A complex court decision holds that a developer is entitled to recover its losses from the design-builder who employed the engineer and constructed the failed projects.
This article examines a complex case. Where a developer purchased land and constructed hydroelectric facilities in reliance on an engineer's analysis of the financial viability of proposed hydroelectric projects (including an assessment of the energy to be generated by each project as well as the costs of construction), it was entitled to recover its losses for the financially disastrous projects from the design-builder that employed the engineer and constructed the projects.
In Hydro Investors, Inc. v Trafalgar Power, Inc., 227 F3d 8 (2nd Cir 2000), an engineer by the name of Neal Dunlevy wore multiple hats in his dealings with Trafalgar Power, Inc. (TPI), the entity that developed the plants. Mr. Dunlevy was an engineer with Stetson-Harza and also the principal and sole shareholder of Hydro-Investors, Inc. (HII). He approached TPI with the suggestion that hydroelectric plants could be profitably developed in upstate New York. He also suggested that TPI provide the capital to develop the plants and that he, Dunlevy, would contribute the hydroelectric expertise either through Stetson-Harza or HII. As a result of these discussions TPI retained Stetson-Harza and HII to perform work associated with TPI's licensing and possible development of six plants.
TPI entered into a contract with Dunlevy, through HII, calling for TPI to provide the capital while HII would identify sites to be developed. Dunlevy's activities for TPI were not limited to his work thought HII, but included a role as chief engineer of the Water Resources Department at Stetson-Harza.
As part of its effort to obtain project financing, TPI asked Stetson-Harza to prepare an analysis that could be used by potential lenders to evaluate whether to invest in the projects. Included in this analysis was an assessment of projected energy output.
The plants were constructed and, as stated by the court, "have proven to be financial disasters," the primary problems being costs overruns and inadequate energy production. At trial, a jury found Stetson-Harza and Dunlevy jointly and severally liable in the amount of $7.6 million for damages arising out of engineering malpractice.
On appeal, Stetson-Harza and Dunlevy argued the jury's findings of engineering malpractice were unsustainable. They asserted that TPI failed to prove that the alleged acts of malpractice were the proximate cause of its injury, since "negligent measurements of the flow and head at Forestport and Ogdensburg did not cause those plants to generate less energy." Instead, they argued that it was the low head of the river and surrounding terrain that caused the lower energy output.
The appellate court rejected that reasoning as "specious" and concluded: "It was not merely the failure of the plants, based on their physical characteristics, to generate the desired amount of energy that caused TPI's damage. The legal cause of TPI's injury was Dunlevy's failure to adequately convey the realities of Ogdensburg and Forestport with a level of professional care that would have allowed TPI to make its business decisions with respect to those sites based on reasonably reliable technical information."
The court further stated that the physical traits of the sites served only to provide the conditions precedent to the malpractice committed by Dunlevy. To find "proximate cause" does not require that a jury determine that harm was caused solely by one party, but rather requires only that the identified cause be a substantial factor in bringing about the injury."
Having satisfied itself that the jury did not err in finding proximate cause in the actions of Mr. Dunlevy, the court held, "Once the jury was convinced that the minimal standard of professional care was not met in this case, the proximate cause of TPI's injury could easily be construed to be the carelessness of Dunlevy, and through the doctrine of respondeat superior, his employer, Stetson-Harza."
Stetson-Harza and Dunlevy argued on appeal that TPI should not have been permitted to recover "lost revenues" since the "economic loss rule" applies in New York. Under that rule, they argued that even if the evidence supported a finding of professional malpractice, the damages awarded were of the type that arise out of breach of contract rather than compensatory damages customarily awarded in tort (negligence) actions.
The basic rule in New York is that where there is no property damage or personal injury, pure economic losses may not be recovered in a negligence action. Only a party in contract with another can seek such purely financial losses, and the recovery is restricted to an action in contract.
In this case, the court concluded that the economic loss rule would not be applied to bar the damages. It held, "While we recognize that some cases have applied the economic loss rule to bar recovery where the only loss claimed is economic in nature [ ], and still others have applied that rule to professional malpractice cases [ ], the better course is to recognize that the rule allows such recovery in the limited class of cases involving liability for the violation of a professional duty. To hold otherwise would in effect bar recovery in many types of malpractice cases."
On two of the other hydroelectric plants that were at issue, the trial court dismissed TPI's causes of action for breach of contract and malpractice. TPI cross-appealed that aspect of the trial court's judgment. The appellate court affirmed the judgment because TPI had presented no expert evidence concerning professional malpractice at the two sites and consequently the claims lacked proof.
On the question of breach of contract, the court said that TPI's service contracts with Stetson-Harza and Dunlevy did not include a contractual guarantee that any particular site would produce a particular amount of energy. TPI failed to prove any contract breach for those two facilities.
Dunlevy and HII argued that the trial court erred in allowing evidence of alleged conflict of interest between Dunlevy's duties as an employee of Stetson-Harza and as an owner of HII. They argued that this was highly prejudicial. The appellate court stated that the trial court had broad discretion to admit such evidence.
Another interesting claim that TPI brought against Stetson-Harza and Dunlevy was based on negligent misrepresentation. The trial court dismissed that claim, and the appellate court affirmed the trial court's decision. The basis for the claim was that Stetson-Harza and Dunlevy misrepresented the energy that would be generated from the plants. The trial court found that the alleged misrepresentations related to future events and were promissory in nature rather than factual, and could not support a claim for negligent misrepresentations.
The appellate court agreed, holding, "In the present case, the negligent misrepresentation claim fails because the energy output predictions were mere promises of future output as opposed to present representations of existing fact." But even if they had made representations sufficient to support a claim, the court stated that TPI's claim would fail for lack of reliance on the alleged representations since TPI possessed adequate knowledge that the project's financial success was unlikely and, in any event, "should have known not to rely on the energy output estimates."
There are several things to learn from this complex case. A design professional may be subject to claims for consequential damages, including lost profits, even in the absence of property damages or personal injury. State law varies on whether the economic loss rule bars recovery for such damages.
Agreements between the parties should specifically address the risks and liabilities to be accepted by each party. Waivers of consequential damages, limitations of liability and similar clauses may be used to better define the commercial relationship between the parties and enable the parties to evaluate whether the risk-to-reward ratio is reasonable.
Caution should be exercised in permitting one individual to serve more than one entity. The question of alleged conflict of interest was apparently raised to the jury in this case and, according to Dunlevy and Stetson-Harza, caused prejudice and harm to their position. It is also interesting to note that despite the lack of performance guarantees, and the fact that the court did not allow the cause of action for negligent misrepresentation to go forward, TPI was able to recover its financial loss on the basis of professional malpractice. From an insurance perspective, this may be a preferable result since a professional liability policy for a design professional would have excluded recovery for losses arising out of non-negligent breaches of warranties and guarantees.
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