On February 9, 2015, the Colorado Supreme Court in SK Peightal Engineers, Ltd. v. Mid Valley Real Solutions V, LLC reversed decisions of the district court and court of appeals, holding that a construction lender's wholly owned subsidiary that acquired title to a failed construction project by a deed in lieu of foreclosure was not a "subsequent purchaser" (342 P.3d 868 (Colo. 2015)). This distinction barred the subsidiary from pursuing a tort claim for defective construction against the project's subcontractors under the economic loss rule.

In April 2007, developer Sun Mountain Enterprises LLC secured construction financing from Alpine Bank to build a residential home. The housing market soon declined and the home failed to sell before the loans matured. Sun Mountain and Alpine Bank entered into a deed in lieu of foreclosure agreement to grant a deed in lieu of foreclosure to Mid Valley Real Estate Solutions V, LLC, a newly created, wholly owned subsidiary of Alpine Bank, formed solely to hold title to the home.

Before Mid Valley could sell the home, cracks in the foundation emerged because of settling soil. Mid Valley then asserted a negligence claim against the structural engineer and geotechnical subcontractors for economic damages caused by defective construction.

The subcontractors moved for summary judgment based on the economic loss rule, which bars tort claims for purely economic losses (as opposed to death or bodily injury) due to breaches of contractual duties in the absence of an independent tort duty. Under the interrelated contract doctrine, the subcontractor argued that Mid Valley was contractually interrelated to the duty provisions contained in the subcontractors' contracts with Sun Mountain. The trial court denied the motion, stating that Mid Valley did not have a contract with any of the parties so the economic loss rule was inapplicable. The denial was affirmed by the Colorado Court of Appeals in Mid Valley Real Estate Solutions V, LLC v. Hepworth-Pawlak Geotechnical, Inc. (No. 13CA0519, (Colo. 2013)).

The Colorado Supreme Court granted certiorari to decide:

The Colorado Supreme Court held that the deed in lieu agreement demonstrated the parties' intent to benefit a third-party, despite that party's non-existence at the time of execution. The court also held that the agreement was interrelated to the construction loan agreement. However, the issue was remanded to determine if the deed in lieu agreement was interrelated to the subcontractors' contracts.

In Cosmopolitan Homes, Inc. v. Weller, the Colorado Supreme Court acknowledged that a builder owes subsequent purchasers an independent duty to use reasonable care in the construction of homes (663 P.2d 1041 (Colo. 1983)). In Town of Alma v. AZCO Construction, Inc., the Colorado Supreme Court affirmed that this independent duty is compatible with the economic loss rule (10 P.3d 1256 (Colo. 2000)). Then in A.C. Excavating v. Yacht Club II Homeowners Association, the Colorado Supreme Court held that this independent duty applies not only to builders, but also to subcontractors (114 P.3d 862 (Colo. 2005)).

An independent duty of care is triggered by the special relationship between construction professionals and subsequent homeowners. The purpose of the independent tort duty in construction defect claims is to protect subsequent purchasers and transferees who would otherwise lack adequate contractual remedies. However, as Cosmopolitan Homes made clear, the independent duty is only owed to subsequent homeowners (663 P.2d 1041 (Colo. 1983)).

The Colorado Supreme Court held that Mid Valley was a third-party beneficiary of a commercially negotiated agreement, through which Mid Valley could enforce its rights. Mid Valley could also enforce the construction loan agreement because it was interrelated to the deed in lieu agreement, which preserved Alpine Bank's enforcement rights against Sun Mountain. The interrelated agreements were negotiated at arm's length to contain significant protections for the lender and Mid Valley as a a third-party beneficiary, and outlined the duties and liabilities of each party during the construction of the home. Mid Valley had contractual remedies available, which precluded it from subsequent homeowner status as contemplated by Cosmopolitan Homes.

Because Mid Valley did not qualify as a subsequent homeowner, no independent tort duty was owed to Mid Valley by the subcontractors, and Mid Valley's tort claim was barred by the economic loss rule. However, the ultimate issue of the subcontractors' liability was remanded to determine if Mid Valley had other actionable claims.

This case highlights the importance of ensuring that remedies in loan documents anticipate the concerns of future assignees and third-party beneficiaries. Before executing a loan agreement, a construction lender should obtain collateral assignments of the construction contract and all major subcontracts. The lender should review each contract to ensure that remedies are specifically expressed for common claims.

The lender should also negotiate to include provisions stating that any remedies, warranties, indemnities and other protections granted to the borrower or owner are assigned to the lender and any of the lender's subsidiaries later taking title. Additionally, the contracts must be properly assigned when the lender or its successor takes title to the property. Doing so ensures that adequate contract remedies are available if defective construction tort claims are barred by the economic loss rule.