Until its abandonment over the last half-century, the law of privity was a reliable defense for architects and engineers against claims for negligence brought by third parties, even if personal injury was involved. The law provided a contract does not confer rights or benefits on third parties who were not signatory to the agreement. In fashioning the law of privity, 18th century English jurists were establishing a foundation for the benefits of contract to provide predictable risk and certainty of duties and obligations—important considerations for business and industry.
Justice Benjamin Cordozo, sitting on the New York Court of Appeals in 1932, but later a Supreme Court justice, described the law this way: “The Law of Privity provides that suits against parties to a contract for negligence in performance of the duties and obligations of the contract could only be brought by signatories to the contract, not by third-party strangers.”
The common law of privity—part of British colonial law that provided a framework for U.S. law—was almost universally disliked, even by the English jurists who wrote it for the perceived injustices it wreaked on injured parties. In the latter half of the 20th century, jurists began to disavow privity because it deprived injured parties of recovery for damages caused by negligence even excluding personal injury. It is strange, then, that it is retained in some state’s jurisdictions even today.
Just as there are social benefits to the protections from personal financial ruin provided entrepreneurs by corporate law, there are social benefits to providing predictable risk and certainty of duties and responsibilities for those in contract. The decline of privity defense raised the possibility the benefits of contract could be overwhelmed by tort law, and jurists in separate states began to experiment with replacements for the privity defense that would refortify the benefits of contract.
Economic Loss Doctrine
In a California products liability case, Seeley vs White Motors (1965), the owner of a truck built by White Motors brought a suit against the manufacturer for damages to his business incurred while he waited for repairs to his truck to be completed. The repairs were covered by the warranty, but the lost business profits were not, and the owner of the truck sued for his economic losses.
The California Supreme Court enunciated a new rule in the case—the Economic Loss Rule (ELR)—that prohibits parties in contract from suing the other party in tort for economic losses (i.e. losses that could only be expressed on a financial statement) except when there was bodily injury or damage to ancillary property. The Seeley court denied the owner’s financial recovery on that basis.
While the Economic Loss Rule was more policy than law, it gave judges a point to rally around to enforce the boundary line between tort and contract law, and it allowed for recovery in tort for personal injury and property damage. This renewed authority to keep tort litigation in check, especially coming in the wake of the loss of the privity defense, ensured it would be quickly adopted in jurisdictions across the country.
The problem became, the ELR had developed in a product liability case where there was a warranty that clearly lent itself to the application of the rule, but when the ELR was applied in construction contract cases (or where there was only an implied contract) confusion reigned and multiple, sometimes contradictory, interpretations emerged state by state.
The American Law Institute
The American Law Institute (ALI) is a group of 3000 or more jurists, established “in 1923 to promote the clarification and simplification of United States common law and its adaptation to changing social needs.” Common law in the United States develops independently by state, sometimes leaving large gaps in the law and irreconcilable differences from one state to another.
ALI does not dictate law, but its publications are widely read and often integrated into state common law. By periodically publishing what is referred to as “Restatements,” ALI attempts to realign varying interpretations around central concepts in common law. In response to inconsistent applications of ELR, the group issued the “Restatement of Torts Second” in 1979 and the “Restatement of Contracts Second” in 1981. They became some of the most read and widely adopted provisions ever issued by the society.
Tort law proceeds from duties imposed by lawmakers and is intended to protect unsuspecting individuals from the unlawful acts of others (e.g. fraud, defamation or negligence). Litigators prefer to raise tort issues at court instead of contract ones because tort law provides better benefits for plaintiffs than contract law. However, each state is free to experiment with individual interpretations of the law, and this experimentation has resulted in the total disregard for the traditional balance of contract relationships in the construction context in many states.
The “Restatement of Torts Second” reaffirmed the importance of the ELR as separating tort from contract law, but provided tort with the power to pierce the immunities of contract by providing exceptions and ways around the economic loss rule. ALI declared where a contract existed or was implied, or a third-party beneficiary was established, the parties were limited in their pursuit of losses to the terms of the contract. However, the “Restatements” defined two important exceptions to the ELR: third-party beneficiaries and negligent misinformation.