William W. Carstens, et aux. v. City of Phoenix, et al.

William and Deborah Carstens and Deborado, LLC, ("the
Carstens") sued the City of Phoenix ("City") and three of its building inspectors alleging that the inspectors were grossly
negligent because they failed to discover serious construction
defects in the house that the Carstens later purchased. The trial
court dismissed the tort claims under the economic loss rule
because the Carstens had suffered no personal injuries or damage to
property other than the alleged construction defects. For the
following reasons, we affirm the trial court's judgment.

Background

2 In July 1996, Corwa, Inc. purchased the house at 56
Biltmore Estates. Later that year, Corwa obtained a construction
permit from the City to add 3,150 square feet to the kitchen and
second story of the house. The remodeling work was done in 1997.
Between January 31 and December 12, 1997, City building inspectors
Richard Ryall, Dale Borger, and Jerry Coke inspected the house
several times to determine whether, among other things, the
footings and structural, electrical, and mechanical aspects of the
project complied with the City's uniform building codes. Based
upon those inspections, the City approved the work done by Corwa.

3 In May 1999, the Carstens bought the house from Alvarado,
Inc., a successor in interest to Corwa, for $2,000,000. Soon
thereafter, the Carstens hired a contractor to do some minor
remodeling on the house. Because the contractor discovered a few
construction defects and building code violations, the Carstens
hired engineers to assess the structural, mechanical, and electrical systems of the house. The engineers found numerous
defects and code violations, including missing fire blocking,
deeply-notched floor and ceiling joists, inadequate beam support,
inadequate natural gas piping, and improper and hazardous venting
and electrical wiring. Major repairs were necessary to make the
house safe for occupancy.

4 In December 1999, the Carstens filed a notice of claim
against the City and the three inspectors pursuant to Arizona
Revised Statutes ("A.R.S.") section 12-821.01(A) (Supp. 2002).
They alleged that the City had breached its duty to conduct a
proper inspection of the house in accordance with applicable
building codes. Thereafter, in January 2000, the Carstens had the
house demolished.

5 In June 2000, the Carstens sued the City and the three
inspectors (collectively the "City defendants").1 They alleged
that the City defendants were grossly negligent in failing to
discover numerous violations of the building codes during the
inspections performed in connection with the 1997 remodeling project and that their gross negligence created a substantial risk
of physical harm to the Carstens.

6 The City defendants moved for summary judgment. They
argued that, because the alleged construction defects had not
caused any personal injury or property damage, the economic loss
rule barred the Carstens from maintaining a tort claim against them
for the amounts necessary to repair or replace the defects.

7 The trial court granted the motion. It found that the
City defendants "did not owe [the Carstens] a duty of care to
protect them from the type of harm that they have allegedly
suffered in this matter." The court further stated that, although
government agencies and employees may be liable for negligent
inspection when the negligence causes physical injury and property
damage, they could not be liable for the economic losses suffered
by homeowners when contractors failed to construct home
improvements in compliance with building codes or in a workmanlike
manner. The Carstens timely appealed from the judgment.

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DISCUSSION

9 The Carstens argue that the trial court erred in
concluding that no duty existed due to the nature of the injury
suffered. They also maintain that the trial court erred by ruling
that their claim against the City was barred by the economic loss
rule. Because the City's duty in these circumstances is clear, the
only question here is whether the economic loss doctrine precludes
tort recovery when the Carstens have alleged no physical injury or
property damage resulting from construction defects. See Daggett
v. Maricopa County, 160 Ariz. 80, 85, 770 P.2d 384, 389 (App. 1989)
(governmental regulations requiring inspections may create a duty
to protect public from physical harm).

10 The economic loss rule bars a party from recovering
economic damages2 in tort unless accompanied by physical harm,
either in the form of personal injury or secondary property damage.
Sidney R. Barrett, Jr., Recovery of Economic Loss in Tort for
Construction Defects: A Critical Analysis, 40 S.C. L. Rev. 891,
895-96 (1989). The rule stems from the principle that contract law
and tort law each protect distinct interests. Generally, contract law enforces the expectancy interests between contracting parties
and provides redress for parties who fail to receive the benefit of
their bargain. Id. at 894-95, 901-02. Its focus, therefore, is on
standards of quality as defined by the parties in their contract.
Id. at 901. Tort law, in contrast, seeks to protect the public
from harm to person or property. Id. at 901-02. To this end, it
evaluates the objective reasonableness of a person's conduct and
compensates victims for their actual harm resulting from that
conduct. Id. The economic loss rule thus "serves to distinguish
between tort, or duty-based recovery, and contract, or promisebased
recovery, and clarifies that economic losses cannot be recovered under a tort theory." Calloway, 993 P.2d at 1264. In
the construction defect setting, "[i]f a house causes economic
disappointment by not meeting a purchaser's expectations, the
resulting failure to receive the benefit of the bargain is a core
concern of contract, not tort, law." Casa Clara Condo. Ass'n v.
Charley Toppino & Sons, Inc., 620 So.2d 1244, 1247 (Fla. 1993).

