RETHINKING HAMON CONTRACTORS, INC. V. CARTER & BURGESS, INC. TO CLARIFY APPLICATION OF COLORADO’S ECONOMIC LOSS RULE TO POST-CONTRACTUAL FRAUD CLAIMS

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By Joel Fulton

I. Introduction

Through recent decisions, Colorado courts have expanded the economic loss rule. These decisions have applied the rule to bar post-contractual fraud claims by relying on the implied contractual duty of good faith and fair dealing. This expansion does not serve the policy interests underlying the rule and goes beyond the scope of the rule. Therefore, the Colorado Supreme Court should rethink the application of the economic loss rule to post-contractual intentional torts such as fraud.  

II. Background

In 2000, the Colorado Supreme Court adopted the economic loss rule in Town of Alma v. AZCO Construction, Inc., which provides “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.”[1]

The court designed the rule to serve three main policy interests: (1) to maintain a clear distinction between contract and tort law; (2) to enforce expectancy interests of the parties so that they can reliably allocate risks and costs during their bargaining; and (3) to encourage parties to build cost considerations into contracts.[2] This article focuses on the first policy interestclarity of the lawand argues Colorado courts’ recent application of the economic loss rule to post‑contractual fraud claims makes the distinction between contract and tort law in this context less clear.  

The supreme court’s rationale in adopting the economic loss rule is to hold sophisticated parties to the benefit of their bargain.[3] In this sense, “Parties must be able to confidently allocate risks and costs during their bargaining without fear that unanticipated liability may arise in the future, effectively negating the parties' efforts to build these cost considerations into the contract.”[4] Generally, where tort law creates an independent duty separate from the contract, the economic loss rule does not apply.[5] Application of the rule focuses on the source of the duty owed to the party, not whether the damages suffered are physical or economic. Therefore, the economic loss rule may be more accurately termed the “independent duty rule.”[6]

For a duty to be “independent” of a contract, two conditions must be met. First, the duty must arise from a source other than the relevant contract.[7] Second, the duty must not be imposed by the contract.[8] Deciding whether a tort duty is separate from a corresponding contractual duty turns on whether the duty was “memorialized” in the contract.[9]

III. Analysis

a.  The Colorado Supreme Court has determined fraud claims to be outside the scope of the economic loss rule.

In adopting the rule in Alma, the Colorado Supreme Court took care to eliminate confusion by recognizing two situations that are “outside the scope of the rule.”[10] The first situation involves cases in which a special relationship between the parties, such as an attorneyclient or physicianpatient relationship, triggers an independent duty of care even when the parties have entered into a contract. The second situation involves tort claims expressly designed to remedy economic loss, such as fraud.[11]

In these situations where we have recognized the existence of a duty independent of any contractual obligations, the economic loss rule has no application and does not bar a plaintiff's tort claim because the claim is based on a recognized independent duty of care and thus does not fall within the scope of the rule.[12]

Furthermore, while applying Colorado law, the Tenth Circuit Court of Appeals has also recognized that the economic loss rule does not apply to intentional tort claims.[13] However, more recently, Colorado courts started to apply the rule to intentional torts, including fraud.[14]

b.  The Hamon court expanded Colorado’s economic loss rule to bar claims for post- contractual fraud.

In 2009, a division of the Colorado Court of Appeals, in Hamon Contractors, Inc. v. Carter & Burgess, Inc., expanded the economic loss rule when it recognized a distinction between pre- and post-contractual fraud.[15] The court applied the economic loss rule to bar fraud or other intentional torts claims based on post-contractual conduct. To support this decision, the court reasoned the implied covenant of good faith and fair dealing encompasses an allegation of fraud in the performance of a contract. Thus, no independent duty exists.[16]

Hamon involved a suit between a general contractor, Hamon Contractors, Inc. (Hamon), the City of Louisville, Carter and Burgess, Inc. (C & B), the project administrator, and Craig Kitzman, the Assistant City Engineer. Hamon claimed C & B and Mr. Kitzman concealed and misrepresented site conditions causing Hamon to submit change orders which caused delay damages. The contracts in Hamon contained four provisions that addressed a potential dispute of this nature: (1) C & B had discretion in whether to accept change orders; (2) C & B’s discretion was governed by the implied covenant of good faith and fair dealing; (3) the city impliedly warranted the adequacy of plans and specifications; and (4) C & B’s duty of care was to be “in accordance with the prevailing standard of practice.”[17] The court determined the covenant of good faith and fair dealing, which is implied in every contract under Colorado law, precluded C & B and Mr. Klitzman from denying a change order for a reason they knew to be false and from attributing delays to Hamon when they knew the delays were caused by design flaws.[18] Therefore, the court concluded Hamon’s fraud claim was not based on a duty independent of the contracts and the economic loss rule should be applied.

