Beware: The economic loss doctrine is lurking

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The recent expansion of a judicially created rule, originally meant to apply to product liability claims, has crossed over to real estate transactions, and lawyers need to understand its nuances.

The economic loss doctrine, or ELD, precludes tort recovery for economic losses when there is a contract, economic losses being those damages resulting from the decreased value of an inferior product that does not perform as it was intended. The policy behind the ELD presumes parties are sophisticated, negotiate their responsibilities within the contract and, therefore, tort law should not be an end-run around contract law.

Though originally applied to manufactured products, the ELD has recently been extended to some commercial and now residential or construction transactions.

Prior to extending the ELD to real estate transactions, a disgruntled buyer had remedies against a seller or contractor in either contract or tort (negligence, intentional misrepresentation or strict liability misrepresentation). Where a seller has made a misrepresentation in the sale of real estate, the ELD limits the buyer’s remedies to only breach of contract.

While Wisconsin courts have not extended the ELD to all real estate transactions, the following cases are illustrative of the evolution:

• Real estate was a “product” for purposes of the ELD. The Court of Appeals determined that land is no different than a “widget” and barred negligence and strict liability claims relating to the sale of commercial real estate. Mose v. Tedco Equities, 228 Wis. 2d 848, 859 (Ct. App. 1999).
• The ELD applied to a commercial, arm’s length real estate sale between two sophisticated and represented parties during negotiations who have a written, bargained-for contract. Whether the ELD applied to commercial real estate transactions was a matter of first impression for the Supreme Court. The court did not apply the ELD to all real estate transactions, but held that a commercial transaction involving sophisticated parties represented by counsel is “tailor made” for applying the ELD. Van Lare v. Vogt Inc., 2004 WI 110.
• A narrow, “fraud-in-the-inducement” exception to the ELD was created in a product case involving intentional misrepresentation. The buyer thought it was unfair not to allow a tort claim when the buyer was wrongfully induced to sign a contract. The Supreme Court created a narrow “fraud-in-the-inducement” exception: The ELD did not apply where misrepresentation occurred before the contract was formed. The party was induced to enter into a contract based on misrepresentation, and the fraud was unrelated to the parties’ contract. Kaloti Enters., Inc. v. Kellogg Sales Co., 2005 WI 111).
• The narrow “fraud-in-the-inducement” Kaloti exception was extended to residential real estate, where one party was unsophisticated and unrepresented. The Supreme Court found that the ELD does not bar an intentional misrepresentation claim when a defendant fraudulently induced a plaintiff to sign an option to purchase real estate, and the parties’ contract is unrelated to the option. Wickenhauser v. Lehtinen, 2007 WI 82.
• The ELD barred tort claims in a residential real estate transaction, including intentional misconduct under Wis. Stat. Sec. 895.446 in violation of Wis. Stat. Sec. 943.20(1)(d). The ELD did not bar a false advertising claim under Wis. Stat. Sec. 100.18. The Court of Appeals held that a buyer could only pursue a breach-of-contract claim when a seller failed to disclose a material issue in a real estate condition report. Below v. Norton, 2007 WI App 9.

In her concurrence in Wickenhauser, Chief Justice Shirley S. Abrahamson noted that prior decisions have not specifically addressed whether the ELD applied to all tort claims arising in transactions involving residential real estate, or unsophisticated and unrepresented parties who negotiate an oral agreement, or transactions involving a not fully bargained-for contract. Wickenhauser at 61. High Court to Hear Below This term, the Wisconsin Supreme Court will review Below v. Norton. The court will address:

• Whether the ELD bars intentional misrepresentation claims arising from non-commercial and/or residential real estate transactions; and,
• Whether the ELD bars cases based on Wis. Stat. Sec. 895.446 for an alleged violation of Wis. Stat. Sec. 943.20 (obtaining title to property of another by intentionally deceiving with false representation, where representation is known to be false and made with intent to defraud). This decision will help real estate lawyers advise their deceived clients.

Based on the distinction made in Van Lare, the court might address the first issue by looking at whether parties are sophisticated and represented by counsel. Since many homebuyers are unrepresented, it may decide that the ELD does not bar intentional misrepresentation claims. The court could broaden the narrow “fraud-in-the-inducement” Kaloti exception found with intentional misrepresentation cases. This latter decision would essentially re-adopt the ELD exception that existed before Kaloti (see Douglas-Hanson Co. v. BF Goodrich Co., 229 Wis. 2d 132 (1999) [intentional misrepresentation claims not barred by the ELD when the misrepresentation fraudulently induced the party to enter into the contract]). Addressing the second issue, if the Supreme Court decision upholds the Court of Appeals, the homebuyer’s claims will be reduced to a breach-of-contract or warranty claim. This would seem to be a drastic result. Alternatively, the court could hold that a tandem Sec.Sec. 895.446 and 943.20 claim is identical to a false advertising Sec. 100.18 claim and is immune to the ELD. All participants in the Wisconsin real estate market, whether they be buyers, sellers, developers or lawyers, will be affected by the court’s decision in Below. Lawyers who negotiate real estate transactions should make certain there are meaningful contractual remedies, since only limited tort remedies may survive if the buyer is wrongfully damaged. Schwarz and Wal are members of the Banking, Bankruptcy and Business Restructuring Practice Group of von Briesen & Roper s.c. in Milwaukee. Schwarz can be reached at [email protected]; Wal can be reached at [email protected].