Kalahari Development, LLC v. Iconica, Inc.: Major Clarifications to Wisconsin Law for the Construction Practitioner

WDC Journal Edition: Winter 2012
By: Scott J. Thomsen, W. Wayne Siesennop, & Brent A. Simerson, Siesennop & Sullivan

Introduction

On February 23, 2012, the Wisconsin Court of Appeals issued a published decision in Kalahari Development, LLC v. Iconica, Inc.,[i] which has far-reaching implications for the construction law practitioner. The decision clarifies that there is no “professional services” exclusion to Wisconsin’s economic loss doctrine. That doctrine, which has been the subject of much litigation and numerous appellate decisions over the past decade, limits a plaintiff-owner exclusively to its contractual remedies when the predominant purpose of a contract is to provide a product, rather than a service. Kalahari has broad implications for practitioners of construction litigation and particularly those who have occasion to represent a “design-builder.”

Design-build has emerged as an increasingly popular construction delivery method whereby one entity, the “design-builder,” has a contractual relationship with the owner and is responsible for both design and construction. By contrast, with the “traditional” “design-bid-build” approach, an owner commissions an architect or engineer to prepare drawings and specifications under a design contract and separately selects a contractor by competitive bidding or negotiation to build the project under a separate construction contract.

With the Kalahari decision, a design professional, be it an architect or engineer, who self-performs or subcontracts the work under the design-build method, can now enjoy the benefits of the economic loss doctrine and eliminate unbargained-for tort liability so long as the predominant purpose test is satisfied such that a “product,” as opposed to a “service,” is ultimately being delivered to the owner.

The opinion is equally significant for its clarification of whether Wisconsin’s six-year statute of limitations on breach of contract actions under Wis. Stat. § 893.43 or the ten-year statute of repose for improvements to property embodied in Wis. Stat. § 893.89 controls an owner’s claim for breach of contract related to a construction project. Kalahari now makes clear that the six-year statute of limitations on contract actions trumps the “general ten-year statute of repose covering lawsuits involving improvements to property.”[ii] Prior to the Kalahari decision, there was an air of uncertainty and confusion surrounding this unresolved question.



Background

In May 1999, Kalahari and Iconica entered into a design-build agreement for the design and construction of the “Kalahari Resort & Conference Center” in Wisconsin Dells, Wisconsin.[iii] The contract established a commencement date of December 1, 1998 and a substantial completion date of May 1, 2000. The cost of the work was established by contract to be a lump sum of $26,200,000.[iv] A breakdown of the contract price revealed that roughly four percent was for architectural and engineering services and five percent for the general contractor fee.[v] The balance of the contract price was for payment of subcontractors and materials.

This was a design-build, single-source contract whereby Iconica, identified throughout the agreement as the “Contractor,” would be providing the architectural and engineering services and be contractually obligated to furnish all of the component parts of the building and to perform all of the actual construction work, using its own personnel and subcontractors. The contract also contained a detailed warranty provision under which Iconica warranted its and its subcontractors’ work for defective workmanship and materials for a period of one year from the date of substantial completion.

Substantial completion of the waterpark project occurred in May 2000. Nearly a decade later, on April 23, 2010, Kalahari filed suit against Iconica alleging that beginning in 2008 it discovered substantial moisture damage in the building’s walls stemming from a defectively designed and/or defectively installed vapor barrier. Kalahari asserted causes of action for “professional negligence” and breach of contract. Iconica denied these allegations, affirmatively alleging, among other things, a lack of maintenance.

Kalahari attempted to characterize the claim as one involving “professional” negligent services because of the architectural component of Iconica’s work, based primarily upon the Wisconsin Supreme Court decisions in 1325 North Van Buren, LLC v. T-3 Group, Ltd.,[vi] and Linden v. Cascade Stone Co.[vii] The trial court disagreed, instead concluding that the contract was a “mixed contract,” the predominant purpose being the delivery of a product:

Like the contractors in Linden and 1325 North Van Buren, Iconica did not get paid at an hourly rate. Instead, a fixed price was determined in advance. Just as the Lindens entered into a contract to have a custom house built for them, Kalahari entered into an agreement with Iconica so that Iconica could deliver a finished product that included a water park, hotel, convention center and restaurant.
Because the mixed contract between Iconica and Kalahari was predominantly for the sale of a product, the economic loss doctrine applies. Kalahari did not contend its losses were anything but economic losses. Therefore, as a purchaser of a water park, convention center, hotel and restaurant, Kalahari cannot recover from Iconica on its negligence claim.[viii]

The conclusion that the contract between Iconica and Kalahari was “mixed” in nature with the predominant purpose being for the delivery of a product was affirmed by the Wisconsin Court of Appeals without serious consideration of the “predominant purpose test.”[ix] Like the trial court, the court of appeals had no difficulty concluding that the predominant purpose of the contract was for the delivery of a product—namely, a fully constructed waterpark resort and convention center.[x] The court of appeals found it significant that when breaking down the contract price, 96% of the contract was not distinguishable from the contracts in Linden and 1325 North Van Buren.[xi]

The true import of the Kalahari decision, at least with respect to the economic loss doctrine analysis, lies in the court of appeals’ pronouncement that there does not exist a professional services exclusion to Wisconsin’s economic loss doctrine and, as a result, architectural and engineering services are indistinguishable from other types of “nonprofessional” services when evaluating the doctrine’s application.



