Rushing water overcomes economic loss doctrine

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The durability of Wisconsin’s economic loss doctrine was no match for a flood of destructive water running out the door of Larry Krueger’s Sheboygan County home.

In a recently issued Wisconsin Court of Appeals decision, State Farm Fire and Casualty v. Hague Quality Water Int’l, et al, 2012 AP 392, the court found that State Farm’s subrogation claim would survive summary judgment in part because the damages that occurred were “not an integrated part” of a system and consisted of damages to “other property.”

Plaintiff Larry Krueger claimed a defective water softener caused more than $44,000 in severe water damage to drywall, flooring and woodwork at his rental home in Cascade, Wis.

Krueger, who bought the home in 2004, stopped by a Menard’s in West Bend in February 2005 to purchase a water softener for the property. The product, manufactured by Hague Quality Water, came with a five-year limited warranty in the event of defect. Hague would repair or replace the defective part, but was not responsible for any “incidental, consequential, or secondary damages.”

Krueger used his own plumber to install the water softener, adding a shutoff valve bypass system, part of a larger $45,000 rehab of the investment property.

Two years later, Krueger said, the property flooded. He arrived at the house to find “water running out of his house, the walls of the house, into the garage.” There was a half-inch of water covering the floor and more water “gushing” out of the water softener, Krueger stated at his deposition.

His insurer, State Farm, covered Krueger’s damages and later filed a subrogation action against the water softener manufacturer and its insurance company, Cincinnati Insurance Co., for negligence and warranty claims.

The Sheboygan County Circuit Court granted Hague’s summary judgment motion to dismiss the case, stating that the economic loss doctrine barred recovery. The damages were “disappointed expectations,” Judge James Bolgert said, and should have been expected by Krueger.

On appeal, counsel for State Farm argued that the economic loss doctrine did not apply. In fact, the damages to the drywall, the flooring and woodworking, as well as the associated repairs, were damages to “other property” and thus not barred by the economic loss doctrine. Citing 1325 North Van Buren LLC v. T-3 Group Ltd, 2006 WI 94, State Farm asserted that economic loss is generally defined as damages resulting from inadequate product value because the product is “inferior and does not work for the general purposes for which it was manufactured and sold.”

State Farm said that its claims were not based on a water softener that failed to sufficiently soften water. The product failed “in an unexpected manner,” and “failed catastrophically,” creating damages that Krueger could not anticipate.

The appellate court looked to Wisconsin’s longstanding two-part test to judge: 1) whether the defective product and the harm caused were part of an “integrated system” or 2) whether the purchaser’s damages arose from “disappointed expectations” in that the product failed to function as it should, and if the damages were then foreseeable. The integrated system test looks to whether the alleged defective product is a component in a larger system, explained the court, in that the system would have to be “unable to function without that product,” citing Cincinnati Insurance Co. v. AM International, 224 Wis.2d 456 (Ct.App.1999).

Hague suggested that the damages to Krueger’s house were more on point with several other cases, including Bay Breeze Condo Association v. Norco Windows Inc. 2002 Wis.App. 205. There, defective windows caused water to leak into the surrounding window casements and walls of several condominium units. The court found that the condominium windows, casements and surrounding walls were all part of a single “integrated” system or structure, so the economic loss doctrine applied to deny recovery against the window manufacturer.

Like in Bay Breeze, Hague suggested, Krueger’s damages occurred from intruding water that spread throughout a common, interconnected environment and to different household components that all had a certain common thread, thus making it all part of an “integrated system.”

The appellate court disagreed with Hague’s reliance on Bay Breeze, indicating that a window is a much more “integral” part of a home than a water softener, and so is substantially more integrated with the surrounding casements and walls. A water softener that is installed as an “add-on” to an existing water delivery system has no functional link to the drywall, the flooring and the woodwork, the appellate court found. Additionally, the court found that Krueger’s damages were not just “disappointed expectations,” and were not foreseeable damages that came from a product that just failed to live up to its promised performance.

“The alleged failure of the water softener,” the appellate court explained in its Dec. 12 decision, “did not have anything to do with the purpose for which the water softener was purchased. Because of that, the resulting water flooding was not foreseeable.” The appellate court determined that damage done was in fact to “other property”, finding that the water softener was not ”integral to the functions of …. [the] drywall, flooring and woodwork.”

Counsel for Hague took issue with the nature of State Farm’s claim, calling the insurer’s action an attempt to “circumvent terms of his insured’s contract” by pursuing tort claims. Hague looked to language from Tietsworth, Tietsworth v. Harley Davidson Inc. 2004 WI 32, which stated that “if a contracting party is permitted to sue in tort when a transaction does not work out as expected, that party is in effect rewriting the agreement … .”

The purpose of subrogation, replied State Farm, is to place the loss ultimately on the wrongdoer, quoting Torres v. Dean Health Plan Inc., 2005 Wis. App.89.

When a defect in the product is responsible for personal injury or damages to “other property,” the appellate court found, “tort theory may permit recovery for economic losses (quoting Wausau Tile Inc. v. County Concrete Corp., 226 Wis.2d 235 (1999).

The case was reversed and remanded to the trial court for further proceedings consistent with the appellate court’s decision.