ensures that innocent victims have adequate avenues of redress.[11] Within the same vein, a bar on the rule imposes liability on negligent defendants as well as (a) discourages similar tortious behavior; (b) fosters safer products; (c) vindicates reasonable conduct that promotes safety of others; and (d) shifts risks to those accountable and, thus best able to bear them – the negligent party. [12] Because public policies recognized by the courts vary from state to state, so do exceptions to the rule.

Illustrating the Rule in New Jersey’s Construction Law Arena

     I.         The Privity Trigger 

            Ordinarily, assessing whether the rule bars a tort claim presents itself to the court where the parties are in contractual privity and a cause of action implicates both tort and contract law.[13]  For example, when a general contractor and owner enter into a contract for home remodeling. In that scenario, New Jersey agrees with the majority of states that where privity exists, a tort claim for negligent performance (e.g., owner alleging negligent construction management) will not lie unless accompanied by bodily injury or property damage other than that which is the litigation’s subject matter. Rather, New Jersey courts have consistently held – and the Third Circuit agrees – that recovery in tort sole economic damages requires breach of an independent duty, separate from the contract.[14]

            In practice, New Jersey Courts have relied on Conforti & Eisele v. John C. Morris Associates[15] and Peoples Express Airlines, Inc. v. Consolidated Rail Corp. for guidance that purely economic losses, if “reasonably foreseeable,” are recoverable against a party even in the absence of contractual privity. In Conforti,[16] a New Jersey trial court first established that contractual privity was not a pre-condition for a contractor to recover economic loss from third parties.

            In that case, a plaintiff homeowner recovered unforeseen economic losses as a result of the architect's negligent performance of its services. The court noted that New Jersey has rejected application of the privity defense to a tort claim for personal injuries brought against a design professional, and it saw no reason not to extend negligence liability merely because the contractor's injury was pecuniary.[17] To rule otherwise, the court reasoned, would be akin to "condoning a design professional's right to do his job negligently but with impunity as far as innocent third parties who suffer economic loss."[18]

            Five years after Conforti, the New Jersey Supreme Court–in a thoughtful opinion–narrowed the rule.[19] After careful evaluation of the rule’s exceptions, the court set forth the standard in the Garden State: A “defendant who has breached his duty of care to avoid risk of economic injury to particularly foreseeable plaintiffs may be held liable for actual economic losses that are proximately caused by its breach of duty.”[20]

            In People’s Express, the plaintiff, an airline company, suffered economic loss due to a fire in the Port of Newark freight yard.[21]  The freight yard, the tank car, and the ethylene oxide that ignited were owned or manufactured by different defendants, none of whom had a contract with the plaintiff.[22] The fire resulted in the plaintiff having to evacuate from the premises as a result of its close proximity to the freight yard. Consequently, the plaintiff suffered purely economic loss in its business dealings (e.g., flight cancellations, lost reservations, and fixed operating expenses allocated to the evacuation time).  

            The New Jersey Supreme Court declined to invoke the economic loss rule, rationalizing that numerous exceptions to the general rule justified narrowing the situations to which courts may bar a plaintiff’s claim. In so doing, the court acknowledged the significance of economic distress (as analogous to physical harm), and emphasized that innocent victims of negligent tortious-conduct must have an avenue of recourse.[23]  It would appear, therefore, that the court put to bed the rule’s anchoring of recovery to physical harm alone, and disposed of the fear that runaway liability[24] justifies its survival.

            ConfortiPeople’s Express, and New Mea, among a legion of similar cases, appeared to establish boundaries beyond which the rule could not reach.  Put differently, a trial court’s primary concern in evaluating a tort-based claim alleging purely economic losses was, naturally, whether or not privity existed between the parties.[25]

    II.         Recent Challenges to People’s Express and Conforti

            Since the 1980s, the New Jersey rule that originated with Conforti and, thereafter appeared well-settled in People’s Express, permitted recovery from negligent-tortious parties notwithstanding the contractor’s ability to seek damages elsewhere (e.g., from the owner for economic loss caused by deficient plans and specifications).  In so doing, New Jersey courts have traditionally disregarded the privity defense; the notion that contractual privity between the owner and general contractor preclude that contractor from seeking damages in tort against another subcontractor. 

