MODIFIED OPINION
IN THE SUPREME COURT OF THE STATE OF KANSAS
No. 87,393
STATE of KANSAS ex rel. CARLA J. STOVALL,
Appellant,
v.
RELIANCE INSURANCE COMPANY,
GEORGE M. MYERS, INC., d/b/a GMM, INC.,
PROFESSIONAL MECHANICAL CONTRACTORS, INC.,
DEAN E. NORRIS, INC., and
AMERICAN THERMAL PRODUCTS, INC.,
Appellees.
SYLLABUS BY THE COURT
1. Summary judgment is appropriate when the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law. The trial court is required to resolve all facts and inferences which may reasonably be drawn from the evidence in favor of the party against whom the ruling is sought. When opposing a motion for summary judgment, an adverse party must come forward with evidence to establish a dispute as to a material fact. In order to preclude summary judgment, the facts subject to the dispute must be material to the conclusive issues in the case. On appeal, we apply the same rules and where we find reasonable minds could differ as to the conclusions drawn from the evidence, summary judgment must be denied.
2. The basic principle of contract damages is to make a party whole by putting it in as good a position as the party would have been had the contract been performed. In order to recover damages, a party must not only demonstrate breach of contract and injury; the law also requires that there be a reasonable basis for computation of damages. A party is entitled to recover damages that are the proximate result of the breach of contract. A party is not entitled to recover damages that are remote, contingent, and speculative in character.
3. The purpose of the third-party beneficiary rule is to allow a party to enforce a contract made for its benefit even if it was not a signatory to that contract. The third-party beneficiary rule, however, does not apply under the facts of this case.
4. Privity of contract is that connection or relationship which exists between two or more contracting parties. It is essential to the maintenance of any action on a contract that there be privity between the plaintiff and the defendant in respect to the matter sued on.
5. The burden of establishing standing to bring suit as a third-party beneficiary rests with the party asserting it. Before the issue is reached of whether a third party may directly enforce a contract from which the party would benefit, the third party must show the existence of some provision in the contract that operates to the party's benefit.
6. To be a third-party beneficiary to a contract, the contract must be made for the third party's benefit as its object, and the third party must be intended to be benefitted in order to be entitled to sue upon it. The third-party beneficiary can enforce the contract if the third party is one who the contracting parties intended should receive a direct benefit from the contract. Contracting parties are presumed to act for themselves; therefore, an intent to benefit a third person must be clearly expressed in the contract. It is not necessary, however, that the third party be the exclusive beneficiary of all the promisor's performance. The contract may also benefit the contracting parties as well.
Appeal from Butler district court; JOHN E. SANDERS, judge. Original opinion, State ex rel. Stovall v. Reliance Ins. Co., 278 Kan. 3, 91 P.3d 531, filed June 18, 2004, is ordered withdrawn from publication. Modified opinion filed January 21, 2005. Affirmed in part, reversed in part, and remanded with directions.
Paul G. Schepers, of Seigfreid, Bingham, Levy, Selzer & Gee, P.C., of Kansas City, Missouri, argued the cause, and Duane Fox, of the same firm, and Eliehue Brunson and Scott Poor, assistant attorneys general, were with him on the briefs for appellant.
Donald Patterson, of Fisher, Patterson, Sayler & Smith, L.L.P., of Topeka, argued the cause, and James P. Nordstrom, of the same firm, was with him on the brief for appellee American Thermal Products, Inc.
Wyatt A. Hoch, of Foulston Siefkin LLP, of Wichita, argued the cause, and James D. Oliver, of the same firm, was with him on the brief for appellees George M. Myers, Inc., d/b/a GMM, Inc., and Reliance Insurance Company.
Eric T. Swanson, of Harris, McCausland & Schmitt, P.C., of Kansas City, Missouri, argued the cause, and Matthew F. Mulhern and Ronald D. Montieth, of the same firm, were with him on the brief for appellees Professional Mechanical Contractors, Inc., and Dean E. Norris, Inc.
