Wisconsin: Beware of the “Economic Waste” Doctrine and Its Potential to Limit Your Recovery in Breach of Contract Cases

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The United States Bankruptcy Court for the Northern District of Illinois recently held the “economic waste” doctrine, as applied in Wisconsin, prevented a property owner from recovering the costs to repair a structure on its property even though the court found the structure was defectively designed. This decision spotlights a significant barrier parties aggrieved by a breach of contract could face when pursuing construction or design defect cases.

In WTE-S&S Ag Enterprises, LLC v. GHD, Inc. n/k/a DVO, Inc., — B.R. – (2017), No. 16 A 00400, 2017 WL 3600401 (August 18, 2017), WTE-S&S Ag Enterprises, LLC brought a breach of contract lawsuit against DVO, Inc. (formerly known as GHD, Inc.) in Wisconsin state court alleging that an anaerobic manure digester DVO designed for them for use on a farm in Sturgeon Bay, Wisconsin was defectively designed and not compliant with the applicable code for waste-storage facilities.[1]  The case was removed to the United States Bankruptcy Court for the Northern District of Illinois. After an eight day bench trial, the court agreed with plaintiff that DVO’s design was defective. The defective design made construction of the digester vessel defective and constituted a breach of contract because the digester vessel’s center wall footings were undersized and failed to comply with applicable code. The court, however, in applying Wisconsin’s “economic waste” doctrine denied plaintiff’s request for damages and awarded it nothing for the defectively designed vessel.[2]

To succeed on a breach of contract claim under Wisconsin law, the burden is on the plaintiff to prove three elements: (1) the existence of a valid contract; (2) a violation or breach of the terms of that contract; and (3) damages that flow from the breach. A party harmed by a breach of contract is entitled to recover damages to compensate them for losses stemming from the breach. Here, there was no dispute that the contract between the parties was a valid contract; the issue was whether plaintiff proved that DVO breached the contract and, if so, whether plaintiff incurred damages as a result of the breach.

During the trial, plaintiff’s expert testified that the digester’s vessel — a 300-foot long tank with two side-by-side chambers separated by a center wall that served as the interior-load bearing wall and supported the roof of the vessel — had undersized and overstressed wall footings. Plaintiff’s expert opined that the effect of the undersized and overstressed wall footings could lead to settlement of the vessel and the settlement could lead to cracks in the foundation. This, plaintiff’s expert said, would compromise the vessel’s structural integrity.

The court agreed with plaintiff that DVO breached its contract by designing wall footings that were undersized and that did not comply with code. However, when it came time for the court to assess damages for the design defect, the court denied plaintiff’s request for $988,745 to replace the vessel or, in the alternative, $655,000 to clean out the vessel. The court awarded plaintiff nothing.

In reaching its conclusion, the court summarized Wisconsin’s law on the measure of damages to property. The court explained that in Wisconsin the measure of damages is generally the cost of correcting the defect. This is measured by the cost of repair, the cost to restore, and the diminished value of the property (i.e., the hypothetical value of the property without the defect minus the actual value of the property with the defect). The court went on to explain that when the repairs result in either “unreasonable destruction of the work done” or the cost of the repairs is “materially disproportionate to the value of the corrections,” then the repairs result in “economic waste.” When repairs result in “economic waste,” damages are measured by calculating the value the property would have had if it were properly constructed minus the value the property currently has as constructed.

The court found that plaintiff’s claim for was speculative because it offered no evidence that an inspection would reveal any damages or that the wall footings and/or vessel floor had settled or that cracks had formed in the floor slab. Plaintiff’s expert testified that the only way to determine whether there had been settling or cracking was to empty, clean and observe the inside of the vessel. If the cleanout did reveal cracks or settlement of the center wall then plaintiff’s options were to repair and replace the inside footings or replace a significant portion of the vessel.

The court held that the economic waste doctrine applied here because the cost to shut down the digester and clean out and inspect the inside was incredibly high and plaintiff failed to establish with any reasonable certainty that an inspection would reveal any damage. Accordingly, the court held that under the economic waste doctrine any damages awarded were to be the lesser of the cost of repair/replace and the diminished value. The court found that while the vessel had undersized wall footings and was not code compliant, the defects had not diminished the value of the property and, thus, awarded plaintiff nothing for damages for the design defect.

For any case where you are seeking to recover damages for defects and omissions in the performance of a design or construction contract, be wary of the economic waste doctrine. In Wisconsin, repairs to conform property to the contract result in economic waste when they either result in “unreasonable destruction of the work done” or the cost of the repairs is “materially disproportionate to the value of the corrections.” If a court determines the repairs involve economic waste, then the measure of damages for those defects is the diminished value, which is the difference between the value the property would have had if properly constructed and the value the property has as constructed.  Given the decision in WTE-S&S Ag Enterprises, LLC it is also extremely important that the party aggrieved by the breach of contract demonstrate it sustained some injury. Under Wisconsin law, the uncertainty that could prevent a recovery is uncertainty as to the fact of the damage and not to its amount.

If you have questions on this decision or its implication, please contact Lauren Nuffort at 612.336.9308 or lnuffort@lommen.com.

 

[1] An agricultural anaerobic digester system is designed to take manure produced at a dairy farm and break it down into biogas, solid wastes and liquid wastes. Anaerobic digestion is a series of biological processes where microorganisms break down biodegradable material when there is no oxygen present. Some of the end products in this process are the production of biogas, methane gas, and hydrogen sulfide. Digesters generate revenue for the owner by converting the biogas to renewable energy and exporting the renewable energy to the state’s electrical utility company. The owner can also receive carbon credits in exchange for destroying methane, a harmful greenhouse gas.

[2] The parties consented that the bankruptcy court could decide plaintiff’s breach of contract claim. Even though the matter was pending in Illinois, the bankruptcy court applied Wisconsin law because it found that Wisconsin law governed the contract between the parties. The general conditions of the contract stated that the “Contract Documents will be construed in accordance with the law of the place of the Project.” Id. at *7.  The digester was located on a farm in Wisconsin and therefore Wisconsin law applied.