Subrogee Fails To Establish Third-Party Beneficiary Status Of Subrogor

By Don R. Sampen, published, Chicago Daily Law Bulletin, June 1, 2021

The 1st District Appellate Court recently held that a property insurer lacked subrogation rights because its insured property owner-landlord was not a third-party beneficiary of contracts pursuant to which allegedly faulty work on the insured’s property was being performed, and the damages being sought were barred by the economic loss doctrine.

The case is Harleysville Insurance Co. v. Mohr Architecture, 2021 IL App (1st) 192427 (April 27). The insurer, Harleysville, was represented by Thompson Brody & Kaplan LLP of Chicago. A number of firms represented the defendant contractors, including Gordon Rees Scully Mansukhani LLP; the Cincinnati Insurance Company staff counsel; SmithAmundsen LLC; Karbal Cohen Economou Silk & Dunne LLC; and Foran Glennon Palandech Ponzi & Rudloff PC, all of Chicago.

The insured, Navigant Development LLC, owned property in Chicago on which two separate tenants completed separate renovations. One tenant, Old Town Entertainment LLC, renovated the property in 2008-09 to operate a restaurant on the premises. It hired an architect firm, an engineering firm, and another contractor to maintain and repair trusses during the renovation.

A second tenant, Bottleneck Wells LLC, performed renovations in 2011-12, again to operate a restaurant. It hired a general contractor and an architectural design firm, the latter of which hired an engineering firm.

According to Harleysville, the various contractors knew that Navigant was the owner, and the leases with the tenants required Navigant’s approval for the work to be done.

In 2016, Navigant or Bottleneck discovered that the property’s ceiling was sagging, and that several trusses supporting the roof and ceiling were bowed or damaged. Pursuant to its policy, Harleysville then paid Navigant $870,000 for the damage to the trusses and lost rent.

In 2018, Harleysville, as subrogee, brought this suit claiming that improper work during either one or both the renovations damaged the trusses. It further claimed that Navigant was an intended third-party beneficiary under the contracts the tenants entered into with the contractors, because the contractors knew the work was to be performed on Navigant’s property. It thus sought recovery for breach of contract. In addition, Harleysville alleged that the work, being negligently performed, caused damage to the trusses, which was a second basis for recovery.

Navigant named as defendants the various contractors involved with the work, and all the defendants filed motions to dismiss and/or a motion for summary judgment as to substantially all the claims. The trial court granted the motions, and Harleysville took this appeal.

Third-Party Beneficiary Claim

In an opinion by Justice Terrence J. Lavin, the 1st District affirmed. He began by addressing the breach of contract claims and some of the principles relating to third-party beneficiaries. He pointed out, for example, that absent privity of contract, an owner of real property cannot sue for breach of contract unless it can show the contracting parties undertook duties and obligations for the owner’s direct benefit. Although unnecessary for the contract to specifically name the third-party beneficiary, it must at least define a class of individual beneficiaries that would include the plaintiff.

As to construction contracts in particular, Lavin wrote, it is insufficient for the contracting parties to merely know, expect, or intend that others will benefit from the construction. Rather, the contract must specifically reference obligations to the owner, and a presumption exists that no third-party benefit was intended.

In this case, Lavin examined the terms of each of the contracts entered into by the defendants and found no evidence of a benefit to be conferred upon Navigant. Harleysville argued that some of the contracts at least required approval by Navigant, but Lavin observed that, even if the leases so required, such a provision was not incorporated into the construction contracts. Some contracts also referred to “owner,” but that terms always appeared to refer to one of the two contracting parties, not Navigant.

As a result, Lavin found that Harleysville’s claim for third-party-beneficiary enforcement rights failed.

Economic Loss Doctrine

He then turned to negligence claim and analyzed it in the context of the economic loss doctrine. That doctrine denies a tort remedy for claims rooted in the disappointment of commercial or contractual expectations. The doctrine denies recovery in tort for inadequate value, the cost of repairing or replacing a defective product, or resulting lost profits, excluding any claim for personal injury or property damage caused by the defective work or product.

Lavin further explained that the doctrine precludes recovery in tort particularly where a service provider’s duties are defined by contract. It does not bar recovery where a defendant breaches a duty that existed independently of a contract. However, the inability to succeed in contract does not in and of itself prevent application of the doctrine.

In this case, Lavin wrot, Navigant could have negotiated for a term requiring its tenants to ensure that Navigant had express contractual rights in any renovation contract. But that did not occur, and the negligence claims currently being asserted were clearly based on commercial expectations. Had the defendants caused damage to Navigant’s existing property, the circumstances would be different. Lavin also found that Harleysville failed to explain how the defendants’ relationship with Navigant created an independent duty in tort.

The 1st District therefore affirmed in favor of the defendants, finding no third-party beneficiary relationship and that the tort claims were barred by the economic loss doctrine.

Key Points

A subrogee seeking to enforce a third-party beneficiary claim of the subrogor must establish that the subrogor was an intended beneficiary of the contract sought to be enforced.

The economic loss doctrine bars recovery in tort for economic losses not involving personal injury or damage to other property caused by the defective work or product.