11 In Arizona, it is well-established that a homeowner may
not recover in tort against a contractor for economic losses
attributable to defective construction when the negligence has not
caused personal injury or damage to property other than the
defective structure itself. Our supreme court first recognized the
applicability of the economic loss rule in construction defect
litigation in Woodward v. Chirco Constr. Co., 141 Ariz. 514, 687 P.2d 1269 (1984). In Woodward, homeowners sued the builder of
their house for both breach of the implied warranty of workmanlike
performance and habitability and negligence after large cracks
developed in the house walls and foundation, the fireplace
separated from the wall, a family room wall shifted forward, the
kitchen ceiling began to bow, and the floor warped. Id. at 515,
687 P.2d at 1270. The trial court dismissed both claims. On
appeal, this court affirmed the dismissal of the negligence claim,
but reversed the court's ruling on the implied warranty claim
because the six-year statute of limitation on that claim had not
expired. Woodward v. Chirco Constr. Co., 141 Ariz. 520, 526, 687
P.2d 1275, 1281 (App. 1984).

12 On review to our supreme court, the builder argued that,
because the implied warranty is imposed by law, it did not arise
out of contract, and therefore the statute of limitations for tort
claims applied. Woodward, 141 Ariz. at 515, 687 P.2d at 1270. The
supreme court, however, disagreed, holding that a claim based on
the implied warranty was contractual in nature and distinct from a
tort claim based upon a builder's breach of the common law duty of
care. Id. at 515-16, 687 P.2d at 1270-71. Thus, the Woodward
court recognized that an injury resulting from negligent
construction may give rise to claims sounding in both contract and
tort. Specifically, the court stated that the homeowners could claim damages in contract for defects in the structure that rendered the home less than the purchaser bargained for, and,
further, that the homeowners could also sue in tort for injuries
sustained due to the contractor's breach of its duty of care. Id.
at 516, 687 P.2d at 1271. To illustrate the distinction between
these claims, the court explained that "if a fireplace collapses,
the purchaser can sue in contract for the cost of remedying the
structural defects and sue in tort for damage to personal property
or personal injury caused by the collapse." Id. The supreme court
thereby established the applicability of the economic loss rule to
construction defect claims.

13 Applying Woodward's reasoning, this court, in Nastri v.
Wood Bros. Homes, Inc., 142 Ariz. 439, 444-45, 690 P.2d 158, 163-64
(App. 1984), held that, absent property damage or personal injury,
plaintiffs could not maintain a negligence claim against a
homebuilder. In Nastri, the subsequent purchasers of a house sued
the builder for latent construction defects that caused severe
damage to the house, including cracks in the cement pad, walls,
ceilings, a joist, and bricks in a front archway. Id. at 440-41,
690 P.2d at 159-60. The trial court dismissed the action, and on
appeal, this court noted that the plaintiffs' damage claim involved
only the structure itself, without additional claims for damages to property or person. Id. at 444-45, 690 P.2d at 163-64. We
therefore held that the trial court had properly dismissed the
negligence count because a tort claim was available only for damage to personal property or for personal injury caused by defective
construction. Id.

14 Four years later, in Colberg v. Rellinger, 160 Ariz. 42,
44, 770 P.2d 346, 348 (App. 1988), this court relied on the
reasoning in Woodward and Nastri to hold that the plaintiffs could
not recover in negligence against a construction supervisor. The
plaintiffs brought a breach of contract claim against the
construction company and a claim alleging negligence and breach of
implied warranty against the construction supervisor, who was both
the president of the construction company and the qualifying party
for the company's contractor's license. The trial court awarded
the plaintiffs damages against the construction company on the
contract claim but denied recovery against the supervisor. Id. On appeal, the plaintiffs argued that the supervisor could be liable
in negligence for breaching his duty of care under the contractor
licensing statutes. Id. This court concluded, however, that
because the plaintiffs had not alleged any damage to other property
or any personal injuries, they could not recover in tort for the
supervisor's negligence. Id. at 47, 770 P.2d at 351.

