Vol. 82, No. 4, April 2009
hether the economic loss doctrine (ELD) acts to prevent contract law from “drowning in a sea of tort” or actually drowns tort jurisprudence in a “sea of contract,” the ELD now clearly applies to the purchase and sale of residential real estate in Wisconsin.1 In July 2008, the Wisconsin Supreme Court applied the ELD in Below v. Norton to bar a homebuyer’s intentional misrepresentation claim against a seller for the seller’s alleged failure to disclose a defect in a real estate condition report (RECR).2
As a result of the Below decision, a seller who misrepresents the condition of a home – even intentionally – can hide behind the ELD to avoid liability in tort. Even so, homebuyers may not be left without a remedy. In addition to a recent effort to legislatively overturn Below, breach of contract, false advertising, and theft-by-fraud claims provide some teeth to keep sellers honest.
The Economic Loss Labyrinth
Deciphering Wisconsin’s ELD is no small task. While the heart of the doctrine is relatively simple – to keep parties from circumventing a product’s contract or warranty terms by suing in tort for purely economic loss – Wisconsin’s application of the ELD is anything but straightforward. Since adopting the ELD in 1989,3 the Wisconsin Supreme Court has revisited the judicially created doctrine more times than any other state.
Courts first applied the ELD as a limit on tort claims in product liability cases, in which the Uniform Commercial Code and law of warranty historically provided remedies for purely economic loss caused by defective products.4 The doctrine is based on the premise that “contract law and the law of warranty, in particular, is better suited than tort law for dealing with purely economic loss in the commercial arena.”5
The core idea behind the doctrine is illustrated by the case that made it law in Wisconsin. In Sunnyslope Grading Inc. v. Miller, Bradford & Risberg Inc., the Wisconsin Supreme Court held the ELD barred negligence and strict liability claims for lost profits and repair costs incurred by a commercial party after a backhoe it purchased broke down.6 In that case, the backhoe’s warranty explicitly limited the manufacturer’s liability to the replacement of defective parts. As a result of the ELD, a commercial party was not allowed to make an end-run around a warranty by suing in tort for costs a warranty specifically excluded.
Despite the principled origins articulated in Sunnyslope, the ELD was considerably expanded over the next two decades. In recent years, the doctrine made its way into cases involving real estate transactions.
The ELD Reaches Real Estate. Before the Wisconsin Supreme Court took a position, several Wisconsin court of appeals and federal court decisions applied the ELD to commercial real estate transactions.7 According to the Wisconsin Court of Appeals, the application of the ELD should not be forgone simply because the “product” in question is real estate.8
In 2004, the Wisconsin Supreme Court took up the issue but declined to clarify whether the ELD would extend to all real estate transactions.9 Instead, the court limited its application of the doctrine in Van Lare v. Vogt to a written, bargained-for contract for the sale of commercial land between two sophisticated parties represented by counsel.10 In Van Lare, the court held that the ELD barred a strict liability misrepresentation claim in a situation in which a buyer discovered the gravel pit it purchased was previously used as a dump for construction debris. Van Lare began to make it clear that in most cases, a buyer’s remedy for a seller’s misrepresentation in a commercial real estate transaction would not lie in tort.
Three years later, the ELD snuck into a noncommercial real estate transaction involving an option to purchase farmland. In Wickenhauser v. Lehtinen, although no party contended the doctrine applied, the court articulated how its decision in an election-of-remedies case was consistent with a narrow, fraud-in-the-inducement exception to the ELD.11
When fraud occurs that is “extraneous to” rather than “interwoven with” a contract, a party may bring an intentional misrepresentation claim as an exception to the ELD.12 Stated another way, the exception only applies when “the fraud concerns matters whose risk and responsibility did not relate to the quality or the characteristics of the goods for which the parties contracted.”13 In real estate transactions, the exception is unavailable to buyers who claim a seller misrepresented the condition of property in a real estate purchase contract.
Contracts for Construction of Products. Although the ELD applies to contracts for the purchase and sale of products, it does not apply to contracts for services.14 By limiting its application in this way, the court removed the potential for professional service providers to avoid liability for malpractice but left many people wondering how construction contracts would be treated.
Lucas N. Roe, U.W. 2008 cum laude, is a real estate associate with Reinhart Boerner Van Deuren s.c., Milwaukee.
