Colorado Supreme Court weighs punitive damages in contract breach cases

The Colorado Supreme Court is currently considering whether business disputes are limited to contractual remedies or whether liability can expand through the use of fraud claims. Whichever way the court decides, there will be new challenges for businesses.

Businesses will either have to contend with expanded liability or face reduced ability to pursue remedies when facing injustice. A few precautions, however, can turn that uncertainty into an opportunity.

Veolia Water v. Antero is a dispute over the design and construction of a hydraulic fracturing wastewater treatment plant. The contract required a design that would create dry waste that could be disposed of in a landfill while using less than a set amount of power. During the project, the designer proposed a modification to reduce power consumption without disclosing concerns that the design change could cause the resulting waste to be too moist for landfill disposal. The owner approved the change and construction proceeded.

Upon completion, the parties discovered that, in fact, the waste was not sufficiently dry for landfill disposal. The owner claimed fraud in the designer’s failure to disclose its concerns about the modification. The parties’ contract limited damage to 60% of the project cost except in cases of gross negligence, fraud or willful misconduct.

The trial court found in favor of the owner and determined that the contractual damages limitation did not cap damages because of the allegations of fraud. That decision was not preordained, however, and may not be correct because of a legal doctrine called the economic loss rule.

The economic loss rule limits parties to a contract to contractual remedies. In doing so, it precludes punitive damages and other increased penalties that can come from non-contractual claims (i.e., “tort” claims, such as fraud). Although the economic loss rule is the law in Colorado, there is a divergence in Colorado Court of Appeals cases on whether it applies. The trial court did not apply the economic loss rule.

On appeal, the Colorado Court of Appeals acknowledged that its prior decisions both applied and refused to apply the economic loss rule and then affirmed. It did so, however, in a third way, finding that the economic loss rule could apply in this situation, but did not apply because the designer did not have discretion on the breached requirement.

The Colorado Supreme Court held an argument last week and is now considering how to rule. It could determine that economic loss rule does not bar intentional tort claims in Colorado (something it suggested in a prior decision), or that the rule does bar intentional torts, or that the rule doesn’t apply under particular circumstances (as the appellate court decided).

However, the Supreme Court ruled that the ruling would change the environment for those doing business in Colorado. If the court rules that the economic loss rule precludes tort claims, that reduces potential liability, but also could incentivize misrepresentations. On the other hand, a decision allowing tort claims to go forward despite contracts makes liability less predictable.

In Veolia, the designer thought it had negotiated for a cap on its potential liability, which the current ruling has undone. If the Colorado Supreme Court chooses to apply the economic loss rule in specified circumstances, that could create unexpected loopholes in contractual relationships. Parties will have to deal with the new understanding while in the middle of their undertakings.

Because of the Court of Appeals’ different approaches, businesses and individuals face a somewhat uncertain future in their contractual relations until the Colorado Supreme Court rules. Thereafter, a ruling will likely upset at least some settled expectations. It is, however, possible to ward against disruption.

First, a clear contract can allocate the risks. Parties wishing to exclude tort damages (or specifically allow for them) can make that express in their agreements.

Second, regardless of the law, the designer would have been in a better position had it disclosed its concerns about the redesign. A clear disclosure is everyone’s friend.

Third, whichever way the court rules, parties who are aware of the ruling can renegotiate their relationships in light of the law, as appropriate. Being forewarned in this situation is being forearmed.

Adam Lyons, shareholder with Brownstein Hyatt Farber Schreck, leverages his experience in consumer protection enforcement to handle complex commercial litigation, encompassing matters related to fraud, contracts and employment. His experience leading high-stakes trials at the Department of Justice and conducting investigations at the Consumer Financial Protection Bureau enables him to understand the inner workings of government agencies and to bring civil and criminal actions against companies.