The court of appeals rejected Hamon’s argument that under Colorado law fraud claims are outside the scope of the economic loss rule. The court stated, “The [Alma court] did not articulate any sweeping principle exempting post-contractual fraud claims from the ambit of the economic loss rule.”[19] The court further distinguished Alma by stating Alma did not cite any cases involving post-contractual fraud.[20] The court ultimately held the implied covenant of good faith and fair dealing subsumes a claim for fraud in the performance of the contract.[21]

In doing so, the court reasoned the facts in Hamon did not present the type of fraud claim for which the Alma court stated, “The economic loss rule has no application.”[22] Depending on how one reads Hamon, it may have been a case in which the allegations of fraud were not substantiated and therefore the primary issue was breach of contract. However, the Hamon court’s decision to apply the economic loss rule to post-contractual fraud claims does not serve clarity in the law for other cases. Importantly, the court did not cite Colorado precedent to support the post-contractual fraud distinction it recognized.  Rather, the court followed cases from other jurisdictions which held fraud claims relating to the performance of a contract are barred by the economic loss rule. [23] As a consequence, the court has potentially expanded the economic loss rule beyond its boundaries as articulated by the Colorado Supreme Court in Alma.

c.  The Hamon court’s holding is not clearly derived from Colorado precedent and therefore does not serve clarity in the law.

Applying the economic rule to fraud based on post-contractual conduct, as the court did in Hamon, does not serve the first recognized policy interest underlying the economic loss rule: to maintain a clear distinction between contract and tort law. In a vacuum, the Hamon case appears consistent with the first policy interest because it creates a bright line rule which differentiates between pre-contractual and post-contractual fraud. The guiding principle behind the policy, however, is to maintain a clear understanding of the law. This understanding is informed by precedent. The Hamon court’s decision to bar fraud claims by relying on the duty of good faith and fair dealing is not clearly derived from Colorado precedent such as Alma.

The implied obligation of good faith and fair dealing requires good faith in the performance and enforcement of commercial transactions.[24] This obligation does not support an independent cause of action for failure to perform or enforce in good faith. Rather, a failure to perform or enforce a specific contractual duty in good faith constitutes a breach of that contract.[25] In 1995, the Colorado Supreme Court recognized that every contract contains an implied duty of good faith and fair dealing.[26] One must assume the Alma court was aware of the duty of good faith and fair dealing when it stated “the economic loss rule has no application” to fraud claims.[27] Therefore, under Colorado precedent, where there is not merely a failure to perform, such a party’s breach of the obligation of good faith, but an intentional act of fraud, there is not merely a breach of contract but a separate and independent tort.[28] In this way, the Alma and Hamon cases are in conflict with each other.

The rule from Hamon has also created a split among divisions of the Colorado Court of Appeals. In 2013, a division of the Court of Appeals, in In re Estate of Gattis, rejected Hamon’s broad interpretation of using the economic loss rule to bar fraud claims.[29] Gattis concerned a home seller’s nondisclosure of a home built on expansive soil, which caused damage to the home after the sale. The court declined to apply the economic loss rule to bar fraud claims in the context of real estate transactions utilizing contracts that do not expressly provide remedies for nondisclosure.[30] The court recognized the Colorado Supreme Court has not applied the economic loss rule in a misrepresentation or nondisclosure case. [31] To support its reasoning, the court cited a Florida Supreme Court case which determined, where the boundaries of the economic loss rule are not confined, over time the rule proved to be unwise and unworkable in practice.[32] Therefore, Hamon has created some disagreement among Colorado courts’ interpretation of the rule. This disagreement contributes to inconsistent applications of the rule by trial and appellate courts, which has implications for parties and society as a whole. Therefore, the Hamon holding undermines the first policy interest underlying the economic loss rule. 

The Colorado Supreme Court should clarify the circumstances under which the economic loss rule may bar a claim for post-contractual fraud. A rule which bars post-contractual fraud may be appropriate for cases like Hamon in which the evidence more closely resembles a breach of contract claim. However, more consistent with Colorado precedent such as Alma, a rule barring post-contractual fraud is not appropriate where there is substantial evidence of fraudulent conduct.

