Appeals Court Revisits and Revises Economic Loss Rule for Condominiums

Published on: January 22, 2013

It is undoubtedly true, and something of an understatement, to say that ‘you don’t always get what you want’ in court decisions. It is also true that you don’t always get what you expect. A Massachusetts Appeals Court recently provided a rare combination: An outcome we wanted but didn’t really expect.

In Wyman v. Ayer Properties, the court held that the “economic loss” rule, which limits recovery in tort actions (as distinguished from breach of contract claims), did not apply to a community association seeking damages for flawed construction.

That conclusion was unexpected because the Massachusetts Supreme Judicial Court (SJC) seemed to be moving in a different direction a decade ago in Berish v. Bornstein. Making this somewhat quirky situation a little quirkier, I was involved in both of these cases.

A key point in the Wyman decision was the way in which the economic loss rule plays out in a condominium setting. The rule holds that plaintiffs in a tort action can recover damages only for actual property damage or personal injury; they can’t recover for defective construction or design flaws unless those deficiencies cause secondary damage. So, it can be argued, if the roof of a condominium is poorly designed or poorly constructed, the community association can’t recover the cost of correcting those flaws; it can recover only if the roof leaks and damages units or common areas.

No Bite of the Apple

The rationale for this legal theory is that home purchasers can negotiate a warranty on which they can rely if construction is flawed, and don’t deserve what the courts have termed “a second bite of the tort apple” if they fail to do so. The obvious problem for community associations is, they assume operating control after the construction has been completed, don’t have a contract with the developer, have no opportunity to negotiate a warranty, and have no alternative means of recovery; they never get the “first bite of the apple” the economic loss doctrine assumes.

Berish was a landmark decision for condominiums, because the SJC affirmed clearly that condominium owners enjoy the same warranty of habitability as the purchasers of single-family homes. Equally important, the court ruled that the warranty of habitability also applied to community associations and to the common areas for which they are responsible. The court said the association’s “exclusive right” to seek remedies for defects in common areas, “combined with the unit owner’s virtually nonexistent control over the common areas…may result in an incomplete remedy for unit owners against a builder whose improper design, material, or workmanship is responsible for a defect in a common areas that causes units to be uninhabitable or unsafe.”

We suggested that the same logic – the lack of alternative remedies — argued for waiving the economic loss rule for community associations, but the court wasn’t persuaded. So in Berish and in cases following it, associations have been forced to follow a sometimes contorted legal path, proving not only that a design was negligent or construction was flawed, but that those defects caused quantifiable damages beyond the need to correct the defects themselves.

That was how the Superior Court approached its analysis in Wyman, awarding damages for construction and design defects in the roof and windows, because they had caused water damage in several units, but rejecting the claim for masonry defects, because “they did not extend to any harm beyond the masonry itself.”

A Different View

Appeals Court Justice Mitchell Sikora, Jr. reversed on that point, concluding that, in fact, a condominium association “may recover damages in tort from a responsible builder-vendor for negligent design or construction of common area property in circumstances in which damages are reasonably determinable, in which the association would otherwise lack a remedy, and in which the association acts within the time allowed by the applicable statute of limitations or statute of repose.”

An “overly mechanical” application of the economic loss rule, Justice Sikora argued, would “diverge from its fundamental purpose, [which] is to confine the indeterminacy of damages, not to nullify a right and remedy for a demonstrated wrong and its harm.”

Embracing the argument the SJC failed to adopt 10 years ago, Justice Sikora noted that “liability should not hinge on the fortuity of secondary harm…however minor, to a separate property. No Massachusetts authority prohibits compensatory damages for a negligently designed or constructed condominium common area…. [In this case], no alternative remedy is available. [And] most fundamentally, no danger of speculative exorbitant damages is apparent….”

The defendants in Wyman are seeking further appellate review, arguing that this decision contradicts the view the SJC expressed in Berish. The SJC could take the case on further appellate review and either reaffirm its old position on economic loss or accept Justice Sikora’s rethinking of it.

There is no certainty that the SJC will accept the case .on further appellate review. But fFor now, the exception to the economic loss rule that Judge Sikora carved out for community associations stands as controlling law, providing welcome relief for community associations pursuing negligent design and construction defect claims.

Two More Issues

This represents a major victory for community associations, but it’s not the only one the decision provides. The opinion states that community associations may recover damages from a “responsible builder-vendor.” This is the standard description of a condominium developer and the wording is notable for that reason: This is the first time a Massachusetts appellate court has acknowledged that the developer who creates a condominium (as distinguished from the builder who constructs it) has liability in negligence for the defective condition of the common area. The significance of that finding can’t be overstated.

The Wyman decision raised another important question on which we have requested further appellate review, dealing with the formula used to assess the damages owed the community association. The Superior Court based its award on what the repairs would have cost at the time the construction was completed, coming up with a total 20 percent less than what it actually cost the association to make the repairs. Had the court used the actual repair costs, the 12 percent annual interest mandated by statute would have equaled 60 percent of the judgment. Apparently finding that excessive, the court used its discretion to reduce the damage award, substituting a formula that the plaintiff views as questionable.

It could be several years before a construction defect is identified and several years more before a judgment is awarded. From the plaintiff’s perspective it makes no sense as a matter of law or public policy for a court to tell a plaintiff: “You’re right – the contractor is liable, but we’re going to award you what it would have cost the contractor to do the work correctly in the first place, not what it will cost you to have the work done correctly today.”

The Appeals Court concluded that this formula was “permissible,” falling within “the range of reasonable calculations” the Superior Court might have used. If the SJC takes the case on this issue, we’re hoping the Justices will have a different definition of ‘reasonable.’