Per Curiam: This litigation arises from the failure of the underground thermal piping system for heating and cooling at the El Dorado Correction Facility (EDCF). The State sued various entities believed responsible for the defective construction, including George M. Myers, Inc., d/b/a GMM, Inc. (GMM), Professional Mechanical Contractors, Inc. (PMC), Dean E. Norris, Inc. (DEN), and American Thermal Products, Inc. (ATP). The district court entered final orders which fixed the amount of the State's potential recovery against GMM and its surety, Reliance Insurance Company (Reliance), and dismissed the State's third-party beneficiary claims against PMC, DEN, and ATP. The State's applications for interlocutory appeal and notices of appeal were timely filed, and the appeal was granted. The appeal is before this court pursuant to a K.S.A. 20-3018© transfer. We filed our original opinion in this case on June 18, 2004 (State ex rel. Stovall v. Reliance Ins. Co., 278 Kan. 3, 91 P.3d 531). On July 8, 2004, the State filed a timely motion to clarify or modify that opinion. We grant the motion to modify, order the original opinion withdrawn from publication, and file this modified opinion.
Two issues are raised on appeal:
1. Did the district court err in fixing the amount of the State's potential recovery of damages? Our answer is, "Yes."
2. Did the district court err in dismissing the State's third-party beneficiary claims? Our answer is, "No."
We affirm in part, reverse in part, and remand for further proceedings.
The Underlying Circumstances and Proceedings
In 1989, under federal court order, the State undertook construction of a 1,000-bed maximum security prison in El Dorado, Kansas. The State employed a multi-bid prime contracting scheme under which several contractors contracted directly with the State for various phases of the project. The State employed Booker & Associates (Booker) as construction manager to coordinate the activities of the various prime contractors. The $50 million project was completed in 1992.
GMM constructed the prison's site utilities pursuant to a $6.5 million lump sum contract with the State. For contract billing purposes, GMM allocated approximately $1.097 million of its contract to the cost of the 3,900-foot long underground thermal piping system. The State has stipulated, for purposes of the summary judgment motions giving rise to this appeal, that the State's cost for the original underground thermal piping system was $1.097 million.
The underground thermal system pipes transport chilled water and steam at temperatures in excess of 300ºF from the central plant to all the buildings in the facility. The contract required GMM to insulate the system for the underground pipes to meet performance criteria set out in the contract. Generally, the insulation system was to insulate the pipes to approximately 100ºF where the system interfaces with the soil and to protect the pipe exteriors from corrosive moisture.
Different types of underground thermal piping systems for heating and cooling fall into several broad categories: (1) walk-through utility tunnels; (2) shallow concrete trenches; (3) direct-bury preinsulated piping; and (4) direct-bury piping with a poured-in-place insulation envelope. Walk-through tunnel systems cost the most initially but have the lowest lifetime costs due to ease of access, maintenance, and correction of maintenance errors. Shallow concrete trenches are usually the next most expensive system, followed by direct-bury preinsulated piping, and then direct-bury piping with poured-in-place insulation.
The State's design team initially recommended a walk-through tunnel system but rejected the idea due to cost and security concerns. It found that the direct-bury pipe with poured-in-place insulation was the lowest cost alternative.
The project mechanical engineer, Professional Engineering Consultants, P.A. (PEC), warned the State that "[a]though the poured-in-place insulation system appears to offer considerable first savings, our firm has no past experience with this method and has some skepticism regarding the long term insulating value of the material." PEC therefore recommended that the State solicit construction bids setting forth prices for not only poured-in-place insulation but also the preinsulated piping alternative.
GMM subcontracted with Professional Mechanical Contractors, Inc. (PMC) for the installation of the underground thermal system to meet the performance criteria specified by the State. PMC in turn entered into a contract with American Thermal Products, Inc. (ATP) for the design of a preengineered insulation system to meet the performance criteria for the underground thermal system. There were no direct contracts between the State and the subcontractors.