“Professional Services” Exclusion

Kalahari argued both before the trial court and court of appeals that the economic loss doctrine did not bar Kalahari’s “professional” negligence claim against Iconica, irrespective of the outcome of the “predominant purpose test.”[xii] The gravamen of Kalahari’s argument was that, by virtue of the fact that Iconica provided design services as part of its overall contract, Iconica could not benefit from the economic loss doctrine because Iconica had duties “separate and apart from any contractual duties.”

In support of this argument, Kalahari argued that neither Linden nor 1325 North Van Buren involved the purveyance of architectural and engineering services.[xiii] Kalahari also argued that the decisions in Shister v. Patel[xiv] and Insurance Co. of North America v. Cease Electric, Inc.,[xv] supported its position.

In Shister, at issue was what can be classified as “pure” services—namely, real estate brokerage services.[xvi] The court of appeals held that, given the absence of a contract between the buyer and the real estate broker (who listed the property for the sellers), the buyer could maintain a tort claim against the broker and the claim would not be barred by the economic loss doctrine.[xvii]

This was unlike Kalahari, where there was a bargained-for contract, negotiated at arm’s length, between two commercially sophisticated parties, which detailed the parties’ rights and obligations and contained a detailed warranty provision and other provisions which allocated risk. As the supreme court has stated, those factors alone “weigh heavily for the application of the economic loss doctrine.”[xviii]

Concluding that Shister was purely a contract for services and inapplicable to the facts before it involving a “mixed” contract, the court of appeals in Kalahari stated:

Kalahari also relies on our statement in Shister v. Patel … that “[t]he supreme court [in Cease Electric] has specifically stated that the [economic loss] doctrine should not apply to causes of action in tort for professional malpractice.” This wording places an unfortunate emphasis on “professional,” but it was not meant to suggest that the economic loss doctrine never applies when alleged negligence involves professional negligence. Rather, in Shister, we were referencing a situation in which it had already been determined that a contract was for services and, as Cease Electric teaches, this meant that the economic loss doctrine did not bar the tort claim. The pertinent discussion in Shister did not turn on the nature of the services.[xix]

Kalahari also argued that Cease “categorically exempted” professional negligence from the economic loss doctrine.[xx] Refusing to treat some categories of services differently for purposes of the doctrine, the court of appeals reaffirmed that the focus instead is on the predominant purpose of the contract.

This is consistent with the Cease court’s rejection of the notion that the application of the economic loss doctrine stands or falls depending on whether the defendant’s services are considered “professional” or “non-professional.” Refusing to adopt such a distinction, the supreme court in Cease held that to do so would place the court “on a slippery slope of having to decide whether an exception should be made for some or all professional groups.”[xxi]

Indeed, the Cease court criticized the Illinois appellate courts’ erratic and arbitrary development of that state’s economic loss doctrine, which had grown dependent upon creating an “exception of the month” for “professional services.”[xxii] The Cease court quoted the “lament” of one Illinois Supreme Court justice, who complained in dissent that attempting to draw such fine distinctions placed “trial judges and litigants in the unenviable position of guessing which additional professions will receive protection under the [state’s] economic loss doctrine.”[xxiii] Refusing to follow the Illinois Supreme Court down this path, the Wisconsin Supreme Court rejected any distinction between professional and non-professional services within the context of the economic loss doctrine, concluding that “[t]his bright line rule will limit the uncertainty and increased litigation that would accompany any other decision.”[xxiv]



Statute of Limitations on Contract Actions vs. Builders’ Statute of Repose

The Kalahari opinion also sought to resolve ambiguity in the language and structure of Wis. Stat. § 893.89, commonly referred to as the Builders’ Statute of Repose.[xxv] In general, the Builders’ Statute of Repose requires that any claims against owners, builders, and design professionals relating to an improvement to property must be brought within ten years of substantial completion of such improvement. [xxvi] However, the Builders’ Statute of Repose also directs that, if a statute of limitations applicable to the damages bars the claim before the repose period ends, then that statute of limitation acts to bar the claim.[xxvii]

At first glance, there is no apparent doubt that the six-year statute of limitations for actions on contract, Wis. Stat. § 893.43, would apply to bar Kalahari’s breach of contract claim rather than the longer, ten-year Builders’ Statute of Repose. However, Kalahari argued before both the trial court and the court of appeals that the language and structure of the Builders’ Statute of Repose precluded this straightforward interpretation. First, Kalahari noted that only those statutes of limitations applicable to “damages” may bar claims prior to the end of the repose period.[xxviii] Because Wis. Stat. § 893.43 bars only “causes of action,” Kalahari contended, it is not the type of statute of limitations contemplated by the Builders’ Statute of Repose to bar claims prior to the end of the repose period.