            Nevertheless, two unpublished decisions threaten new challenges to contractor claims against design professionals. As articulated in a well-reasoned district court opinion,[26] both cases fail to reconcile with the great weight of New Jersey law.  Rather, the courts appear to misstate facts in the Conforti case in an ostensibly unfair attempt to distinguish it.

a.     Spectraserv unfairly distinguishes well-established case law

            The most recent attack came in the form of an unpublished decision from a New Jersey trial court in Middlesex County; Spectraserv, Inc. v. Middlesex County Utilities Authority (“MCUA”).[27] In what appeared to be a case of first impression, the court barred a general contractor from asserting a claim against an engineer with which it was not in privity of contract. The trial court reasoned that engineers have no independent duty imposed by law (as contrasted with attorneys and doctors) and that the contractor had a remedy for its economic losses through its contract with the owner.

            The court’s attenuated reasoning, however, ostensibly fails on for a myriad of reasons. First, the court does not consider exculpatory provisions that generally exist on contracts prepared by the owner. Naturally, the owner’s interests are better protected by shifting risk to the contractor through the use of disclaimers as well as exculpatory clauses. For example, although the court found that the contractual remedies were feasible, it failed to inquire as to whether the customary “no damage for delay” clause existed.[28]

            Whether the court would enforce the provision, however, remains beyond the scope of this article.  Within the public work’s context, New Jersey has two statutes that address the enforceability of such clause.[29]  For that reason, the existence of statutory authority regulating “no damage for delay” implies the notion that courts must address such provisions, which alone may amount to dispositive finding. Because the court dismissed the tort claim against MCUA, and thereafter failed to address such clauses, the defendant–a public agency–may be able to trigger the terms of its contract and invoke its protection.

            In turn, it appears that the Spectraserv opinion incorrectly reasoned that the court in People’s Express “declined to invoke the economic loss doctrine because doing so would have deprived the plaintiff of its only avenue for redress.”[30]

b.     Horizon’s analysis and legal reasoning are tenuous at best

            Spectraserv is not the black sheep of New Jersey’s case law as far as the economic loss rule is concerned.  Rather, that decision was hot on the heels of an unpublished 2011 Appellate Division decision, Horizon Group of New England, Inc. v. New Jersey School Construction Corp. In Horizon, the court applied the economic loss doctrine to a plaintiff’s negligence claim, notwithstanding the absence of a direct contractual relationship between the parties. In denying a contractor’s claim against a design professional, the court’s reasoning appeared to rely on the availability of an alternative remedy.[31]  Such application fails for two reasons. First, Horizon sued the owner, and thereafter recovered – albeit not the entire amount of sought damages. Therefore, the court mistakenly stated the facts underlying the Horizon claim and, as a result, Horizon did not have other recourse available.

            Second, even if Horizon failed to sue the owner, the notion that other recourse may preclude a tortious claim cannot be reconciled with the majority of New Jersey case law, which permits tort-based recovery notwithstanding the plausibility of an alternate cause of action nor takes into account the likelihood of recovery.  For example, in Juliano v. Gatson[32] the Appellate division permitted a plaintiff-homeowners to pursue an action under a tort-based theory for negligent workmanship against the subcontractors who constructed a part of their new home. The court noted that no direct contractual privity existed between the parties.[33]  And, although the plaintiffs sued and prevailed against the homebuilder in contract, the court permitted plaintiffs to pursue their tort-based suit against the subcontractors.[34]

            It is worth mentioning that the Horizon court was particularly concerned with the nature of the contracts that were involved.  As such, it would be reasonable to infer that the Court barred tort-based recovery because the terms of each distinct contract were incorporated by reference.  That is, such incorporation may have persuaded the court to characterize the relationship as akin to actual privity. 