During the design process, the State's representatives met with representatives of ATP and its sales representative, R.B. Summers Associates, Inc. (Summers), concerning ATP's insulation product, Gilsulate 500xr. The State later chose the poured-in-place insulation alternative. In its first amended petition, the State alleged that it approved the use of Gilsulate 500xr as the poured-in-place insulation around all the underground thermal piping based on the representations of ATP and Summers. ATP's president stated that such a system, if properly installed, was a "zero maintenance" system.
The State contends that ATP provided a preengineered insulation system that included, in addition to the Gilsulate 500xr insulation, the design for the pipe guides, pipe anchors, pipe expansion loops, insulation thickness details and calculations, and heat transfer calculations. PMC eventually installed ATP's system by placing the pipe and ancillary features into an open earthen trench, encasing the pipes in a formed envelope of dry-powdered Gilsulate 500xr insulation, then backfilling the trench with sand and soil. The district court and the parties referred to this as an "earthen trench" system.
The site utilities package work awarded to GMM under its contract with the State was substantially completed in May 1991. The EDCF staff soon began reporting problems with the steam condensate return system, which appeared to be the result of malfunctioning steam traps throughout the thermal piping system. By the end of 1991 there were indications that high heat was escaping from various areas of the underground thermal system. The first symptoms were dead grass and melted snow above the steam pipes in an area outside the prison fence. The State notified GMM of the problems within 1 year of completion but claims that GMM did not return to the site to investigate further during the warranty period.
Excavations identified construction defects by PMC, and an infrared survey revealed hot spots. Excavators noted wet insulation, improperly installed pipe support anchors, wood blocks being used as pipe supports, lack of flashing above pipe penetrations in the manholes, and inadequate insulation coverage.
The State also attributed damage to other underground lines situated near the underground steam pipes including fire alarm, fiber optic telephone, energy management, electric, and water lines to the failure of the earthen trench system. In approximately October 1999, the State abandoned this earthen trench system and installed a concrete shallow trench system.
On November 26, 1997, the State filed suit against Gossen, Livingston & Associates (Gossen), the project architect; PEC, the mechanical engineering consultant; Booker, the construction manager; GMM, the contractor for the underground thermal system and its surety, Reliance; PMC, GMM's installation subcontractor; DEN, alleged by the State to be the parent company of PMC; and ATP, the subcontractor to PMC. The State alleged that a combination of product defects and design and installation errors caused a failure of the system over time.
Under the State's theory, it alleged that (1) GMM, PMC, and ATP breached their contracts by failing to provide materials and work in compliance with the contract documents, (2) the Gilsulate 500xr system was not reasonably suited for the use to which it was applied at the prison, and (3) the most reasonable solution was to abandon the earthen trench system and replace it with a concrete trench system, which was done at a lower cost than repairing or replacing it with another earthen trench system.
DEN filed a motion for summary judgment in September 1999, contending that it had not entered a contract involving Bid Package 3A, had performed no work at the prison, and, as a matter of law, should not be made a party to the lawsuit.
On February 10, 2000, PEC filed a motion in limine to determine the measure of damages. Defendants GMM, ATP, and PMC joined the motion, arguing that the concrete trench system was a "trade-up" to a better system than the earthen trench system. Although for purposes of the motion the defendants stipulated that the earthen trench system had failed and was necessarily abandoned and replaced, the defendants urged the court to reject the typical repair or replacement cost measure of recovery.
They argued the court should instead apply the economic waste exception, which would limit damages to diminished value. As a result, they argued that the diminished value was at most the difference between the value of the earthen trench system in its defective condition ($0) and its value without defects, which they contended was the $1.097 million original cost of the system. They claimed that the State would receive a windfall if recovery was measured by the cost of the shallow concrete trench system.
On December 19, 2000, the district court entered an order ruling on the motion in limine. The district court framed the questions addressed as follows:
"The question to be decided by the Court is: 'If it is assumed that replacement of the underground thermal system was necessary, is the State's claim for reimbursement for its replacement costs limited to the original cost of installing the system?' Also: 'What date are we going to use to determine the breach for purposes of determining the amount of damages?'"