IV. Conclusion

Hamon expanded the economic loss rule beyond its origins to bar claims for post‑contractual fraud. This has resulted in a rule not clearly derived from Colorado precedent, which does not serve clarity in the law. Because of the Hamon holding, the Colorado Supreme Court should clarify the extent to which the economic loss rule applies to post-contractual intentional torts such as fraud.

 

 


        †     Joel Fulton is an attorney licensed in Colorado and Nebraska. The author would like to thank his friends Erik Speicher and Nicholas Bussey for reviewing this piece and offering valuable suggestions.

       [1].     10 P.3d 1256, 1264 (Colo. 2000); Grynberg v. Agri Tech, Inc., 10 P.3d 1267, 1269 (Colo. 2000).

       [2].     BRW, Inc. v. Dufficy & Sons, Inc., 99 P.3d 66, 72 (Colo. 2004).

       [3].     Alma, 10 P.3d at 1262.

       [4].     Vanderbeek v. Vernon Corp., 50 P.3d 866, 871 (Colo. 2002).

       [5].     S K Peightal Engineers, LTD v. Mid Valley Real Estate Solutions V, LLC, 342 P.3d 868, 872 (Colo. 2015).

       [6].     Town of Alma v. AZCO Constr., Inc., 10 P.3d 1263-64; 1262 n.8 (“[A] more accurate designation of what is commonly termed the ‘economic loss rule’ would be the ‘independent duty rule’”).

       [7].     Id. at 1263.

       [8].     BRW, Inc., 99 P.3d at 74.

       [9].     Id. (listing three factors that aid the inquiry on whether the duty is memorialized in the contract: (1) whether the claims seek the same relief; (2) whether there is a recognized common law duty in tort; and (3) whether the tort duty differs from the contractual duty).

     [10].     Alma, 10 P.3d at 1263 n.10.

     [11].     Id. (citing Brody v. Bock, 897 P.2d 769, 776 (Colo. 1995) (explaining common law fraud claim is based on violation of a duty independent of contract)); id. at 1263 n.10 (citing with approval Formosa Plastics Corp. USA v. Presidio Eng'rs & Contractors, Inc., 960 S.W.2d 41, 46-47 (Tex. 1998) (explaining fraudulent inducement claim is based on violation of independent duty, precluding application of economic loss rule)).

     [12].     Id. at 1263 (emphasis in original).

     [13].     United Int'l Holdings, Inc. v. Wharf (Holdings) Ltd., 210 F.3d 1207, 1227 (10th Cir. 2000) (plaintiff's “fraud claim, although premised on representations made in the course of contractual negotiations, [] arose independently of the contract.”) (applying Colorado law); see also Williams Field Servs. Grp., LLC v. Gen. Elec. Int'l Inc., No. 06-CV-0530-CVEFHM, 2009 WL 151723, at *5 (N.D. Okla. Jan. 22, 2009) (“[T]he Tenth Circuit stated with no uncertainty that the economic loss rule does not apply to intentional torts.”) (applying Colorado law).

     [14].     Top Rail Ranch Estates, LLC v. Walker, 327 P.3d 321 (Colo. 2014).

     [15].     229 P.3d 282, 291 (Colo. App. 2009).

     [16].     Id. at 293.

     [17].     Id. at 292–93.

     [18].     Id.

     [19].     Id. at 291.

     [20].     Id.

     [21].     Id. at 293.

     [22].     Town of Alma v. AZCO Constr., Inc., 10 P.3d 1256, 1263 (Colo. 2000).

     [23].     Hamon Contractors, Inc. v. Carter & Burgess, Inc., 229 P.3d 282, 292 (citing cases applying Pennsylvania, New Jersey, and Michigan law).

     [24].     Colo. Rev. Stat. § 4-1-304 (2014).

     [25].     Id.

     [26].     Amoco Oil Co. v. Ervin, 908 P.2d 493, 498 (Colo. 1995).

     [27].     Alma, 10 P.3d at 1263.

     [28].     See Rhino Fund, LLLP v. Hutchins, 215 P.3d 1186, 1194 (Colo. App. 2008).

     [29].     318 P.3d 549, 557 (Colo. App. 2013) (rejecting Hamon’s suggestion that other jurisdictions uniformly allow the economic loss rule to trump fraud claims relating to the subject matter of a contract).

     [30].     Id.

     [31].     Id.

     [32].     See Tiara Condo. Ass'n v. Marsh & McLennan Cos., 110 So.3d 399, 407 (Fla. 2013) (receding prior case law to limit application of the economic loss rule to products liability cases).