15 Despite Woodward, Nastri, and Colberg, the Carstens
assert the following arguments: (1) whether the economic loss rule
applies in cases in which the plaintiff does not have a contract
claim against a specific defendant; (2) whether the economic loss
rule applies in cases in which construction defects render a house unsafe to its inhabitants; and (3) whether application of the
economic loss rule in this case is inconsistent with Arizona law
authorizing tort claims against governmental entities for breach of
duty. We address each of these arguments in turn.

16 First, the Carstens argue that the economic loss rule
should only apply in cases in which a plaintiff also has
contractual remedies available against that same tortfeasor. Here,
the Carstens argue that, unlike the plaintiffs in Woodward, Nastri,
and Colberg, they have only tort-based claims available against the
City defendants. Thus, the Carstens reason that they should be
permitted to pursue their claim against the City defendants. We,
however, disagree.

17 Contrary to the Carstens' characterization, Arizona
courts have never held that the application of the economic loss
rule depends upon the plaintiff also having a viable contract claim
against the defendant. Instead, irrespective of a plaintiff's
contractual claims against a defendant, the rule bars recovery of
economic damages in tort because such damages are not cognizable in
tort absent actual injury. In this case, because the Carstens
allege purely economic losses, their damages sound in contract,
and, presumably, may be asserted against those defendants with whom
the Carstens are in privity. Thus, the rule does not prevent the
Carstens from recovering their economic losses, but merely restricts them to suits against those defendants actually liable in
contract.

18 This limitation, we note, is consistent with the result
in Colberg, where the court affirmed the dismissal of the
plaintiffs' negligence claim against the supervisor because of the
economic loss rule even though the plaintiffs had no other cause of
action against him. 160 Ariz. at 45-47, 770 P.2d at 349-51. The
plaintiffs, thereby, were forced to pursue their contract-based
remedies against only the construction company with whom they were
in privity. Id.; see also Anderson Elec., Inc. v. Ledbetter
Erection Corp., 479 N.E.2d 476, 479 (Ill. App. Ct. 1985) (holding
that economic loss rule applies even when the plaintiff has no
contract claim against the specific defendant and application of the rule would therefore leave the plaintiff without a remedy),
aff'd, 503 N.E.2d 246 (Ill. 1986). That same situation exists
here.

19 Second, without citing supporting Arizona authority, the
Carstens argue that the economic loss rule should be limited to
cases in which homeowners are faced with only non-dangerous
defects. Again, we disagree.

20 The application of the economic loss rule in a
construction defect case has never been based upon the inherent
dangerousness of the defect. In fact, in Woodward, Nastri, and
Colberg, the homeowner-plaintiffs alleged structural defects similar in nature to those alleged here. However, those courts did
not suggest any exception to the economic loss rule based on the
potential safety hazard posed by the defects. Particularly, we
reject the Carstens' interpretation of Nastri as allowing a tort
action for economic loss when structural defects expose the
inhabitants to the threat of personal injury. The Nastri court
considered only whether there had been damage to other personal
property or to a person. After concluding that the damages claimed
were merely to the structure itself, the court applied the economic
loss rule and affirmed the dismissal of the plaintiffs' negligence
claim against the builder.3

21 This conclusion is also consistent with our supreme
court's analysis of the economic loss rule in a products liability
context. Salt River Project Agric. Improvement & Power Dist. v.
Westinghouse Elec. Corp., 143 Ariz. 368, 694 P.2d 198 (1984).
There, the court proposed five hypothetical equipment failures and
resulting damages. Id. at 378, 694 P.2d at 208. In two of the
hypotheticals, the defect was discovered or caused a malfunction
but did not injure anyone or cause damage to any other equipment,
although losses for shutdown, start-up, testing costs, and/or loss
of profits were incurred. Id. The court stated that in such instances the economic losses were not recoverable in tort because
"[t]here was no accident; the danger remained latent, even though
the loss is attributable to a defect that could have become
unreasonably dangerous. The loss is only economic in nature." Id.
at 379, 694 P.2d at 209.

22 Further, contrary to the Carstens' reasoning, limiting
the economic loss rule to cases in which the homeowners have
alleged only non-dangerous defects does not force such homeowners
to wait until they sustain injury to their person or property
before they can recover. Instead, applying the economic loss rule
merely limits homeowners to contract-based remedies when seeking
damages; they are free to initiate a suit for the cost to repair or
replace the defective conditions immediately upon discovering such
defects. We therefore reject the Carstens' argument.

