Monday, January 24, 2022

The Economic Loss Rule: From Where Does the Duty Arise?

When entering a contract under Colorado law or attempting to enforce your rights when the other party breaches a contract, it is important to know and understand what rights you have and what claims you can bring or defenses you may have.  One important consideration is Colorado’s version of the economic loss rule.  The Colorado Supreme Court has issued several opinions clarifying the scope of the economic loss rule since it adopted the rule in 2000.  The purpose of the economic loss rule is to maintain the boundary between contract law and tort law.

In Colorado, the economic loss rule provides that a party suffering only economic loss from the breach of an express or implied contractual duty may not assert a tort claim for the breach without an independent duty of care under tort law.  In most instances the economic loss rule will not bar intentional tort claims.  The question becomes: from where does the duty arise?  Is there an independent duty in tort law?  Did the duty arise solely from the contract?

On January 14, 2021, a division of the Colorado Court of Appeals released its opinions in McWhinney Centerra v. Paog & McEwen, 486 P.3d 439 (Colo. App. 2021), answering the question as to when the economic loss rule applies and altering Colorado’s economic loss rule. The Court of Appeals noted in its decision, that while the decision is contrary to several other decisions, it was based on the recent decision of the Colorado Supreme Court in Bermel v. BlueRadios, Inc., 440 P.3d 1150 (Colo. 2019).  The Court specifically determined that where an independent duty exists, outside the agreement, the economic loss rule does not bar a tort claim.

The McWhinney case arose from a land development deal gone bad during the real estate collapse of 2008.  McWhinney Centerra Lifestyle Center LLC (“MCLC”), a subsidiary of McWhinney Holding Company, LLP (“McWhinney”), and Poag & McEwen Lifestyle Centers-Centerra LLC (“P&M”), a subsidiary of Poag & McEwen Lifestyle Centers, LLC (“PMLC”), formed Centerra LLC.  The purpose of Centerra LLC was to acquire, develop, own, and operate an upscale shopping center in Loveland, Colorado, The Promenade Shops at Centerra.  MCLC provided the capital, land, and an established public-private partnership with the city and county entities for infrastructure financing.  P&M served as the managing member of the joint venture.  MCLC & P&M signed an operating agreement (the “Agreement”), and McWhinney and PMLC signed as guarantors.

The Agreement required P&M to obtain a construction loan for Centerra LLC and later a permanent loan.  In 2005, P&M obtained the construction loan for $116 million in accordance with the Agreement, and the shopping center opened in October 2005.  In 2006, P&M purchased a $155 million forward swap loan on behalf of Centerra LLC without first obtaining the permanent loan.  P&M’s intent for obtaining the forward swap loan was to gain the trust of other investors to obtain a loan for personal reasons not for the benefit of Centerra LLC.

In 2007, P&M entered a $40 million mezzanine loan.  A loan which the Court found P&M used for personal interests.  P&M used the $40 million dollar loan for Dan and Josh Poag to buy out their co-founder, Terry McEwen.  The Court found that P&M intentionally concealed this buyout and its intention to use these self-dealings to fund it.  P&M gave MCLC limited and misleading information or no information at all about the buyout.

Shortly after P&M’s buy out of McEwen, it began defaulting on its loans and lacked the funds to pay property taxes.  In 2008, the real estate market collapsed, and P&M allowed the construction loan to go into default.

In 2011, after the joint venture failed, MCLC sued P&M, asserting a breach of contract claim based on the Agreement and seven tort claims.  The district court dismissed all seven tort claims under the economic loss rule.  The Court of Appeals determined P&M owed a duty of fair dealing to MCLC, including a duty of disclosure and that P&M had purposefully concealed and misrepresented material facts about the $40 million loan.  Further, the Court of Appeals concluded that the district court erred when it applied the economic loss rule to bar MCLC’s common law intentional tort claims of fraudulent concealment, intentional interference with contractual obligations, and intentional inducement of breach of contract.

The Agreement between MCLC and P&M stated that P&M owed fiduciary duties of care and loyalty to Centerra LLC and MCLC.  The duty of loyalty requires that the best interest of the company and its members take precedence over any of the manager’s individual interests and that the manager act in good faith.  The duty of care requires that a manager act on an informed basis.  P&M breached its fiduciary duties under the Agreement when it purchased the forward swap, entered the $40 million mezzanine loan, and failed to secure permanent financing.

P&M’s purchase of the forward swap on behalf of Centerra LLC was a breach of P&M’s fiduciary duties because of the individual benefit P&M derived from it.  P&M used the forward swap as a tool to obtain the $40 million mezzanine loan to buyout McEwen.  P&M purposefully concealed the purpose and significant details of the $40 million mezzanine loan and failed to give MCLC a complete or accurate picture of how the loan would impact the operations of Centerra LLC.  P&M had a duty to disclose material facts related to the mezzanine loan to MCLC and they failed to do so, therefore, breaching their fiduciary duties.  

Finding that P&M owed fiduciary duties under the Agreement and breached those duties the Court of Appeals turned to MCLC’s intentional tort claims.  The Court determined that the district court erred in dismissing MCLC’s common law intentional tort claims, except for the civil conspiracy claim.  Under the guidance of the Colorado Supreme Court’s decision in Bermel the Court noted that while the intent of the economic loss rule is to prevent tort law from “swallowing” the law of contract, courts must also be cautious not to allow contract law to swallow tort law.  “The economic loss rule generally should not be available to shield intentional tortfeasors from liability that happens to also breach a contractual obligation.” Town of Alma v. AZCO Constr., Inc., 10 P.3d 1256, 1260 (Colo. 2000).

The Court reinstated MCLC’s fraudulent concealment, intentional interference with contractual obligations, and intentional inducement of breach of contract claims.  The Court reasoned that the three claims stem from a duty based in tort law independent of the Agreement.  The conduct underlying each of the claims may also support a breach of contract claim, however, in this case, the Court did not shield the intentional tortfeasors simply because the conduct also happens to breach a contractual obligation.

However, the economic loss rule did bar MCLC’s civil conspiracy claim.  MCLC alleged P&M and PMLC conspired to breach the Agreement.  As signatories to the Agreement, P&M and PMLC’s duty not to conspire to breach the contract stemmed solely from the Agreement itself.  P&M and PMLC had no independent duty in tort law not to conspire to breach the Agreement with another signatory of the Agreement.  Thus, the economic loss rule barred MCLC’s civil conspiracy claim.

Though the McWhinney decision was contrary to previous holdings, one must bear in mind, the Court had new direction from the Colorado Supreme Court’s decision in Bermel.  While the economic loss rule had barred tort claims which happened to breach a contractual obligation the court has moved away from this one-track mind analysis.  McWhinney makes it clear that the economic loss rule does not bar an intentional tort claim simply because a breach of contract claim exists.

McWhinney’s effect may be that plaintiffs’ attorneys ramp up efforts to bring intentional tort claims.  It is important for defense counsel to know to what claims the economic loss rule can serve as a defense.

For additional information regarding the McWhinney decision or Colorado construction law, you can reach Taylor Hite by e-mail at Hite@hhmrlaw.com or by telephone at (303) 653-0043.

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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.