The Economic-Loss Rule: Conflicting Signals

As we have discussed before, courts in North Carolina have not agreed on how the economic-loss rule applies, if at all, to claims under N.C. Gen. Stat. § 75-1.1.  Two recent decisions by the North Carolina Court of Appeals—ten days apart—illustrate the varying approaches to this issue.

Applying the economic-loss rule to section 75-1.1 (sort of)

The economic-loss rule holds that when a claim involves economic losses in a contractual setting, a plaintiff cannot use extracontractual claims to recover those economic losses.

On December 30, 2016, in Buffa v. Cygnature Construction & Development, Inc., the Court of Appeals held that the economic-loss rule barred a section 75-1.1 claim.

In 2006, the Buffas built a home in Beech Mountain.  Five years after the construction ended, the Buffas discovered extensive water damage that had already harmed the structural integrity of the home.  Several inspections suggested that the water had entered through windows.           

The Buffas sued several companies associated with the construction, including the window manufacturer.  The Buffas’ 75-1.1 claim against the window manufacturer stated only the following (emphasis added): 

Windsor Windows engaged in unfair and deceptive acts or practices . . . when, in selling and advertising the windows in the Buffa Home, Windsor Windows failed to give the Buffas adequate warnings and notices regarding the defect in the windows despite the fact that Windsor knew or should have known of this defect, with the intent that the Buffas would rely upon Windsor’s failure to disclose the defect when purchasing the windows.  The Buffas were deceived by and relied upon Windsor Windows’ failure to disclose.

The trial court granted summary judgment in favor of the window manufacturer.  The court held that the economic-loss rule barred the 75-1.1 claim and several tort claims. 

The Buffas appealed.  On the section 75-1.1 claim, the Buffas argued that the economic-loss rule does not apply to 75-1.1 claims at all.  They cited a string of state and federal cases that, they argued, allowed consumers to recover under section 75-1.1 “for purely economic loss.”

Because the Buffas had not contracted directly with the window manufacturer, the Court of Appeals first considered whether the case was even within the general ambit of economic-loss rule.  The court held that it was within that ambit.  Although the Buffas did not contract directly with the window manufacturer, they were beneficiaries of a contract:  the window manufacturer’s express warranty.

After reaching that conclusion, the court rejected the Buffas’ “conten[tion that] the trial court erred by applying the economic-loss rule to a claim of unfair and deceptive trade practices.”  The court, however, did not analyze the economic-loss rule beyond that.  Instead, the bulk of the court’s opinion asked the more usual question in contract-based 75-1.1 cases: whether a breach of contract was accompanied by “egregious or aggravating circumstances.”

As the above block quote shows, the Buffas’ section 75-1.1 claim alleged only that the window manufacturer failed to notify the Buffas of a known design defect.  The Court of Appeals held that this nondisclosure was nothing more than a breach of warranty.  On that basis, it upheld the trial court’s summary judgment against the 75-1.1 claim.

Declining to apply the economic-loss rule to section 75-1.1 (sort of)

Just ten days earlier, a different panel of the Court of Appeals issued an opinion in the opposite direction—an opinion that might have a significant effect on the interplay among fraud claims, 75-1.1 claims, and the economic-loss doctrine.

In Bradley Woodcraft, Inc. v. Bodden, the Court of Appeals appeared to hold that fraud claims are never subject to the economic-loss rule—a holding that could affect section 75-1.1 claims as well.

In 2013, Christine Bodden and her husband bought a 20-year-old home in Raleigh.  They signed an agreement with a contractor to renovate the home.  The homeowners were dissatisfied with the renovation work and discussed their complaints with the contractor.  After the discussion, they believed that the contractor had promised to fix the problems, so Ms. Bodden used her credit card to pay the final $26,000 due.  The contractor, in contrast, did not believe that he had agreed to do any further work.  When the contractor did no further work, Ms. Bodden disputed the $26,000 charge on her credit card.

The contractor then sued for breach of contract.  Ms. Bodden counterclaimed for breach of contract, fraud, and violations of section 75-1.1.  The case went to trial.  At the close of Ms. Bodden’s evidence, the contractor moved for a directed verdict on the fraud and section 75-1.1 counterclaims, citing the economic-loss rule.  The trial court granted the contractor’s motion.

On appeal, the Court of Appeals focused on the fraud claim. The court seemed to hold categorically that the economic-loss rule does not apply to fraud claims:  “[W]hile claims for negligence are barred by the economic-loss rule where a valid contract exists between the litigants, claims for fraud are not so barred.” 

The court went on to reverse the directed verdict against Ms. Bodden’s 75-1.1 claim because that claim was “factually interwoven” with the fraud claim.  This ruling arguably extended the court’s economic-loss reasoning to section 75-1.1.