Conclusion

            In its most broad terms, many jurisdictions support the proposition that the economic loss rule does not bar a contractor's or subcontractor's claim for pecuniary losses brought against the project's design professional. Put another way, a majority of jurisdictions that have addressed the issue conclude that the absence of privity will not bar a negligence action by one construction professional against another for economic losses, where reliance by the plaintiff was reasonably foreseeable. [35] In light of the holding in People’s Express and Conforti, as well as the legion of case law supporting tort-based economic recovery, it appears that New Jersey law does indeed acquiesce with the majority.



* Staff Editor, Rutgers Journal of Law and Public Policy; J.D. Candidate May 2016, Rutgers School of Law.

[1] See, e.g., People’s Express Airlines, Inc. v. Consol. Rail Corp., 100 N.J. 246 (1985).

[2] See Travelers Indem. Co. v. Dammann & Co., 594 F.3d 238, 248 (3d Cir. 2010) (“In keeping with the purpose of the economic loss doctrine, New Jersey courts have consistently held that contract law is better suited to resolve disputes . . . where a plaintiff alleges direct and consequential losses that were within the contemplation of sophisticated business entities.”).

[3] Jesse M. Brush, Mixed Contracts and the U.C.C.: A Proposal for a Uniform Penalty Default to Protect Consumers, Yale Law School Legal Scholarship Repository 1, 21 (2007).

[4] The Court first explains the notion of a “foreseeable plaintiff” in People’s Express:

[T]he cases do not involve a breach of contract claim between parties in privity; rather, they involve tort claims by innocent third parties who suffered purely economic losses at the hands of negligent defendants with whom no direct relationship existed. Courts have justified their finding of liability in these negligence cases based on notions of a special relationship between the negligent tortfeasors and the foreseeable plaintiffs who relied on the quality of defendants' work or services, to their detriment. The special relationship, in reality, is an expression of the courts' satisfaction that a duty of care existed because the plaintiffs were particularly foreseeable and the injury was proximately caused by the defendant's negligence.

100 N.J. at 256-57.

[5] Rappaport v. Nichols, 31 N.J. 188, 205 (1959) ("Policy considerations and the balancing of conflicting interests are the truly vital factors in the molding and application of the common law principles of negligence.").

[6] See Clark E. Alpert, Guide to NJ Contract Law § 13.3.6.A. (2013), for a discussion of public policy issues posed by the economic loss doctrine in the constriction law setting.

[7] Spring Motors Distribs., Inc. v. Ford Motor Co., 98 N.J. 555, 579 (1985) (finding that New Jersey’s Supreme Court articulated that the objective of tort duty of care is to shield society’s interest in freedom from harm).

[8] People’s Express, 100 N.J. at 252 (explaining that this concern manifests as an issue of causation, leading to the requirement of physical harm as an element of proximate cause).

[9] Id. 

[10] See 6 Bruner & O'Connor Construction Law § 19:10 F; Malcom Cunningham, Jr. & Amy L. Fischer, The Economic Loss Rule: Deconstructing the Mixed Metaphor in Construction Case, 33 Tort & Ins. L.J. 147, 150 (Fall 1997).

[11] People’s Express, 100 N.J. at 254.

[12] Id. at 255.

[13] Vincent R. Johnson, The Boundary Line Function of the Economic Loss Rule, 66 Wash. & Lee L. Rev. 523, 526 (2009) (“[W]hether a tort claim for economic damages is viable when there is some other contract between the parties . . . that allocates or could have allocated the risks of economic loss”).            

[14] See, e.g., Conforti & Eisele, Inc. v. John C. Morris Ass’n, 175 N.J. Super. 341 (Law Div. 1980), opinion aff'd on other grounds, 199 N.J. Super. 498 (App. Div. 1985); SRC Constr. Corp. v. Atl. City Hous. Auth., 935 F. Supp. 2d 796 (D.N.J. 2013).