The court of appeals dispatched this argument by simply noting that Kalahari was seeking monetary damages from a breach of contract.[xxix] Specifically, Kalahari sought damages for the repair of the water damage incurred at the water park. The court of appeals was careful to note that, for a statute of limitations which differentiates between the types of remedies sought, whether or not the claimant seeks damages may lead to different outcomes.[xxx] In other words, a shorter statute of limitations period that does not apply to a damages remedy may not bar a claim prior to the ten-year repose period under the Builders’ Statute of Repose.

Kalahari next contended that the ten-year statute of repose would apply, as opposed to a shorter limitations period, if the property damage occurred within three years of the expiration of the ten-year repose period.[xxxi] Kalahari’s argument stemmed from the confusing structure of Wis. Stat. § 893.89(3). In relevant part, this subsection states:

(3)

(a) Except as provided in pars. (b) and (c), if a person sustains damages as the result of a deficiency or defect in an improvement to real property, and the statute of limitations applicable to the damages bars commencement of the cause of action before the end of the exposure period, the statute of limitations applicable to the damages applies.
(b) If, as a result of a deficiency or defect in an improvement to real property, a person sustains damages during the period beginning on the first day of the 8th year and ending on the last day of the 10th year after the substantial completion of the improvement to real property, the time for commencing the action for the damages is extended for 3 years after the date on which the damages occurred.
. . .

The confusion lies in the legislature’s use of the phrase “[e]xcept as provided in pars. (b) and (c)” in the first sentence of Wis. Stat. § 893.89(3)(a). Under Kalahari’s interpretation of the statute, a shorter statute of limitations would not bar a claim prior to the expiration of the ten-year repose period if the claimant sustained damages within three years of the repose period’s termination. Kalahari contended that its water park did not sustain water damage until after the seventh year; therefore, Kalahari maintained that the six-year statute of limitations under Wis. Stat. § 893.43 did not apply.[xxxii] The court of appeals refused Kalahari’s interpretation, instead concluding that the expiration of a shorter statute of limitation period acts to bar a claim regardless of when damage is discovered under the Builders’ Statute of Repose.[xxxiii]

Iconica demonstrated to both the trial court and court of appeals that interpreting Wis. Stat. § 893.89(3)(b) to be an exception to Wis. Stat. § 893.89(3)(a)—despite seemingly clear language to this effect—would lead to absurd and unfair results. Indeed, a contrary interpretation would disadvantage both plaintiffs and defendants. As to plaintiffs, a claimant who sustained damage after a shorter statute of limitations had expired but before the beginning of the eighth year would be out of luck while a similarly situated claimant who sustained damage after the beginning of the eighth year would be free to bring its claim.[xxxiv] As to defendants, a defendant, who has a constitutionally and statutorily protected right to rely on the expiration of statutes of limitations, may have to defend claims merely because they happen to fall within the final three years of the repose period.[xxxv] Neither of these consequences is consistent with the purpose of the Builders’ Statute of Repose, and the court of appeals correctly declined to render such an interpretation.



Conclusion

The Kalahari decision will have immediate ramifications for the construction industry and its ever-growing segment of “design-builders.” As always, attorneys should impress upon their clients the need for a written contract. This is especially true for design-builders. As the Kalahari decision teaches, it is important that the design-build contract clearly delineate the architectural and engineering components, and associated costs, from the construction aspect of the project. This will aid a court in application of the economic loss doctrine’s “predominant purpose” test should that ever become necessary.

For both builders and attorneys alike, the decision also reconciles the tension between the Builders’ Statute of Repose and other applicable statutes of limitations. The court of appeals reaffirmed that the Builders’ Statute of Repose protects against the potential for unlimited tort liability in construction matters, while statutes of limitations protect builders against stale claims. Despite being presented with unclear statutory language, the court of appeals chose an interpretation of the Builders’ Statute of Repose which avoided unreasonable results and preserved the separate purposes underlying the statutes. The Kalahari decision is instructive to both courts and practitioners as to the importance of statutory interpretation and construction.


[i] Kalahari Development, LLC v. Iconica, Inc., 2012 WI App 34, 340 Wis. 2d 454, 811 N.W.2d 825.