The district court was not clear as to the cost of installing the concrete trench system, stating: "[A]s the Court understands it, [the concrete trench system] cost $5,728,090." Although the State had identified repair and replacement costs of $5.7 million, it asserts on appeal that this figure included not only the cost of the concrete trench but also the cost of repairing other systems damaged by GMM's earthen trench system, e.g., telephone lines.
The court concluded that "the State should not be awarded damages which would place it in a better position or with a better system than that originally contracted for and contemplated by the parties." According to the district court, placing an outside limit of damages at $5.7 million for the concrete trench system would award the State an improper windfall. In addition, the court was of the opinion "that present day costs of replacing an earthen trench system originally installed in 1991 is not the proper measure of damages."
The district court, however, also rejected defendants' argument that the State's recovery was limited to the original cost of the earthen trench system, stating:
"The Court finds that damages should be measured by the cost of installation of an earthen trench system on the date that plaintiff would have had notice that a cause of action might be accruing, i.e., the date that plaintiff became aware that the system was failing."
At the time the district court entered its order in limine, scant evidence, if any, had been provided to estimate the cost of repair or replacement of the earthen trench system. After the order was entered, the State proceeded to obtain evidence of what it would have cost to install an earthen trench system for the occupied prison in 1995, the time of discovery. The State retained an expert, William R. Bassette, P.E., who, according to his deposition transcript attached to the State's response to a motion for summary judgment, determined that the cost to replace the system with another earthen trench system at the time the State should have discovered the system failure varied from $4.5 million to $6.3 million, depending upon the alignment used. According to the State, that amount did not include the cost to repair other utilities damaged by the defective system, e.g., telephone lines. The State asserted these figures were high primarily because of the difficulties in performing the construction work in an occupied prison.
Defendants and the State disagreed as to whether the limine order limited the State's replacement cost recovery to the original cost of the earthen trench system. After the State settled with Gossen, PEC, and Booker, the disagreement was presented to the court through a February 2001 summary judgment motion by GMM and Reliance. GMM and Reliance asserted that GMM was entitled to credit the amount of the prior settlements against the State's total damages. According to GMM and Reliance, the settlement amounts exceeded the State's damages and, thus, the State had been fully compensated. PMC and DEN then filed their own summary judgment motion and incorporated the same credit-for-settlements argument against the State. The State's response objected to disclosure of the specific amounts of confidential settlements but stipulated that settlement proceeds exceeded the original cost of the earthen trench system.
At a March 16, 2001, hearing, the State asked the district court to clarify whether the limine order limited replacement cost recovery to the original contract amount. The partial transcript of that hearing reflects the following comment by the district judge:
"I think that we want to go to the very end of my opinion because that when it's all said and done, what I was trying to summarize, will cap damages as of the date the plaintiffs first had notice that it would have a cause of action due to the system failure. And the costs of installation of an earthen trench system on such date, whatever that may be, would be the upper limit of possible damage claims.
"While I realize there could be some consequential damages . . . ."
Subcontractor ATP was the first of the defendants to file a motion for summary judgment. It argued that the Kansas Product Liability Act, K.S.A. 60-3301 et seq., and the economic loss rule barred the State's tort claims against it for negligence, strict liability, breach of express warranty, and breach of implied warranty. According to ATP, a products liability action based on tort cannot be maintained in Kansas for purely economic losses, and the State's alleged damages were solely economic. Similarly, ATP argued that Kansas common law and the economic loss rule barred the State's claims for strict liability and negligence.
Subcontractor PMC also filed a motion for summary judgment. The stated purpose of the motion was to demonstrate that, as a matter of law, it had no direct contractual relationship with the State and that under the economic loss doctrine, the State could not maintain direct claims against PMC.
On May 16, 2001, in a memorandum decision and order, the district court granted motions for summary judgment to the subcontractors PMC and ATP. Then, by orders filed June 25, 2001, the district court further granted motions for summary judgment to GMM and Reliance, PMC and DEN, and ATP.
The district court found that all of the State's claims against GMM and Reliance for breach of contract, negligence, and breach of implied warranty arose out of the parties' written construction contract. It held that, as a matter of law, the existence of the contractual relationship barred the State's assertion of tort claims arising from GMM's performance of contractual obligations. The court further held that breach of contract was the State's only actionable claim against GMM and dismissed the State's tort-based claims against GMM and its surety, Reliance.
