Insurers May Soon be Forced to Defend Increased Claims
Insurers covering risks in Pennsylvania may soon find themselves defending claims in greater numbers and kinds than ever before. There are two main reasons for this possibility. First, the Pennsylvania Supreme Court will soon review the “gist of the action” doctrine under Pennsylvania law. Second, the Pennsylvania Supreme Court recently held that a contractor may bring a tort claim against a design professional with whom the contractor is not in privity, and that such a claim is not barred by the “economic loss” doctrine.
Previously, insurers could utilize the “gist of the action” doctrine and the “economic loss” doctrine to argue that construction claims that were fundamentally breach of contract claims could not be “re-cast” as tort claims for the purpose of falling within the coverage provisions of a liability insurance policy. Now that the Pennsylvania Supreme Court has limited the “economic loss” doctrine, and is reviewing the scope of the “gist of the action” doctrine, insureds may claim tort liability coverage for a variety of fundamentally contractual claims.
The Scope of the “Gist of the Action” Doctrine
There is currently a split among Pennsylvania courts regarding the appropriate test or inquiry to use in determining whether an underlying claim for insurance coverage sounds in contract or tort. Under the “gist of the action” doctrine, many courts will examine a tort claim to determine whether it is duplicative of a contract claim. However, other courts have stated that even if a tort claim is duplicative of a contract claim, if “misfeasance” in the performance of a contractual obligation is alleged, such a claim alleges an independent duty and is therefore not precluded by the “gist of the action” doctrine. Both the “gist of the action” doctrine and the “misfeasance/nonfeasance” test are examined in detail below.
The “Gist of the Action”
Under Pennsylvania’s “gist of the action” doctrine, plaintiffs are prevented from re-casting common breach of contract claims into tort claims in order to come within the provisions of their liability insurance policies. When a plaintiff claims that the defendant committed a tort in executing a contractual obligation, Pennsylvania courts utilizing this test consider the claim and decide whether the “gist” of it sounds in contract or tort.1 This distinction is vital, as “an insurer has no duty to defend or indemnify an insured for a contract action when the policy contains an express contractual claim exclusion, even if the action asserts tort claims, so long as the contract is not collateral to the tort claim and is the ‘gist of the action.’”2 This doctrine is particularly applicable to construction companies since construction companies’ obligations to perform, by
and large, arise from a construction contract.
In Redevelopment Auth. of Cambria County v. Int’l Ins. Co., the Pennsylvania Superior Court applied the “gist of the action” doctrine and held that an insured was not entitled to coverage under a general liability policy for claims arising from improper performance of an agreement to operate a water system.3 The plaintiff in Redevelopment Auth. brought a declaratory judgment action against its general liability and nonprofit organization’s liability insurer, seeking a defense of a lawsuit arising out of the alleged failure of the plaintiff to properly operate a municipal water system.4 The Redevelopment Auth. court explained that there was “no duty to defend since the underlying suit arises out of a breach of contract which is not an accident or occurrence contemplated or covered by the provisions of a general liability insurance policy.”5 The court explained that since the negligence allegations were collateral to the contract, and a general liability policy is not meant to act as a performance bond insuring the performance of contractual duties, the “gist of the action” sounded in contract, and there was no duty of coverage.6
Moreover, in Freestone v. New England Log Homes, Inc., the Pennsylvania Superior Court held that since the “gist of the action” was that the manufacturer of a log home kit provided improper logs, and therefore failed to give the purchasers the benefit of the bargain, the defendant liability insurer had no coverage obligation.7 The court explained that any duty owed by the manufacturer was contractual in nature: the plaintiffs purchased a log home kit that was not up to standard, and as a result, sought a remedy for the manufacturer’s failure to perform properly under the contract.8 Under Pennsylvania law, a general liability policy provides no coverage for failure to perform properly under a contract.9 In addition, although the plaintiff argued that coverage existed because of the manufacturer’s alleged “negligent advice,” the court found no facts establishing that the advice given relating to the performance of the contract was either an “accident” or “occurrence” under the policy.10
Some Pennsylvania courts use a second test, known as the “misfeasance/nonfeasance” test, to determine whether an underlying claim for insurance coverage sounds in contract or tort. In Tenos v. State Farm Ins. Co. and Yocca v. Pittsburgh Steelers, the Pennsylvania Superior Court stated that “the test used to determine if there exists a cause of action in tort growing out of a breach of contract is whether there was an improper performance of a contracted obligation (misfeasance) rather than the mere failure to perform (nonfeasance).”11
