Construction and the Law in Texas

Unless a project is design-build, contractors do not have a direct contractual relationship with design professionals on most projects. However, a design engineer on an infrastructure project typically plays an active role as the owner’s representative. In drafting the plans and specifications, in conducting inspections, and in interpreting and responding to RFIs, among other activities, a design engineer can cause delay and interfere with a contractor’s means and methods such that losses occur on the project.

When this situation arises, contractors used to have no choice but to pursue the owner or a higher tier contractor, in the event work is subcontracted out, because Texas law prevented direct recovery against a design engineer without a contractual relationship. In a good shift for contractors in this arena, in the past couple of years, Texas courts have opened the door to the use of negligent misrepresentation as a viable cause of action by contractors against an owner’s design professional.

Prior to these recent cases, courts have prevented the extension of this cause of action because of a legal doctrine called the economic loss rule. The economic loss rule previously barred the recovery of negligence damages when the work resulting in the alleged damages was the subject of a contract. In the construction context, because contractors have a contract with the Owner, any damages arising from the performance of that contract were thought to be recoverable solely from the Owner.

That line of thinking worked fine for contractors in direct privity with an owner. Privity is a legal term meaning having a direct relationship. However, for contractors that did not have privity of contract with an owner whose design engineer interfered with performance and created losses, this situation created a multi-layered litigation where the intermediate contracting parties were essentially stuck in the middle. By relaxing the application of the economic loss rule, the courts have added efficiencies to the judicial process and made recovery against the responsible parties easier.

CCE, Inc. v. PBS&J Construction Services Inc. 2011 Tex. App. LEXIS 809 (Tex. App.— Houston [1st Dist.] January 28, 2011)(pet. filed); Martin K. Eby Construction Co. v. LAN/ STV, 350 S.W.3d 675 (Tex. App.—Dallas)(pet filed.); and Sharyland Water Supply Corp. v.City of Alton, 2011 Tex. LEXIS 805, (October 21, 2011). 

Looking more closely into the recent cases in this area is instructive and illustrative of the situation at hand. In CCE, the court recognized that a design professional’s plans and specifications may constitute a representation containing false information. The court further held that contractors who rely on a misrepresentation in the plans and specifications may recover damages resulting from that reliance. The recoverable damages are those necessary to compensate the contractor for the pecuniary loss resulting from the misrepresentation – the out-of-pocket expenses that would not have been incurred if the plans and specifications had not contained the misrepresentation.

In CCE, the contractor was working on a TxDOT project requiring erosion controls. CCE constructed the erosion control measures in compliance with the Storm Water Pollution Prevention Plan (SW3P) that was designed by PBS&J. When the erosion controls failed, TxDOT ordered CCE to correct the problem. The dispute between CCE and TxDOT erupted and TxDOT terminated CCE. TxDOT then ordered CCE’s surety to perform. As a result, CCE paid a replacement contractor to enter and complete the project. Ultimately, CCE paid $2.4 million more than its anticipated costs to finish the job. CCE claimed the SW3P was negligently prepared and contained misrepresentations of fact that caused the failures and ultimately the termination. Due to the losses incurred, CCE sued PBS&J for damages resulting from the negligent misrepresentations in the SW3P. The court found CCE’s out-of-pocket damages to be recoverable because they were not anticipated profits from the job.

In the second case, Eby v. LAN/STV, a different court reached a similar conclusion. Eby contracted with Dallas Area Rapid Transit (DART) to construct a rail line. LAN/STV prepared the plans and specifications that DART used in the solicitation of bids. During construction, Eby encountered numerous deficiencies with the plans and specifications that resulted in increased costs and delays. As a result of these deficiencies, Eby incurred millions of dollars in extra costs to complete the work. The Eby court relied on the CCE case and determined that Eby could recover out-of-pocket damages on its negligent misrepresentation claim. Those damages, the court reasoned, were distinct from benefit-of-the-bargain damages that would be allowed only in a breach of contract suit.

Prior to CCE and Eby, the economic loss rule had been used to prevent the recovery of these types of damages. The economic loss rule says that negligence and negligent misrepresentation claims cannot be asserted by a party who has been injured if the injures arose from the performance of a contract. The only exceptions previously allowed were for personal injury or property damage. The economic loss rule has steadily grown throughout the years to prevent all manner of tort recovery, even against parties who did not have a contract with one another – as was the case in CCE and Eby.

The CCE and Eby cases signal a shift in the application of the economic loss rule and the availability of a negligent misrepresentation claim for contractors against design engineers on infrastructure projects.

Following these two cases, the Texas Supreme Court released an opinion that echoed the limitation of the economic loss rule. In that case, Sharyland vs. Alton, the court concluded that the economic loss rule does not automatically preclude a negligence claim against defendants where a contract exists for the work. The court recognized that tort claims are viable and damages are available between parties that did not contract with one another, even if work was being done pursuant to a contract.

As a result, in future construction disputes, when a design professional materially misrepresents facts in its plans and specifications or negligently designs a portion of a project, and a contractor suffers out-of-pocket losses because of its reliance on the design professional’s misrepresentation, then the contractor should be able to recover those damages in reliance on the CCE, Eby, and Sharyland cases.

– As seen in the June issue of Texas Contractor