In 2005, the court applied a predominant-purpose test to determine in Linden v. Cascade Stone Co. that a contract for constructing a home was one primarily for a product – a house.15 Although the Linden court applied the ELD to bar negligence claims for faulty construction, the court did not characterize the case as one involving real estate.16 Linden may have foreshadowed the application of the ELD to residential real estate transactions, but it was not entirely clear that a case interpreting a contract for constructing a home would automatically bring residential real estate sales within the scope of the ELD. This is especially true because Linden did not once mention the phrase “real estate.”
The court’s first hint that Linden was intended to apply the ELD to residential real estate actually came as a footnote to Wickenhauser. There, the majority characterized Linden by stating, “[I]n a recent case … we concluded that a contract to construct residential real estate was subject to the economic loss doctrine.”17 While the seed was planted in Wickenhauser, it continued to grow in Below v. Norton.
Extending the Maze to Residential Real Estate Transactions
The court’s decision in Below rested on facts that every homebuyer hopes to avoid. Soon after moving into her new house, Shannon Below learned the sewer line running between her home and the street was broken. A property condition report executed by the seller before the sale did not disclose any defect with the home’s plumbing system, except for a problem with a bathtub drain handle.
Procedural History. Below filed claims against the seller for 1) intentional misrepresentation, 2) strict responsibility misrepresentation, 3) negligent misrepresentation, 4) misrepresentation in violation of Wis. Stat. section 100.18 (false advertising), and 5) misrepresentation in violation of Wis. Stat. sections 895.446 and 943.20(1) (theft by fraud). Below also brought a breach-of-contract claim in an amended complaint, but this claim was dismissed by the circuit court and court of appeals because it was not properly filed and served.
The circuit court held that each of Below’s common-law tort claims was barred by the ELD, and each of the statutory claims was inapplicable under the facts of the case. The court of appeals largely affirmed the decision, but it held Below’s section 100.18 claim for false advertising was not barred by the ELD and remanded this claim to the circuit court.18 On petition for review, Below conceded that the ELD barred her common-law strict responsibility and negligent misrepresentation claims.
In its decision, the supreme court remanded Below’s statutory theft-by-fraud claim to the circuit court to clearly articulate why it was dismissed.19 In doing so, the supreme court emphasized that the claim was not barred by the ELD and directed the circuit court to review Stuart v. Weisflog’s Showroom Gallery Inc. In Stuart, the court stated, “We are satisfied that the ELD cannot apply to statutory claims.”20
The only claim left for the supreme court to squarely address in Below was whether the ELD applies to an intentional misrepresentation claim arising out of a residential or noncommercial real estate transaction. On this issue, it held in the affirmative.
The Majority. In a 4-3 decision, the majority concluded that barring common-law claims for intentional misrepresentation in residential and noncommercial real estate transactions was in line with prior decisions that applied the ELD to bar negligence and strict liability claims in cases involving consumer goods,21 recovery of economic losses in intentional misrepresentation cases,22 and strict liability misrepresentation in a commercial real estate transaction.23 The court also relied on its decisions in Linden and Wickenhauser.
Without much explanation, the majority broadly characterized the court’s holding in Linden, stating, “It seems clear that we decided in Linden that the ELD applies to residential real estate transactions.”24 Then, relying on language in Wickenhauser, the majority declined to draw a distinction between residential and noncommercial real estate. Because Linden applied the ELD to residential real estate and Wickenhauser applied it to noncommercial real estate, the court held intentional misrepresentation claims arising out of either type of transaction are barred.
The majority decision emphasized that Below was not left without a remedy. In addition to the breach of contract claim she failed to file properly, Below might still succeed on a section 100.18 claim for false advertising.
The Dissent. As is typical in recent ELD cases, the majority opinion in Below was countered by a spirited dissent that criticized the majority for characterizing its opinion as one compelled by precedent. According to Justice Bradley, the majority articulated an expansion of the doctrine by carefully phrasing Linden.25 The dissent pointed out that Linden originally concerned the construction of a product, and Wickenhauser addressed the ELD even though none of the parties contended it applied.
The Aftermath. Through Below, the majority extended Linden and solidified the application of the ELD to noncommercial real estate transactions. Below thereby signals the court’s willingness to continue expanding the ELD and forces Wisconsin attorneys to wait a while longer for a doctrine “with a well-defined and logical reach.”26
Justice Bradley’s dissent explains why many people may be opposed to applying the ELD to residential real estate transactions: “According to the majority, a person selling a home can look the buyer in the eye, lie about the condition of the home, and escape legal consequences in tort for the lie because of the economic loss doctrine.”27
While in most situations homebuyers will not be left without a remedy, any effect Below does have on residential real estate transactions may be short lived. Recently, 2009 Senate Bill 9 and Assembly Bill 6 were introduced into the legislature. If enacted, the legislation would specifically overturn Below by allowing a tort action for fraud or intentional misrepresentation in those real estate transactions requiring an RECR. [Note: At press time, both the Senate and the Assembly had passed the legislation.]