A misfeasance results from an “improper performance of a contract during the course of which the defendant breached a duty imposed by law as a matter of social policy.”12 Under this test, a “misfeasance” in the performance of a contractual obligation can properly give rise to a tort claim.13 On the other hand, “nonfeasance” alleges that the defendant breached his duty to perform under the terms of the contract.14 In such cases, a plaintiff cannot properly bring an action but for the contract.15
The Pennsylvania Supreme Court’s Review
Freestone’s application of the “gist of the action” doctrine in the insurance coverage context was consolidated with Kvaerner Metals Div. of U.S., Inc. v. Commercial Union Ins. Co. (argued in October 2004), and the consolidated appeal is under review by the Pennsylvania Supreme Court.16 The Appeal Docket for Freestone described the scope of the appeal, and directed the parties to address the following:
The parties are directed to address the appropriate test or inquiry in ascertaining whether an underlying claim sounds in contract or tort for purposes of insurance coverage. Compare Redevelopment Auth. of Cambria County v. International Ins. Co., 454 Pa. Super. 374, 685 A.2d 1251 (1996) (en banc) with Yocca v. Pittsburgh Steelers Sports, Inc., 806 A.2d 936 (Pa. Commw. Ct. 2002), appeal granted, 573 Pa. 713, 827 A.2d 1203 (2003) and Tenos v. State Farm Ins. Co., 716 A.2d 626 (Pa. Super. 1998). This matter is consolidated for argument with Kvaerner Metals Div. of Kvaerner U.S., Inc. v. Commercial Union Ins. Co., 543-44 MAL 2003.17
While the Freestone appeal has been discontinued, the appeal docket in Kvaerner18 directs the parties to address the same exact question. Thus, it appears that the Kvaerner appeal will resolve whether the “gist of the action” doctrine articulated in Redevelopment Auth. or the “misfeasance/nonfeasance test” provided in Tenos and Yocca is the “appropriate test or inquiry” under Pennsylvania law for “ascertaining whether an underlying claim sounds in contract or tort for purposes of insurance coverage.”19
Tort Claims Against Design Professionals
The Pennsylvania Supreme Court recently decided Bilt-Rite Contractors, Inc. v. The Architectural Studio,20 and in doing so, increased the possibility that design professionals and other persons who supply information in the course of their business could be subject to significantly more liability.
In Bilt-Rite, a general contractor brought an action against an architect for alleged negligent misrepresentation in the plans and specifications upon which the contractor relied in submitting the winning bid for the construction of a school.21 The general contractor sued the architect on a theory of negligent misrepresentation under Section 552 of the Restatement of Torts,22 alleging that the architect’s specifications were false and/or misleading and sought damages for its increased construction costs.23
The court noted that this issue was one of first impression, and applied Section 552 to Bilt-Rite’s claim.24 In doing so, the court “adopted Section 552 as the law in Pennsylvania in cases where information is negligently supplied by one in the business of supplying information, such as an architect or design professional, and where it is foreseeable that the information will be used and relied upon by third persons, even if the third parties have no direct contractual relationship with the supplier of information.”25
The court also held that there is no requirement of privity in order to recover against a design professional under Section 552.26 The court stated, “Section 552 imposes a duty of reasonable care upon the supplier of professional information for use by others. Both on its face and as a matter of logic, Section 552 negates any requirement of privity; therefore, we find that the absence of privity does not defeat a Section 552 claim . . . .”27
Lastly, the Bilt-Rite court held that economic losses resulting from misrepresentation were an exception to the “economic loss” doctrine.28 Thus, a plaintiff is not barred from recovering economic losses in a tort action simply because a contract existed between the parties, where the allegedly breached duty arose independently of the subject contract.29 There was no contract between Bilt-Rite and the design professional for Bilt-Rite to recover under. However, Bilt-Rite was still permitted to state a claim for negligent misrepresentation under Section 552, and privity of contract was not found to be a prerequisite for maintaining such an action. Thus, Bilt-Rite was not barred from recovering its alleged damages in tort.30 In fact, the Pennsylvania Supreme Court went so far as to say that applying the “economic loss” doctrine in the context of a Section 552 claim would be “non-sensical.”31
What to Take From Bilt-Rite
After Bilt-Rite, design professionals and other persons who supply information in the course of their business could be subject to significantly more liability, because a non-contractual tort claim for negligent misrepresentation has been recognized and such a claim is not (and cannot be) precluded by the economic loss doctrine.
