Limiting the Reach in Tennessee

Economic loss doctrine did not prevent recovery of fraud damages arising from breach of construction contract

December 19, 2023 Photo

The Tennessee Supreme Court recently issued an important opinion in Commercial Painting Inc. v. The Weitz Company LLC that limits the application of the economic loss doctrine to only certain product liability cases, rejecting the Court of Appeals’ expanded application of this doctrine to breach-of-services contracts.

Consequently, parties aggrieved by a breach-of-services contract may be able to recover “tort” damages that are typically prohibited by the plain language of the parties’ contract. Such tort damages may include consequential, incidental, and punitive damages. Left unresolved, however, is where the line is now drawn between enforceable damage-limitation provisions and exposure to potentially eye-popping tort liability in services contracts.

For years, there has been uncertainty in Tennessee state and federal courts as to whether sophisticated parties to services contracts, where contracts prohibit either party from recovering tort damages, are actually limited to the damages provided in the contract. The court in Commercial Painting—which involved a dispute between a general commercial contractor and its drywall-subcontractor related to a 93-page contract governing a $3.5 million job—held that damages may not be so limited by the parties. To do so would risk “the economic loss doctrine [shallowing] much of tort law[.]”

Economic Loss Doctrine Background

Since 2009, in Lincoln General Ins. Co. v. Detroit Diesel Corp., 293 S.W.32 487 (Tenn. 2009) Tennessee courts have explicitly recognized the economic loss doctrine in product liability actions. The doctrine holds that when the only damages arising from a contractual relationship are economic damages (i.e., the plaintiff did not suffer personal injury or injury to other property), the plaintiff does not have an action in tort.

Following U.S. Supreme Court precedent, the Tennessee Supreme Court observed that when a defective product creates a dangerous condition but damages only itself (not causing personal injury or damage to other property), the product’s owner is in the same situation as if they had just simply not gotten the benefit of their bargain and the remedy should be based in the parties’ contract, not the law of torts. This simplifies the dispute and limits the potential damages. The thought goes that it helps the parties to better allocate the risks of their transaction and would prevent risk-inflated prices.

The “economic loss” doctrine, however, can be mind-numbingly confusing. Sometimes it applies to a dispute and prevents a plaintiff from recovering tort damages. Sometimes it does not and defining the line between when tort damages are recoverable and when they are not is complicated, to say the least. The doctrine has led to a number of “permutations,” making it a “confusing morass” (according to the court) and difficult not only to understand, but also for courts to apply.

Along with the growth of actions subject to the economic loss doctrine, so too has grown the number of exceptions, perhaps most notably is the fraud exception. This exception roughly holds  that fraud claims are an exception to the economic loss doctrine because the duty not to commit fraud is independent of any contractual duty. But the approach previously adopted by the Tennessee Supreme Court applies the limited fraud exception, which permits only claims of fraud that are “extraneous to, rather than interwoven with, the contract.”

Under Tennessee law, if the fraud is an inducement to the contract and relates to the “quality or character of the goods sold,” then tort damages for fraud are recoverable. But, what happens if the fraud occurs during the performance of the contract? In 2022, the Tennessee Court of Appeals in the underlying Commercial Painting case held that the economic loss doctrine applied to the construction contract (a services agreement) negotiated between two sophisticated commercial entities.

The appellate decision held that fraud occurring during the contract about material terms of the contract (time, duration, and scope) did not undermine the parties’ limitation on damages for breach of contract. As such, the Tennessee Court of Appeals expanded the economic loss doctrine to include “services” contracts (as well as goods contracts). The Tennessee Supreme Court overruled.

Supreme Court Reasoning in Commercial Painting

In Commercial Painting, the contract provided that “in no event” would the general contractor have to pay any special or consequential damages, and that the subcontractor waived “any claims in quantum meruit, interest on late payments” or any other measure of damages.

But a jury ultimately awarded the subcontractor $1.7 million in compensatory damages and an additional $3.9 million in punitive damages under several theories including unjust enrichment and intentional misrepresentation/fraud. The trial court awarded $2 million in pre-judgment interest and another $1 million in costs and attorney’s fees. Overall, the award ballooned to nearly $8.4 million.

Parsing a 2021 Tennessee Supreme Court opinion, Milan Supply Chain Solutions Inc. v. Navistar Inc., 627 S.W.3d 125 (Tenn. 2021) and relying on non-Tennessee cases, the Tennessee Court of Appeals applied the “economic loss” doctrine limiting the subcontractor’s recovery and reversing portions of the trial court’s ruling. The Court of Appeals specifically refused to apply the exception for fraud to permit Commercial Painting to recover more than its economic loss.

In a gentle rebuke to the Court of Appeals, the Tennessee Supreme Court in Commercial Painting chastened that, in Milan, “We indicated no interest in expanding the economic loss doctrine beyond the products liability context.”

The unmistakable ruling is that, in a non-product liability context, an aggrieved party to a breached services contract might be able to collect much more than contract damages permitted under the parties’ agreement.

The Tennessee Supreme Court in Commercial Painting has plainly limited the application of the economic loss doctrine to product liability/goods contract cases where there is no personal injury and the good did not damage other property. As a result, it has made plain that commercial contracts for services that purport to exclude recovery of incidental, consequential and punitive damages may not actually exclude the recovery of such damages by the defrauded  party.

The message from the court seems to be that, despite the attempts of parties to contractually limit damages and claims, parties to services contracts should pay close attention to their limitation of damages (and other contract provisions) in light of Commercial Painting and make plain whether there are any circumstances such as fraud, gross negligence, or negligence when the limitation of damages provision should be ignored.

Contracting parties should be mindful that Commercial Painting arose in the context of fraud/intentional misrepresentation. It did not specifically address whether negligence or gross negligence in the performance of a services contract would undo a limitation of damages provision in a services contract. Contracting parties should proceed with caution and weigh the risks in each particular agreement of where they draw line between a breach of contract and a tort claim. How commercial entities will respond to this newly reopened avenue of litigation is yet to be seen.

About The Authors
Multiple Contributors
Cannon Allen

Cannon Allen is a partner in the Memphis office of Adams and

John Woods

John Woods is an associate in the Memphis office of Adams and Reese.

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