Although, as currently written, the legislation would not exempt residential real estate transactions from the ELD (strict responsibility misrepresentation and negligent misrepresentation claims would remain barred by the ELD) or apply to claims arising from construction of a home (as in Linden), it may create a more appropriate fraud-in-the-inducement exception in residential real estate transactions.
Representing Misled Homebuyers After Below
Despite application of the ELD to residential real estate transactions, several statutory and contractual remedies remain to provide relief in most cases in which a seller misrepresents the condition of property. Misled homebuyers may continue to pursue claims for 1) breach of contract, 2) theft by fraud under Wis. Stat. sections 943.20(1)(d) and 895.446, and 3) false advertising under Wis. Stat. section 100.18.
Breach of Contract. A buyer who discovers a defect in a home after closing may bring a breach of contract claim against the seller if relevant representations appeared in the WB-11 Residential Offer to Purchase. To be successful, the buyer must prove, within six years of the breach, 1) an affirmation of fact, 2) inducement to the buyer, and 3) reliance by the buyer.28
Wisconsin law requires most sellers of residential property to provide buyers with an RECR, which is incorporated into the WB-11 beginning at line 54.29 In addition to more specific prompts, the RECR requires sellers to state whether they are aware of any “defects affecting the property.” Under Wis. Stat. chapter 709, defect is defined as “a condition that would have a significant adverse effect on the value of the property.”
The merits of a buyer’s breach-of-contract claim will depend on several factual inquiries, including whether there is an actual “condition” affecting or “defect” in the property and whether the seller was “aware” of it. A contract claim also may be affected by the buyer’s decision not to inspect the property.
In Malzewski v. Rapkin, for example, the court of appeals held that a buyer unreasonably relied on a seller’s representation that basement seepage was corrected when the buyer waived the right to have the property inspected.30 By closing a real estate transaction without exercising the right to have the property inspected, a buyer who is aware of, at the very least, “potential defects,” waives his or her right to pursue a contractual warranty claim against the seller based on the RECR.31 Malzewski does not, however, impose a threshold duty on the buyer to inspect the property.32
Theft by Fraud. Wis. Stat. section 895.446 creates a civil cause of action for criminal theft by fraud under section 943.20(1)(d). That section makes it illegal to “obtain title to property of another person by intentionally deceiving the person with a false representation, which is known to be false, made with intent to defraud, and which does defraud the person to whom it is made.” While Below did not directly decide whether statutory theft-by-fraud claims are barred by the ELD, it seems they are not.33
Under section 895.446, a seller in a real estate transaction may be held liable if he or she obtained a buyer’s purchase money by inducing it through a misrepresentation of the property before contract formation.34 If theft by fraud is shown by a preponderance of the evidence, the buyer can recover actual damages, costs, and exemplary damages equal to three times actual damages.35
False Advertising. After Below, homebuyers may continue to bring claims under Wis. Stat. section 100.18 in cases in which a seller makes false representations in the sale of real estate.36 To succeed on a section 100.18 claim, the plaintiff must show: 1) the defendant made a representation to the public with the intent to induce an obligation; 2) the representation was untrue, deceptive, or misleading; and 3) the representation caused a pecuniary loss to the plaintiff.37 Courts interpret section 100.18 to provide a remedy when fraudulent representations are made to even one prospective purchaser.38 If successful in proving such a claim within three years of the violation, buyers can recover any pecuniary loss, along with costs including reasonable attorney fees.39
While Below solidified the application of the ELD to residential real estate transactions, a review of the causes of action that remain for misled homebuyers shows that most homebuyers will not be left without a remedy. Those cases in which adequate remedies do not exist, however, may call into question the expansion of the ELD and the narrow formulation of its fraud-in-the-inducement exception.
Recent legislative efforts respond to concerns that sellers should not escape tort liability for intentional misrepresentations in residential real estate transactions. While it remains to be seen if current efforts will trigger a greater legislative response to Wisconsin’s ELD in general, any such legislation will undoubtedly add another layer of complexity. In the meantime, prudent homebuyers should continue to protect themselves by inspecting the “American dream,” and attorneys should continue to monitor the legislative response to the ELD.