Thursday, January 6, 2022

Contractual warranty agreements may preclude future tort recovery

When a buyer purchases a product that is later discovered to be defective, the court offers a remedy to make the buyer whole.  Such remedies can arise either out of a contract, including express and/or implied warranties, or under common law through a tort theory.  However, what happens when a buyer has already received the remedy specified in the contractual warranty, only to discover the product manufacturer misrepresented the quality of its product by failing to disclose a defect?  Can the buyer subsequently recover for the same product under a tort theory of recovery?  The Colorado Court of Appeals analyzed such questions in its December 2021 decision in Dream Finders Homes, LLC v. Weyerhaeuser NR Co., 2021 COA 143.

In Dream Finders, the court examines the rights of sophisticated buyers who purchased defective products and received a warranty from the product manufacturer with purchase. The court specifically determines whether such buyers may recover under the tort theory product misrepresentation and failure to disclose when the buyers have already received the remedy specified and the warranty expressly excludes the type of damage the buyer now seeks.

The case involved two main parties, including Weyerhaeuser, a product manufacturer which designed and sold engineered joists with a fire-resistant coating to be used in residential construction, and Dream Finders, a home builder, which purchased and utilized Weyerhaeuser’s fire-resistant joists in homes it constructed and sold. Upon purchase of the joists, Dream Finders received two warranties, from Weyerhaeuser to wit: a general warranty delivered with all Weyerhaeuser products and a specific warranty relating to the joists providing that Weyerhaeuser would pay reasonable costs for repair or replacement of the covered joists for any delamination, separation, or inadequacy that might occur in the joists. The reasonable costs were to be capped at three times the cost of the joists themselves. The specific warranty also expressly stated that Weyerhaeuser would not be responsible for incidental, indirect, or consequential damages.

Three months after Dream Finders started purchasing and installing the joists into its homes, Weyerhaeuser received third-party reports indicating that the joists, which were coated with a formaldehyde-based resin, emitted a chemical-like odor that caused eye and throat irritation.  In compliance with the specific warranty, Weyerhaeuser offered remediation options to builders which installed the affected joists.  Dream Finders opted for a mechanical removal option. Weyerhaeuser complied with the request and paid for all remediation costs, which ended up being significantly greater than three times the product cost.  After the remediation was completed, Dream Finders sued Weyerhaeuser for breach of express and implied warranty, negligence, negligent failure to warn, negligence per se, strict product liability, violation of Colorado’s Consumer Protection Act (the “CCPA”), negligent misrepresentation, and fraudulent concealment.  In its claims, Dream Finders alleged that Weyerhaeuser knew that its products contained a urea-formaldehyde resin but failed to disclose the known hazardous levels of formaldehyde in the joists.  Dream Finders alleged that it incurred over $20 million in damages, including remediation costs and costs incurred because of delayed home sales.  

In evaluating the case, the Court first considered the economic loss rule, which bars recovery under tort claims for purely economic losses stemming from a breach of contract.  While Colorado law provides that construction professionals owe homeowners independent, common law, duties of care to homeowners, which do form the basis for tort-based negligence claims safe from the reaches of the economic loss rule, the Court refrained from extending this duty to a builder, which only owned the homes briefly before selling them to the ultimate purchasers. The Court held that the economic loss rule limited Dream Finders’ ability to recover damages arising from tort claims because it and Weyerhaeuser already completed the contractually mandated remedy for the defective joists.

The Court determined that the relief sought by Dream Finders was identical under both tort and contract theories.  To come to this conclusion the Court compared both the tort duties and contractual duties owed by Weyerhaeuser.  Generally, a tort duty can be distinguished from a contractually arising duty when the tort duty extends beyond the scope of duty provided for in the contract.  Dream Finders and Weyerhaeuser agreed that Weyerhaeuser complied with the terms and conditions of its warranty and that because of this compliance, Dream Finders received the benefit for the contract-based bargain.

Because Dream Finders had already received the agreed-upon contractual benefit and expressly chose to contract away any other rights to recover, the Court precluded Dream Finders from recovering anything further. Even though only one of Dream Finders’ entities entered into the warranty agreement with Weyerhaeuser, the Court held that the warranty still controlled under Colorado law.  C.R.S. § 4-2-318 provides that a manufacturer’s warranty “extends to any person who may reasonably be expected to use, consume, or be affected by the goods and who is injured by breach of warranty.”  The Court maintained that the warranty, therefore, impeded recovery under the economic loss rule because, even though one of the entities did not expressly enter into the warranty agreement, its coverage by the warranty was implied by statute.

The economic loss rule does not bar recovery for damages based on pre-contractual fraud where the fraud induced a plaintiff to enter the contract, as discussed in Van Rees v. Unleaded Software, Inc., 373 P.3d 603 (Colo. 2016).  However, in Dream Finders, the alleged claims arose from post-contractual conduct and did not fraudulently induce Dream Finders to enter the warranty agreement.  Because of this fact, Weyerhaeuser did not owe Dream Finders a separate duty apart from those specified in the warranty contract.  The Court concluded, therefore, that the economic loss rule disqualified Dream Finders from recovering anything under its tort-based claims.

There are limitations to the economic loss rule and the Court affirmed that it does not bar CCPA claims.  However, the Court ruled that Dream Finders failed to prove all elements of its CCPA claim.  Additionally, CCPA claims were created to protect individual consumers who are at a bargaining disadvantage compared to more sophisticated buyers, such as Dream Finders.  

Judge Jaclyn Brown issued a warning at the end of the Court’s decision, stating that the expansion of the economic loss rule has the frightening propensity to encourage a contracting party to act fraudulently during the contractual relationship and then attempt to escape liability by hiding behind the rule. Judge Brown further emphasized that the economic loss rule should not apply to cases where the damages arise from an intentional act as it would be bad policy for courts to shield intentional tortfeasors from liability.  Judge Brown’s fears have not yet come to fruition, but we anticipate future Colorado court decisions will further mold the trajectory of the economic loss rule.

Dream Finders now serves as a reminder of the importance of contracts and warranty clauses and why both product manufacturers and contractors should take a close look at what rights are provided or relinquished when entering into such agreements.

For additional information regarding the Dream Finders case or Colorado construction law, you can reach out to Taylor Ostrowski by telephone at (303) 653-0047 or by e-mail at ostrowski@hhmrlaw.com.

Disclaimer

The information contained in this blog is provided for informational purposes only. It is not legal advice and should not be construed as providing legal advice on any subject matter.