The Economic Loss Rule and the Disclosure of Latent Defects: In re the Estate of Carol S. Gattis

In a recent case of first impression, the Colorado Court of Appeals determined that the economic loss rule does not bar a nondisclosure tort claim against a seller of a home, built on expansive soils which caused damage to the house after the sale.  The case of In re the Estate of Carol S. Gattis represents a new decision regarding the economic loss rule.  Because it is a case of first impression, we must wait to see whether the Colorado Supreme Court grants a petition for certiorari.

Until then, we will analyze the decision handed down on November 7, 2013.  The sellers of the home sold it to an entity they controlled for the purpose of repairing and reselling the home.  Before that purchase, Sellers obtained engineering reports including discussion of structural problems resulting from expansive soils.  A structural repair entity, also controlled by Sellers, oversaw the needed repair work.  After the repair work was completed, Sellers obtained title to the residence and listed it for sale.

Sellers had no direct contact with Gattis, who purchased the residence from Sellers.  The purchase was executed through a standard-form real estate contract, approved by the Colorado Real Estate Commission: Contract to Buy and Sell Real Estate, to which no changes were made.  Several years after taking title to the residence, Gattis commenced action, pleading several tort claims alleging only economic losses based on damage to the residence resulting from expansive soils.

Sellers argued, in a pretrial motion for summary judgment, that Gattis’ claims should be precluded by the economic loss rule.  Sellers also raised the economic loss rules through an oral motion to dismiss at the end of Gattis’ case-in-chief at trial.  The trial court denied all of Sellers’ attempts to invoke the economic loss rule.  Sellers appealed on the basis that the economic loss rule should have barred Gattis’ tort claims.

Pursuant to the economic loss rule, “a party suffering only economic loss from the breach of an express or implied contractual duty may not assert a tort claim for such a breach absent an independent duty of care under tort law.”  Town of Alma v. AZCO Constr., Inc., 10 P.3d 1256, 1264 (Colo. 2000).  The source of the underlying duty determines whether the economic loss rule applies.  Id. at 1262.  For a claim to escape the economic loss rule, the duty must arise independently of any contractual obligation.  Id. at 1262.

The trial court held Sellers liable for nondisclosure of material facts.  The trial court explained that Sellers falsely represented in the contract that they had no personal knowledge of the property, including the presence of expansive soils which already had caused serious structural damage to the residence.  On appeal, Sellers did not dispute the trial court’s finding that before the sale closed: no reference was made to “expansive soil;” no person or entity ever informed Gattis, or Gattis’ representatives, that the Sellers were principals of the structural repair entity; and, neither Gattis, nor Gattis’ representatives, were ever made aware of the various engineering reports that Sellers had reviewed when debating their purchase of the residence. 

The Court of Appeals relied on past cases to conclude that an independent duty exists between home sellers and home buyers, as well as residential builders and subcontractors.  The Gattis court relied on Mid Valley Real Estate Solutions V, LLC v. Hepworth-Pawlak Geotechnical, Inc., 2013 WL 3943215, a negligent construction case involving a residence.  In that case, several policy considerations were identified favoring an independent duty to protect homeowners: preventing overreaching by builders, who are comparatively more knowledgeable to determine structural conditions of a house than most buyers; ordinary purchasers of a home are not qualified to determine when or where a defect exists; purchasers of homes rarely have access to make any inspection of the underlying structural work, as distinguished from the merely cosmetic features; magnitude of the investment made when purchasing a home; foreseeability that a house will be sold to someone who is not the original owner; foreseeability that a construction professional’s work on a home is for the benefit of the homeowners, and that harm to the homeowners from negligent construction is foreseeable; and, an independent duty discourages misconduct and provides an incentive for avoiding preventable harm.

The Gattis court drew analogies between a home builder’s common law duty to act with ordinary care, as discussed in the Mid Valley case, and a home seller’s common law duty to disclose known but latent defects in the property.  Both of those duties are long standing, with the Gattis court pointing out that for over 50 years Colorado has required sellers to disclose latent soil defects of which they are aware.  Another analogy was drawn between a builder’s position of superior knowledge related to the structural condition of a home and a seller who has actual knowledge of a latent defect.  The Gattis court then stated that where a disparate knowledge exists, a person has a duty to disclose to another with whom he deals facts that in equity or good conscience should be disclosed.  In contrast, where an original homeowner or a later buyer, both parties have a similar difficulty in learning of a latent defect.

Furthermore, according to the Gattis court, a buyer cannot not afford to suddenly find a latent defect in his or her home, whether it is caused by a negligent home builder or a seller who remains silent despite knowledge of a latent defect.  Typically, this is because a home purchase is the biggest purchase and most important investment, and done on a limited budget.  Such harm to the home and homeowner are also equally foreseeable, whether caused by a latent defect arising from negligent construction or nondisclosure of any latent defect known by the seller.

The final analogy the Gattis court drew between the home builder’s common law duty to act with ordinary care and a home seller’s common law duty to disclose known but latent defects in the property, relates to enforcing the duty of the sellers to disclose the known latent defects.  Just as enforcing the duty to build with ordinary care avoids preventable harm to innocent parties, the Gattis court concludes so will enforcing the duty of the sellers to disclose the known latent defects.  Limiting its holding somewhat, the Gattis court did state that the burden to disclose latent but known defects is minor because the seller’s duty to disclose latent but known defects would only apply to material defects.

We have to wait and see if Gattis will be upheld by the Colorado Supreme Court.  But until then, Colorado home sellers have a new independent tort duty for disclosure of latent but known defects.

For additional information regarding Colorado construction litigation, please contact David M. McLain at (303) 987-9813 or by e-mail at mclain@hhmrlaw.com.