The district court noted its previous ruling that the State could not maintain negligence claims against the defendants because any damages sustained by the State arose from contractual obligations, not negligence as a matter of law. It further found that there were no direct contracts between the State and any of the subcontractors and therefore held that the State could not maintain breach of contract claims against PMC, ATP, or DEN due to a lack of privity.
The court also found that any damages sustained by the State were economic in nature, including "damages to the existing thermal system and its respective parts, the cost of repairs and replacement of portions of the system and eventually the entire unit, heat loss and increased operating costs." It wrote that under Professional Lens Plan, Inc. v. Polaris Leasing Corp., 234 Kan. 742, 750-55, 675 P.2d 887 (1984), "direct and consequential economic loss damages of a non-privity ultimate purchaser are not recoverable from the seller since public policy concerns [of] dangerous product personal injuries to consumers are not present." The district court also ruled out recovery for the State under its claims for breach of implied warranty.
Finally, the district court rejected the State's third-party beneficiary contract claims, stating:
"Plaintiff contends that it is a third party beneficiary and thus entitled to enforce claims directly against ATP, PMC or [DEN]. The purpose of the third party beneficiary rule is to allow parties to enforce a contract made for their benefit even if they were not a signatory to that contract. To apply third party beneficiary rules to the economic loss cases would be to completely ignore Professional Lens and the line of cases it represents. It would completely emasculate the economic loss doctrine. The Court does not believe third party beneficiary rules apply to the case at hand."
Next, the district court found that the State was limited to only one recovery for an injury or damage and that the State sought recovery from GMM and Reliance for the same injury or damage asserted against the settling defendants. Therefore, the district court held that GMM, the utilities general contractor, and Reliance, its surety, were entitled to a credit in the amount of the settlement funds already paid to the State. The court also held that "ATP and PMC/[DEN] are entitled to the same credit, to the extent the State's claims against them sound in contract."
A separate order filed June 25, 2001, memorialized the district court's order granting Reliance and GMM's second motion for summary judgment. Noting that all the State's direct claims against ATP, PMC, and DEN had been dismissed, the court wrote that the defendants had requested an order "limiting the State's total damages to $129,609.00 the State's maximum recovery for direct and incidental damages after credit for settlement proceeds already received by the State." The order set forth the following uncontroverted facts:
"1. On December 18, 2000, the court issued an order on defendants' Motion in Limine regarding damages.
"2. On March 16, 2001, the court 'clarified' its order by saying (as paraphrased by counsel) that the State will be limited to the cost of an earthen trench as of the date the State discovered that it would need to replace the existing utility trench, plus appropriate incidental damages.
"3. In the prior motion for summary judgment it was established that the State paid [GMM] $1,097,000 for the original thermal piping system.
"4. Bill Bassette, the State's only testifying expert, opined that the cost [of] inflation for site utility work for 1991 through 1994 would be two percent (2%) or less.
"5. When the cost of inflation for site utility work is added to the original cost of the insulation system ($1,097,000), to 1995, the result is $1,187,428.
"6. On April 14, 2000, the State filed its expert witness disclosures wherein it identified all of its damages, including its alleged incidental damages. Those incidental damages are comprised of three elements: (i) energy loss [with interest] of $1,360,466, as set forth on Disclosure p. 3, ¶ 3; (ii) cost for a new fiber optic 'backbone' in the amount of $228,869, set forth on Disclosure p. 15, ¶ 4.a.ii; and (iii) the cost of fiber optic tie-in the amount of $37,866, set forth on Disclosure p. 15, ¶ 4.a.iii. The Disclosure does not segregate the energy loss calculation into energy cost and prejudgment interest on energy costs."
The district court held, as a matter of law, "that energy losses (caused by heat loss from the steam piping and heat gain to the chilled water piping) and the installation of the fiber optic system comprise the universe of the State's consequential and incidental damages." The court found that the State's other damage categories arose from the replacement of the pipes, insulation, and associated utilities and, therefore, were direct damages. Moreover, the district court held that the State's maximum direct damage award was fixed at $1,187,428, the amount it paid GMM for the earthen trench system in 1991 adjusted for inflation to 1995.