[15] See generally Conforti, 175 N.J. Super. 341. (acknowledging that after settling with the State, Conforti continued against Morris, as well as other design professionals involved with the project, claiming that all of them were negligent in their failure to co-ordinate project drawings).

[16] Id.

[17] Id. at 344 (acknowledging increased exposure to the design professional, but holding that “extending liability for economic injury is the next logical step”).

[18] Id.

[19] People’s Express, 100 N.J. at 267.

[20] Id.

[21] Id. at 248-249.

[22] Id. at 249.

[23] Id. at 254 (discussing that the requirement that physical harm accompany the economic injury “showers compensation along the path of physical destruction”).

[24] Id. at 264 (“Particularly foreseeable in terms of the type of persons or entities comprising the class, the certainty or predictability of their presence, the approximate numbers of those in the class, as well as the type of economic expectations disrupted.”).

[25] New Mea Constr. Corp. v. Harper, 203 N.J. Super. 486, 489 (App. Div. 1985) (denying a claim for negligent supervision where defendants were in direct contractual privity); see also Saltiel v. GSI Consultants, Inc., 170 N.J. 297, 312 (2002) (finding no redressability for the architect seeking damages from third-parties where “there was no direct contractual relationship”).

[26] SRC Constr., 935 F.Supp. at 800.

[27] Spectraserv, Inc. v. Middlesex Cnty. Utils. Auth., Docket No. L-2577-07, 2013 N.J. Super. Unpub. LEXIS 2173, (N.J. Super. Ct. Law. Div. Feb. 11, 2013).

[28] Daniel J. Kraftson, No-Damage-for-Delay Contract Clauseswww.kraftsoncaudle.comhttp://www.kraftsoncaudle.com/cutsheets/nodamagefordelaycontractclauses.pdf (last visited on May 9, 2015) (“[A] no-damage-for-delay provision excuses a party to a contract from liabilities which it would otherwise incur in the event of a delay on a project.  Such clauses are ordinarily upheld as valid by courts.”).        

[29] In a recent article, one commentator notes: “Recently, on New Jersey public projects, statutory changes have held that such clauses are void as against public policy (N.J.S.A.18A:18A-41 (school boards) and N.J.S.A. 40A:11-19 (local public contracts)), unless they are phrased in such a fashion as to reflect specifically contemplated occurrences.” James Landgraf, Public Contracts and Procurement Regulations in New Jersey: Construction Schedule and Delays.Organization, Lorman (January 02, 2014), http://www.lorman.com/resources/public-contracts-and-procurement-regulat....

[30] People’s Express, 100 N.J. at 267.

[31] See generally Horizon Group of New Eng., Inc. v. New Jersey Sch. Constr. Corp., 2011 N.J. Super. Unpub. LEXIS 2271 (App. Div. Aug. 24, 2011) (“[The plaintiff] could have invoked contractual remedies in their contract with another defendant in the case.”). 

[32] 187 N.J. Super. 491 (App. Div. 1982).

[33] Id. at 496.

[34] SRC Constr., 935 F.Supp. at 796 (discussing that although the homebuilder in Juliano was insolvent, “that fact does not appear to be integral to the court’s holding”).

[35] See Ins. Co. of N. Am. v. Town of Manchester, 17 F. Supp. 2d 81 (D. Conn. 1998) (applying Connecticut law, the court held that financial injury to the contractor was a foreseeable consequence of the architect's negligent performance of its contract obligations, and further concluded that privity is not necessary to recover under the economic loss doctrine); cf. Bagwell Coatings, Inc. v. Middle S. Energy, Inc., 797 F.2d 1298 (5th Cir. 1986) (finding that architect owes duty in tort to contractor that arises out of his contractual obligation to the owner if architect is aware contractor relies on his performance, and contractor suffers economic loss).