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In a case of first impression in Maryland, the Court of Special Appeals addressed the question “whether a lender owes a duty to ensure that a subcontractor receives payment from its disbursements to the general contractor absent any contractual obligation to do so.” Bel Air Carpet, Inc v. Korey Homes Building Group, LLC, No.1006, Sept. Term 2019 (Jan. 28, 2021), at 26.  With an analysis that harkens back to a first-year torts class, the Court of Special Appeals concluded that without privity or some other intimate nexus between a bank and a subcontractor, the bank is not liable for disbursing funds to the general contractor without first ensuring that the subs had been paid.  To hold otherwise, the Court found, would make the lender “an insurer of the subcontractors’ interest,” which this panel was not prepared to do. Id. at 32–33 (citation omitted).

Appellant Bel Air Carpet provided labor and material for the installation of flooring in custom houses built by Korey Homes, a general contractor.  Korey Homes had agreed to pay Bel Air Carpet from draws issued by its homebuyers’ lenders, which included Hamilton Bank.  It did not pay as agreed, and Korey Homes fell $300,000 into arrears.  Bel Air Carpet threatened to file mechanic’s liens, but was convinced not to by Korey Homes’ promise of payment. A few days after that promise was made, Korey Homes shut its doors without paying Bel Air Carpet.  

Bel Air Carpet later sued Hamilton Bank for negligence, alleging that the bank owed it a duty to ensure that funds it paid to the general contractor were, in fact, paid to the subcontractors, and that the bank breached its duty by failing to follow “standard industry practice” and obtain mechanic’s lien releases to verify payment. Id. at 6.  The bank moved to dismiss the complaint, citing the “economic loss rule,” which provides: “[W]here the failure to exercise due care creates a risk of economic loss only, courts have generally required an intimate nexus between the parties as a condition to the imposition of tort liability.”  Id., quoting Jacques v. First National Bank of Maryland, 307 Md. 527, 534 (1986).  As the only risk to Bel Air Carpet was economic and it had no relationship whatsoever with the bank, the latter argued that the complaint failed to state a claim for negligence.  Both the circuit court and the Court of Special Appeals agreed.

The appellate court’s discussion began with the foundational rubric for negligence, requiring that a plaintiff allege and ultimately prove: (1) the defendant owed it a duty to protect it from harm; (2) the defendant breached that duty; (3) there was a causal relationship between the breach and the harm; and (4) the plaintiff suffered damage as a result. Id. at 16. The subcontractor stumbled right out of the gate, unable to establish that the bank owed it a duty to protect against the general contractor’s failure to make payment from loan proceeds.

The Court first observed that “duty” is “an obligation, to which the law will give recognition and effect, to conform to a particular standard of conduct toward another.” W. Page Keeton, et al., PROSSER AND KEETON ON THE LAW OF TORTS § 53 (5th ed. 1984).  The Court continued: “To determine whether a duty exists in a particular context, we examine: 

(1) ‘the nature of the harm likely to result from a failure to exercise due care,’ and (2) ‘the relationship that exists between the parties.’” Id. (citations omitted). Further, “an inverse correlation exists between the nature of the risk on one hand, and the relationship of the parties on the other. As the magnitude of the risk increases, the requirement of privity is relaxed—thus justifying the imposition of a duty in favor of a large class of persons where the risk is of death or personal injury. Conversely, as the magnitude of the risk decreases, a closer relationship between the parties must be shown to support a tort duty.” Id., quoting Jacques, 307 Md. at 537.

When the risk of loss is purely economic and, therefore, at the low end of the risk continuum, the economic loss doctrine precludes liability for negligence in the absence of an intimate nexus between the parties, i.e., contractual privity, “or its equivalent.”  Id.  The underlying reason for this requirement, as taught to every first-year law student, is “[t]o limit the defendant’s risk exposure to an actually foreseeable event, thus permitting a defendant to control the risk to which the defendant is exposed.” Id., quoting Walpert, Smulian & Blumenthal, P.A. v. Katz, 361 Md. 645, 671, 762 A.2d 582 (2000).   This concept, of course, was most famously explored by Justice Benjamin Cardozo in several traditional casebook staples, including Glanzer v. Shepard, 135 N.E. 275 (N.Y. 1922) (where a bean weigher was found to have owed a duty to a limited class of bean buyers) and Ultramares Corp. v. Touche & Co., 174 N.E. 441 (N.Y. 1931) (where an accountant was found not to owe a duty to an unlimited class of third-parties who might rely on a balance sheet prepared for a client).  These cases directly informed the Court of Appeals when it adopted the economic loss doctrine in Jacques (although it passed on the opportunity to address the middle case of Cardozo’s foreseeability trilogy, Palsgraf v. Long Island Railroad Co.,162 N.E. 99 (N.Y. 1928)). 

In the absence of privity, Bel Air Carpet sought to establish its equivalence by alleging that the bank knew or should have known that it was likely to take action based on the bank’s actions. Id. at 8. After reviewing five Maryland cases that addressed this concept in other contexts, the Court agreed that the key to the plaintiff’s success is the defendant’s knowledge of the third party’s reliance on its actions.  Id. at 20–26.  “[O]ur privity-equivalent analysis in economic loss cases looks for linking conduct—enough to show the defendant knew or should have known of the plaintiff’s reliance. This means, of course, that context is critical.” Id. at 26, quoting Balfour Beatty Infrastructure, Inc. v. Rummel Klepper & Kahl, LLP, 451 Md. 600, 620–21, 155 A.3d 4454 (2017). 

Turning to the specific allegations under review, the Court noted that there were no Maryland cases that applied the “privity equivalent” test in the construction lender/subcontractor context.  Courts in several other jurisdictions had, and they “have broadly determined that a lender providing a construction loan owes no duty to an unpaid subcontractor absent the lender’s express promise or assurance of payment.” Id. at 28.  So, too, had the authors of several articles found in scholarly publications.  Id. at 29. The Maryland Court, therefore, concluded:  

If we were to adopt Bel Air Carpet’s theory, we would alter the delicate contractual balance in the construction industry and the privity requirement of the economic loss doctrine. We would render Hamilton Bank the ‘insurer of the subcontractors’ interest’…. Even assuming that there is a standard in the industry that a bank require mechanic’s lien releases, Bel Air Carpet has not alleged how or why a duty of care should be imposed upon Hamilton Bank for its benefit. Although it may be foreseeable that Hamilton Bank’s failure to request mechanic’s lien releases or inspect the properties could harm Bel Air Carpet, unless Hamilton Bank owes Bel Air Carpet a duty, Hamilton Bank cannot be liable to Bel Air Carpet in negligence.

Id. at 33 (citations omitted).

Moreover, “the determination of whether an actionable duty exists represents a policy question of whether the specific plaintiff is entitled to protection from the acts of the defendant.” Id. at 17, quoting Blondell v. Littlepage, 413 Md. 96, 120, 991 A.2d 80 (2010).  The Court was not prepared to impose such a duty.  It did, however, suggest that the General Assembly might want to take up the issue as a question of policy. Id. at 32.  In the meantime, “[w]hether a legal duty exists between parties is a question of law to be decided by the court.” Id. (citation omitted).  While concluding that the bank’s motion to dismiss with prejudice was properly granted, the Court expressly held open “the possibility that a contractor, subcontractor, supplier, or similar entity could allege a specific factual scenario that would demonstrate an intimate nexus with a lender.”  Id. at 32, n. 9. The appellant here failed to do so.