January, 2001

Life in the Land of Aas Last month, the California Supreme Court issued its decision in Aas v. Superior Court of San Diego, 24 Cal.4th 627 (2000). Aas has caused quite a stir in the construction legal community due to the Supreme Court's language in the opinion that construction defects which have not resulted in actual property damage or personal injury have not sufficiently damaged the property owner to support a contractor's liability in certain circumstances. Although this discussion in Aas is provocative, the long-term significance of Aas to contractors is questionable, as discussed below. In California, the general rule has been that a plaintiff who suffered economic loss as a result of a defendant's negligence could sue only if there was a contract in place between the plaintiff and the defendant. Bilich v. Barnett, 103 Cal. App. 2d 921, 924 (1951); Mickel v. Murphy, 147 Cal. App. 2d 718, 721 (1957). This rule is known as the Economic Loss Doctrine. Economic loss is "a monetary loss such as lost wages or lost profits" and does not include personal injury or property damage. See Black's Law Dictionary, 530 (7th ed. 1999). The purpose behind this Doctrine is to set legal limits on litigation where there is no personal injury or property damage. The California courts have modified the Economic Loss Doctrine by allowing a limited exception where there is a so-called "special relationship" between the plaintiff and the defendant. Biakanja v. Irvine, 49 Cal. 2d 647, 650 (1958); J'Aire v. Gregory, 24 Cal. 3d 799, 804 (1979). A "special relationship" exists between the plaintiff and the defendant where: (1) the plaintiff was an intended beneficiary of the defendant's obligations under a contract; (2) the plaintiff's loss was foreseeable; (3) there is a high degree of certainty that the plaintiff would suffer the loss from the defendant's conduct; (4) there is a close connection between the defendant's conduct and the plaintiff's loss; (5) the defendant's conduct is morally blameworthy; and (6) the public policy favors holding the defendant responsible for plaintiff's economic loss. Biakanja at 650; J'Aire at 804. If a contractor can show the above six factors, the scale tips in favor of allowing the contractor to sue for economic losses as a result of the design professional's negligence. The same is true of an owner's attempt to sue a contractor for negligent construction. The Supreme Court in Aas did not modify the Biakanja and J'Aire exceptions to the Economic Loss Doctrine, but merely reiterated that Biakanja and J'Aire are now narrow exceptions to the general rule. 24 Cal. 4th 627. In Aas, owners of single-family homes and the homeowners association in a subdivision sued the developer, the general contractor and subcontractors for construction defects affecting almost all components of the construction. Id. at 633. The homes suffered from many Uniform Building Code and National Electrical Code violations, but there had not yet been any physical property damage or personal injury resulting from those violations. Id. at 634 n.1. Plaintiffs sought economic losses such as the cost of repairs and diminution in value of their homes. Id. at 633. Defendants moved to exclude all evidence of those alleged construction defects that have not caused property damage under the Economic Loss Doctrine. Id. The Aas court explained the degree of certainty requirement of Biakanja and J'Aire. There is a low degree of certainty that a plaintiff would suffer actual injury from defendant's conduct, the court reasoned, where construction defects have "not ripened into property damage, or at least into involuntary out-of-pocket losses." Id. at 646. The degree of certainty of harm must be "appreciable, nonspeculative, [and a] present injury". Id. The Plaintiff must show that the present injury "poses a serious risk of harm to person or property." Id. at 647. The Aas opinion affirmed the basic principle that actual or appreciable damage or injury, rather than potential harm from defective construction, is required in order for a plaintiff to sue for economic loss as a result of a defendant's negligence where there is no contractual relationship. See Zamora v. Shell Oil Co., 55 Cal. App. 4th 204, 212 (1997); Krusi v. S.J. Amoroso Construction Co., Inc., 81 Cal. App. 4th 995, 1005 (2000). The Aas court assumed for the sake of argument that most of the Biakanja and J'Aire factors tipped in favor of permitting the owners and homeowners association to sue for negligence and economic loss; however, the plaintiffs could not show the degree of certainty or appreciable harm required by J'Aire and, therefore, the Aas court precluded plaintiffs' recovery for economic loss. Aas at 647. Many insurance companies are already attempting to apply Aas to the insurance context, arguing that construction defects do not constitute "property damage" or "personal injury" and, therefore, do not trigger coverage under standard commercial general liability ("CGL") policies. However, Aas should not be applied in the insurance coverage analysis because, as the Aas court stated, the procedural posture of its opinion makes the question it addressed fairly narrow and inapplicable to the insurance situation. Id. at 635. The economic loss rule announced in Aas applies only when the parties are not in contract. Insurers and their policyholders, however, are parties to their insurance contract. Furthermore, the Aas court expressly distinguished its tort liability analysis from "interpretation of contractual language in an insurance policy". Id. at 15 n.10. Additionally, there are "different contractual and policy considerations" behind the Economic Loss Doctrine and interpretation of an insurance policy. Armstrong World Industries, Inc. v. Aetna Casualty & Surety Co., 45 Cal. App. 4th 1, 7-8 (1996). For example, the purpose behind the Doctrine is to set legal limits on liability between parties where there is no actual personal injury or property damage. The purpose behind an insurance policy, however, is to protect the reasonable expectations of the insured. Montrose Chemical Corporation of California v. Admiral Insurance Company, 10 Cal. 4th 645, 666-67, 673, 674, 692 (1995). There is a strong argument that the reasonable expectations of the insured when entering into the typical CGL policy are that the policy will cover the cost to repair defective work whether or not the defect has already caused property damage. Armstrong World Industries, Inc. v. Aetna Casualty & Surety Co. suggests that courts should analyze tort liability for construction defects differently from insurance coverage for those defects: [W]hether and to what extent there had been damage to the buildings were factual issues . . . and, for purposes of determining the insurance coverage, it had to be assumed that damage had occurred. . . . Armstrong at 7-8 and 100. [E]vidence . . . that the mere presence of [asbestos] is not necessarily injurious had no bearing on the insurance coverage issue. Id. at 8. The contractual obligations of insurers to a single manufacturer-policyholder are separate and distinct from the tort liability of multiple asbestos manufacturers to an asbestos claimant. Id. at 58. Once again, the insurers have failed to distinguish between questions of liability and questions of insurance coverage. Id. at 93-4. [T]he incorporation of a defective product into another product inflicts physical injury . . . the moment when the defective [products] were installed in the homes. Id. at 100. The reasoning behind a rule that assumes the incorporation of a construction defect is injurious, triggering insurance coverage, is that "if the trier of fact finds that the mere presence of [a construction defect did] not cause damage, then [the insured] will have no liability and no need for insurance coverage." Id. at 94; see also Id. at 89. California cases also have recognized that there is property damage, triggering insurance coverage where the repair of a construction defect would create property damage by injuring other parts of the construction project. See Geddes & Smith, Inc. v. Saint Paul Mercury Indemnity Co., 63 Cal. 2d 602 (1965); Shade Foods, Inc. v. Innovative Products Sales & Marketing, Inc., 78 Cal. App. 4th 847, 865 (2000) (citing with approval Eljer Manufacturing, Inc. v. Liberty Mutual Ins. Co., 972 F.2d 805 (7th Cir. 1992). In sum, the ultimate effect of Aas may be minimal on both a contractor's liability for construction defects and on its ability to obtain insurance coverage for defect claims. Aas' limitation on negligence claims is of nominal importance because a plaintiff may still pursue its contract claims. Moreover, for the reasons discussed above, courts should ultimately rebuff insurers' attempts to extend the Aas decision to the insurance arena to deny coverage for many construction defects. By William T. Eliopoulos & Tien T. Cai