If the holding in Bradley is as broad as it appears, it could muddy the relationship among fraud, section 75-1.1, and the economic-loss doctrine.  Under a broad reading of Bradley, breaches of promises in an oral contract would—despite the economic-loss doctrine—support a fraud claim.  And fraud, it bears remembering, is a per se violation of section 75-1.1. 

These points, if confirmed, could lead to a proliferation of fraud claims in business disputes.  Under Bradley, adding fraud claims might help plaintiffs avoid the usual fate of contract-based 75-1.1 claims—summary rejection.

On the other hand, Bradley is probably narrower than it appears.  The record and briefs in the case show that the fraud and 75-1.1 claims were based on extracontractual statements by the contractor, including statements about the contractor’s qualifications and later representations about potential damage to the home.  Given this context, the court’s decision might well reflect the “independent duty” exception to the economic-loss rule.  That exception holds that even when a contract generally applies, a plaintiff can pursue tort claims that arise from a defendant’s extracontractual duties.

* * *

 As Buffa and Bradley confirm, the relationship between the economic-loss doctrine and section 75-1.1 will remain unclear until the North Carolina Supreme Court considers the issue.  Bradley might give the court such an opportunity, but the small stakes of the case might prevent the opportunity from arising.

Author: Jeremy Falcone

The Year in Review

As 2016 comes to a close, we again thank you, our readers, for your continued interest, support, and ideas. Decisions from the past year have confirmed the powerful role that N.C. Gen. Stat. § 75-1.1 plays in North Carolina business litigation.

The past year featured an array of notable developments:

  • The North Carolina Business Court issued a decision that analyzed how an alleged violation of section 75-1.1 interacts with an alleged violation of the antitrust laws.
  • A decision by a federal court in New York showed why choice-of-law rules can play a pivotal role in deciding whether section 75-1.1 can apply—even when a lawsuit involves a contract that is not governed by North Carolina law.
  • Most recently, a court allowed a lender to pursue a section 75-1.1 claim against a borrower—the opposite of the fact pattern usually found in section 75-1.1 litigation about lending.

You can find all of our posts from the past year (indeed, our 72 posts since the beginning of this blog) at this link.

We look forward to covering the coming year’s developments under section
75-1.1. As always, we invite your ideas on topics that we should address.

Best wishes for a happy and prosperous new year.

Author: Stephen Feldman

Can a Lender Sue a Borrower for Unfair and Deceptive Trade Practices?

In most lending-related cases under N.C. Gen. Stat. § 75-1.1, a borrower sues a lender. Borrowers often pursue these claims to resist their repayment obligations or to seek leverage against foreclosure.

Makadia v. Continental Waste Management departs from this pattern. In Makadia, it was a lender who sued a borrower under section 75-1.1. The lender claimed that the borrower lied about the intended use of loan proceeds. This claim survived a motion to dismiss.

The borrower fails to use the loan proceeds as intended

In Makadia, an individual lender advanced $1 million to a corporate borrower. The CEO of the borrower signed a promissory note to memorialize the loan. 

The sole purpose of this loan was to allow the borrower to acquire two waste-management plants. Under the loan terms, the waste-management plants were supposed to serve as the collateral for the loan—that is, once the borrower actually acquired the plants.

After signing the promissory note, the borrower’s CEO told the lender that the acquisitions of the plants had closed. This statement turned out to be untrue. When the lender learned that the acquisitions had not closed, it demanded immediate repayment of the loan. The borrower refused.

The lender then sued the borrower and its CEO in the U.S. District Court for the Eastern District of North Carolina. The lender’s claims included breach of contract, conversion, and violations of section 75-1.1.

The lender’s claims survive dismissal

The borrower and the CEO moved to dismiss the lender’s conversion claim and 75-1.1 claim. The district court (Senior District Judge James Fox) denied the motion.

On the 75-1.1 claim, the borrower and the CEO argued that the lender’s allegations stated only a breach-of-contract claim and that the lender had not alleged substantial aggravating circumstances.

The court, however, saw two types of aggravating circumstances in this fact pattern: (1) deceptive conduct, and (2) conversion, an intentional tort.

The district court’s decision raises intriguing questions:

  • Why does conversion state a “substantial aggravating circumstance,” given that some decisions hold that conversion alone falls short of a per se violation of section 75-1.1?
  • What other types of conversion, if any, would count as substantial aggravating circumstances? For instance, would a borrower’s intentional misuse of collateral support a 75-1.1 claim? That conduct, unlike the conduct in Makadia, probably would not qualify as deceptive.
  • Speaking of deception, what other types of misrepresentations by borrowers would show substantial aggravating circumstances? Would lies on a loan application or a related financial statement qualify? How about lies about the condition or value of collateral?

The answers to these questions will have significant effects on lending-related litigation. Allowing a lender to seek treble damages from a borrower, after all, would dramatically shift leverage in the lender’s favor. It will be interesting to see whether Makadia starts a trend of “borrower liability” claims under section
75-1.1.

Author: George Sanderson