23 Third, the Carstens argue that applying the economic loss
rule ignores Arizona law that provides for such tort actions
against governmental entities and employees who have a duty to make
competent inspections. In support, they cite Bill Moore Motor
Homes, Inc. v. State, 129 Ariz. 189, 629 P.2d 1025 (App. 1981);
Brown v. Syson, 135 Ariz. 567, 663 P.2d 251 (App. 1983); Donnelly
Constr. Co. v. Oberg/Hunt/Gilleland, 139 Ariz. 184, 677 P.2d 1292
(1984); and A.R.S. § 12-820.02(A)(6) (Supp. 2002).

24 In Moore, a motor home dealer sued the State, alleging
that it negligently failed to detect stolen vehicles during an inspection prior to issuing certificates of title for the vehicles.
129 Ariz. at 191, 629 P.2d at 1027. The court held that, because
the state motor vehicle inspector had inspected vehicles for the
dealer on numerous occasions, a relationship was established under
which the public duty owed by the state inspector was narrowed to
a duty to the dealer that formed the basis for a private cause of
action. Id. at 195, 629 P.2d at 1031. Thus, the court focused on
the particularized relationship between the inspector and the
dealer as the source of the duty; while here there is not even an
allegation of such a special relationship.

25 In Brown, the court was concerned with the immunity of a
city building inspector who allegedly was negligent in inspecting
the construction of a residence. 135 Ariz. at 568, 663 P.2d at
252. The court held that the inspector was not immune from suit,
and it remanded the case for further proceedings because material
facts regarding the alleged construction defects were in dispute.
Id. However, the Brown opinion does not disclose the nature of the
damages suffered by the homeowners, making it impossible to know
whether the economic loss rule arguably applied. In any event, the
rule was not discussed.

26 Nor does Donnelly help the Carstens. There, our supreme
court held that a contractor who suffered financial loss, allegedly
due to faulty plans prepared by the defendant architects, could
maintain a negligence cause of action against the architects. 139 Ariz. at 188, 677 P.2d at 1296. The court reasoned that, given the
duty of design professionals "to use ordinary skill, care, and
diligence in rendering their professional services," id. at 187,
677 P.2d at 1295, the architects were "liable for foreseeable
injuries to foreseeable victims" of their negligent professional
services. Id. at 188, 677 P.2d at 1296.

27 The Colberg court, however, distinguished Donnelly from
Colberg's application of the economic loss rule by noting that
Donnelly "did not involve a claim of negligent construction nor a
claim of implied warranty of workmanlike performance and
habitability . . . [because] there were no structural defects to
remedy." 160 Ariz. at 47, 770 P.2d at 351. In addition, the
Donnelly court's allowance of the negligence claim against the
architects hinged on the special situation in which the contractor,
although not in privity of contract with the architects, had to
rely directly upon their work.4 As the Arizona Supreme Court noted
in Napier v. Bertram, 191 Ariz. 238, 242, 16, 954 P.2d 1389, 1393 (1998), Donnelly recognized a professional's duties to a non-client
where "there was a foreseeable risk of harm to a foreseeable nonclient
whose protection depended on the actor's conduct" such that
"the contractor was in the care of the architect." Here, the Carstens alleged that James Hurst, rather than the City defendants,
represented to them that there were no structural, mechanical, or
electrical problems with the house; that there were no violations
of city, building, zoning, or health laws, codes, statutes,
ordinances, or regulations regarding the house; and that all
latent, material defects had been disclosed. Given these
allegations, the Carstens could not be considered to have been in
the "care" of the City inspectors in the same way that the Donnelly
contractor was in the care of the architects.5 Therefore, Donnelly
does not control here.

28 Finally, the Carstens point out that, under the
provisions of the applicable immunity statute, A.R.S. § 12-
820.02(A)(6), City inspectors are liable for gross negligence for
"[t]he failure to discover violations of any provision of law when
inspections are done of property other than property owned by the
public entity in question." While this, of course, is a correct
statement of law, the fact that the City inspectors may be liable
for gross negligence does not mean that the economic loss rule does not limit recovery when no personal injury or damage to other
property has resulted. Rather, the statute merely establishes the
standard of liability. Thus, in a case where an inspector's gross
negligence leads to personal injury or property damage, the
inspector would be liable in tort and those tort-based damages
would be recoverable. However, when tort-based damages are not
present, the economic loss rule controls.

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