As for other damages, the district court found that the State's "maximum damages incidental to the alleged failure of the thermal piping system is $1,687,181." After adding the figure for maximum direct damages ($1,187,428) to the maximum incidental damages ($1,687,181), and applying credit for settlement monies previously received by the State, the district court held that "the State's maximum recovery against [GMM] and Reliance is $129,609."
As the parties are before this court on an interlocutory appeal, it is important to note that the State's tort claims against GMM and Reliance are not in issue on appeal and that the only issues regarding the contract claims concern damages. Moreover, the only issue on appeal concerning the State and defendants PMC, DEN, and ATP is whether third-party beneficiary contract claims can be brought; the State's tort claims against these defendants are not in issue on appeal.
Standard of Review
"'Summary judgment is appropriate when the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law. The trial court is required to resolve all facts and inferences which may reasonably be drawn from the evidence in favor of the party against whom the ruling is sought. When opposing a motion for summary judgment, an adverse party must come forward with evidence to establish a dispute as to a material fact. In order to preclude summary judgment, the facts subject to the dispute must be material to the conclusive issues in the case. On appeal, we apply the same rules and where we find reasonable minds could differ as to the conclusions drawn from the evidence, summary judgment must be denied.' [Citation omitted.]" Mitchell v. City of Wichita, 270 Kan. 56, 59, 12 P.3d 402 (2000) (quoting Bergstrom v. Noah, 266 Kan. 847, 871-72, 974 P.2d 531 [1999]).
Measure of Damages
The State asserts the district court erred by fixing its direct damages as the original cost of the earthen trench system, $1,097,000, plus an additional amount for inflation through 1995, the outside date the State contends it discovered the system was failing, for a total of $1,187,428. It persuasively argues the effect of the district court's order is to allow restitution, not damages for breach of contract. The State believes it is entitled to recover the costs to build the concrete trench system as those costs are less than would have been incurred to build a new earthen trench system.
Conversely, GMM contends the State's direct damages are limited, as a matter of law, to the difference in value between the original earthen trench system specified in the contract and the value of the system actually delivered. It argues to allow recovery for the cost of the new concrete trench system would constitute a windfall to the State. GMM relies on Service Iron Foundry, Inc. v. M.A. Bell Co., 2 Kan. App. 2d 662, 679, 588 P.2d 463 (1978).
The basic principle of contract damages is to make a party whole by putting it in as good a position as the party would have been had the contract been performed. See Kansas Power and Light Co. v. Thatcher, 14 Kan. App. 2d 613, 616-17, 797 P.2d 162, rev. denied 247 Kan. 704 (1990). See also Restatement (Second) of Contracts § 344(a)(1979) (basic purpose of contract damages is to make a party whole by putting it in as good a position as the party would have been had the contract been performed). Moreover, not only must a party demonstrate breach of contract and injury; the law also requires that there be a reasonable basis for computation of damages. English Village Properties, Inc. v. Boettcher & Lieurance Constr. Co., 7 Kan. App. 2d 307, 310-11, 640 P.2d 1282, rev. denied 231 Kan. 799 (1982) (quoting Venable v. Import Volkswagen, Inc., 214 Kan. 43, 50, 519 P.2d 667 [1974]). A party is not entitled to recover damages "not the proximate result of the breach of contract and those which are remote, contingent, and speculative in character." Apperson v. Security State Bank, 215 Kan. 724, Syl. ¶ 7, 528 P.2d 1211 (1974).
We, of course, agree with the parties that the basic purpose of contract damages is to make a party whole, not recover a windfall.
We reject, however, GMM's argument that the holding in Service Iron Foundry controls. There, the foundry sued to recover damages for breach of warranty in connection with its purchase of a pollution control unit. The Court of Appeals affirmed the trial court's restriction of the foundry's damages to the original purchase price and incidental expenses rather than the