Further, the Bilt-Rite court may have provided a glimpse of how it intends to rule on the “gist of the action” doctrine in Kvaerner. In Bilt-Rite, the Pennsylvania Supreme Court’s analysis of the economic loss doctrine seemed to focus on the origin of the duty alleged, instead of the “gist” of the entire action. This may indicate that the Pennsylvania Supreme Court is disposed to adopt the “misfeasance/nonfeasance” approach articulated in Tenos and Yocca. If the Pennsylvania Supreme Court did so, such a holding would greatly expand the number and kinds of tort claims that may be brought against construction professionals and in other commercial liability contents. It would expand the number and kinds of claims that could trigger a commercial general liability insurance policy, because tort claims could potentially bypass the contractual liability exclusions in certain policies, and fit within the definition of “occurrence” in these policies.
1 Freestone v. New England Log Homes, Inc., 819 A.2d 550, 554 (Pa. Super. 2003), appeal docketed, No. 77 WAL 2003 (Pa. Apr. 5, 2004), and later discontinued.
2 Temple Univ. Health Sys., Inc. v. Nat’l. Union Fire Ins. Co. of Pitt., No. 061705, 2005 WL 167583 (C.P. Phila. Jan. 7, 2005).
3 Redevelopment Auth. of Cambria County v. Int’l. Ins. Co., 685 A.2d 581 (Pa. Super. 1996) (en banc).
4 Id. at 583.
5 Id. at 589.
6 Id. at 592.
7 Freestone, 819 A.2d at 554.
8 Id. at 553.
9 Id. at 554.
11 Tenos v. State Farm Ins. Co., 716 A.2d 626 (Pa. Super. 1998); Yocca v. Pittsburgh Steelers Sports, Inc., 806 A.2d 936 (Pa. Commw. Ct. 2002), appeal granted, 827 A.2d 1203 (Pa. 2003), aff’d in part, rev’d in part on other grounds, 854 A.2d 425 (Pa. 2004).
12 Yocca, 806 A.2d at 944.
16 Freestone, 819 A.2d 550, 554 (Pa. Super. 2003), appeal docketed, No. 77 WAL 2003 (Pa. Apr. 5, 2004), and later discontinued.
17 Freestone, No. 77 WAL 2003 (Pa. April 5, 2004).
18 Kvaerner U.S. Inc. v. Onebeacon Ins. Co., No. 071507, 2003 WL 22282605 (Pa. C.P. Ct. Sept. 29, 2003) appeal docketed, No. 543-44 MAL 2003 (Pa. July 30, 2003).
20 Bilt-Rite Contractors, Inc. v. The Architectural Studio, 866 A.2d 270 (Pa. 2005).
21 Id. at 272.
22 Id. at 272-273. Section 552 of the Restatement (Second) of Torts, entitled “Information Negligently Supplied for the Guidance of Others,” provides:
1. One who, in the course of his business, profession or employment, or in any other transaction in which he has a pecuniary interest, supplies false information for the guidance of others in their business transactions, in which he has a pecuniary interest, supplies false information for the guidance of others in their business transaction, is subject to liability for pecuniary loss caused to them by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or communicating the information.
2. Except as stated in Subsection (3), the liability stated in Subsection (1) is limited to loss suffered (a) by the person or one of a limited group of persons for whose benefit and guidance he intends to supply the information or knows that the recipient intends to supply it; and (b) through reliance upon it in a transaction that he intends the information to influence or knows that the recipient so intends or in a substantially similar transaction.
3. The liability of one who is under a public duty to give the information extends to loss suffered by any of the class of persons for whose benefit the duty is created, in any of the transactions which is intended to protect them.
24 Id. at 287.
27 Id. at 287.
28 Id. at 288. The court addressed the economic loss doctrine using a discussion from the South Carolina Supreme Court in Tommy L. Griffin Plumbing & Heating Co. v. Jordan, Jones & Goulding, Inc., 463 S.E.2d 428 (Tenn. 1991) and explained:
Application of the “economic loss” rule maintains the dividing line between tort and contract while recognizing the realities of modern tort law. Purely “economic loss” may be recoverable under a variety of tort theories. The question, thus, is not whether the damages are physical or economic. Rather, the question of whether the plaintiff may maintain an action in tort for purely economic loss turns on the determination of the source of the duty plaintiff claims defendant owed. A breach of duty which arises under the provisions of a contract between the parties must be redressed under contract, and a tort action will not lie. A breach of duty arising independently of any contract duties between the parties, however, may support a tort action.