[ii] Id., ¶ 1.

[iii] Id., ¶ 2.

[iv] Id., ¶ 2.

[v] Id., ¶ 30.

[vi] 2006 WI 94, 293 Wis. 2d 410, 716 N.W.2d 822 (renovation of an industrial warehouse into a 42-unit condominium project).

[vii] 2005 WI 113, 283 Wis. 2d 606, 699 N.W.2d 189 (construction of a single family residence).

[viii] February 8, 2011, written decision and order by the Sauk County Circuit Court, the Honorable Patrick Taggart presiding.

[ix] Kalahari, 340 Wis. 2d 454, ¶ 33 (“We conclude this part of our discussion with two related observations. First, we acknowledge that a predominant purpose test analysis normally involves the application of that multi-factor test to particular facts. We do not engage in this exercise here because it would be a pointless endeavor. Given Kalahari’s failure to present a persuasive reason why the result here should be different than the results in Linden and 1325 North Van Buren, it necessarily means that an analysis of the individual factors would produce the same result.”).

[x] Id., ¶ 32.

[xi] Id., ¶ 30.

[xii] Id., ¶ 35 (“Relying on Insurance Co. of North America v. Cease Electric Inc., 2004 WI 139, 276 Wis. 2d 361, 688 N.W.2d 462, Kalahari asserts that tort actions that include an allegation of professional negligence are categorically exempted from the economic loss doctrine, regardless of the predominant purpose of the contract. Kalahari asserts that applying the economic loss doctrine to bar Kalahari’s negligence claim conflicts with Cease Electric because that case teaches, in Kalahari’s words, that the doctrine 'was never meant to bar tort claims for malpractice against professionals such as architects'”).

[xiii] Id., ¶ 29.

[xiv] 2009 WI App 163, 322 Wis. 2d 222, 776 N.W.2d 632.

[xv] 2004 WI 139, 276 Wis. 2d 361, 688 N.W.2d 462

[xvi] Shister, 322 Wis. 2d 222, ¶ 2.

[xvii] Id., ¶ 14.

[xviii] 1325 North Van Buren, LLC, 293 Wis. 2d 410, ¶ 28 (citing Van Lare v. Vogt, Inc., 2004 WI 110, ¶ 21, 274 Wis. 2d 631, 683 N.W.2d 46, and stating, “[c]onsidering the [sophistication of the parties and the bargained-for contract], this case seems ‘tailor made for the application of traditional contract law’”).

[xix] Kalahari, 340 Wis. 2d 454, ¶ 37.

[xx] Id., ¶ 35.

[xxi] Id., ¶ 50.

[xxii] Cease, 276 Wis. 2d 361, ¶¶ 50-51.

[xxiii] Id., ¶ 51 (quoting Congregation of the Passion v. Touche Ross & Co., 636 N.E.2d 503, 525 (Ill. 1994)).

[xxiv] Id., ¶ 52.

[xxv] Kalahari, 340 Wis. 2d 454, ¶ 7.

[xxvi] Wis. Stat. § 893.89(1) and (2). Iconica also contended in an alternative argument that the plain language and legislative history of the Builders’ Statute of Repose did not support its application to non-tort claims. Cf. Cianciola, LLP v. Milwaukee Metro. Sewerage Dist., 2011 WI App 35, ¶ 15, 331 Wis. 2d 740, 796 N.W.2d 806. The statutory language refers only to contribution claims, indemnification claims, and claims “to recover damages for any injury to property, for any injury to the person, or for wrongful death.” Wis. Stat. § 893.89(2). Further, the Wisconsin Supreme Court stated that the Builders’ Statute of Repose was “passed out of a concern that groups were reluctant to participate in state-sponsored construction projects because of the limited period of protection offered by state-purchased insurance coverage and the potential for unlimited tort liability past the end of such coverage.” Kohn v. Darlington Cmty. Sch., 2005 WI 99, ¶ 61, 283 Wis. 2d 1, 698 N.W.2d 794 (emphasis added). In light of Wis. Stat. § 893.89(3), the court of appeals declined to address this argument.

[xxvii] Wis. Stat. § 893.89(3).

[xxviii] Kalahari, 340 Wis. 2d 454, ¶ 12.

[xxix] Id., ¶¶ 12-13.

[xxx] Id., ¶ 14.

[xxxi] Id., ¶ 15.

[xxxii] Id., ¶ 18.

[xxxiii] Id., ¶ 19.

[xxxiv] Id., ¶ 20.

[xxxv] See Wis. Stat. § 893.05; Aicher v. Wis. Patients Comp. Fund, 2000 WI 98, ¶ 27, 237 Wis. 2d 99, 613 N.W.2d 849 (“Defendants have a constitutional right to rely upon statutes of limitations to limit the claim against them.”).