I'm writing a chapter on construction defects in the ABA Forum's updated edition of the "Fundamentals" book. Here's a stab at making sense of the Economic Loss Rule by putting it in the overall context of negligence law....
In evaluating negligence causes
of action and what remedies might be precluded in negligence, it is always best
to consider the concepts of foreseeable harm, duty, proximate cause, and the economic
loss rule together. It is not easy to do
because the courts often ignore this advice, but without considering these
concepts as an interrelated whole it is very difficult to make sense of the
cases in this area of the law.
We all remember Palsgraf v. Long Island Railroad from
law school. The court held that Mrs.
Palsgraf could not recover damages from
the railroad that employed a conductor who improvidently pushed a man who
happened to be carrying a package of explosives, which exploded and caused a
scale to topple onto poor Mrs Palsgraf. The court developed the
doctrine of proximate cause to draw a circle outside which the defendant would
not be responsible for harm. The
conductor and railroad in Palsgraf were
held not responsible for damage caused by the toppling of the scale because they
could not reasonably have foreseen this damage.
But once
having formulated the law of negligence in terms of duty to act reasonably to avoid
foreseeable harm, the courts have struggled ever since to figure out where to
draw the line on “foreseeable” damages.
As the quip has it, “on a clear judicial day, courts can foresee
forever!” But society cannot function
properly if defendants are exposed to unlimited liability for normal commercial
conduct. Consider a negligently
installed coupling in a gas line in a commercial district. It is surely foreseeable that an explosion
might result, and that if an explosion results the streets will have to be dug
up for a period of weeks to repair the damage, that every business in the
vicinity will lose customers, that taxi drivers will lose fares, and that restaurants
in the area will serve fewer meals. But
should a worker who installed the defective coupling be held liable in
negligence for all those seemingly foreseeable losses? It would be enough to make us stay in bed,
and for insurance companies to stop underwriting.
The
economic loss rule is one doctrine that serves the purpose of limiting potentially
limitless damages that might flow from negligence or strict liability. Initially
applied to limit a defendant’s exposure in strict liability, it has been
expanded to hold that in an action alleging negligence or strict liability, a plaintiff cannot recover its purely economic
damages caused by a defective product that injures only itself. Needless to say, this has generated a lively
debate in the case law as to what is a “product” and what is consequential
damage to “other” property separate from the product. In the construction context some courts
consider the entire structure as the relevant “product” for purpose of the
economic loss rule, while others hold that particular building components are
distinct “products” so that damage to other building components is damage to “other” property.
The purpose
of the economic loss rule is sometimes expressed as preserving the respective
societal goals of contract law and tort law.
With contract law the courts enforce justifiable expectations that have
been raised by promises parties have made in their agreements; by contrast, with
tort law, the overriding concern of the courts is to compensate victims who are
injured because they were exposed to unreasonable dangers and to discourage
harmful products and conduct. When
negligent construction or manufacturing damages only the product itself, the
courts have held that the contractual expectation is limited to replacement of
the product. For example, when Wilson supplies
a defective tennis racket to Roger Federer, the contractual expectation is that
it will be replaced with a good one.
Although it is foreseeable that if this racket breaks during match point
in the fifth set at the U.S. Open, a million dollar purse might be at stake, the
economic loss rule says that Roger Federer will just have to settle for the
$950,000 second prize, plus a new racket from Wilson. Wilson will not be responsible in negligence or strict liability for the $1
million difference between the first prize purse and the runner up prize because this is a purely economic loss.
The picture
is made murky by the fact that some courts muddle the economic loss rule with
the concept of duty. For example, should
an architect (not in privity of contract with a contractor) be held liable in
negligence for delay and disruption (economic damages) resulting from defective
plans? Although defective plans are more
akin to a service than a product, some courts apply the economic loss rule to
preclude recovery in this situation.
Other courts allow recovery on the theory that this is a species of
fraud (negligent misrepresentation) and thus should be recognized as an
exception to the economic loss rule. But
this mixes the concepts of (1) whether a duty exists, and (2) what damages
should be recoverable if a duty does exist in an unhelpful manner. Whether a
defendant has a duty to a plaintiff in a particular case that the courts should
recognize, and whether the courts should limit certain types of damage (like
economic loss) if a duty exists are separate questions and it is helpful to
keep these in mind as separate issues, even if the courts often fail to do so.
Contrary to what Palsgraf and its “proximate cause”
approach might suggest, negligence is ultimately about more than
foreseeability. In the seminal
California case of Rowland v. Christian (CA
Sup. Ct. 1968)(defective bathroom faucet severed tendons in hand of social
guest) the court set forth several factors that should be considered in
weighing the existence of a duty: (1) the foreseeability of harm to the
plaintiff, (2) the degree of certainty that the plaintiff suffered injury, (3) the
closeness of the connection between the defendant's conduct and the injury
suffered, (4) the moral blame attached to the defendant's conduct, (5) the
policy of preventing future harm, (6) the extent of the burden to the defendant
and consequences to the community of imposing a duty to exercise care with
resulting liability for breach, and (7) the availability, cost, and prevalence
of insurance for the risk involved. Some
courts discuss these factors in terms of “special relationship” between plaintiff
and defendant. But this “special
relationship” is what defines duty.
Thus, for those jurisdictions that hold
an architect has a duty to prevent foreseeable harm to contractors by adhering
to the standard of care of an architect, it makes no sense to artificially
distinguish between physical damage to property and economic damage (e.g. between
a wall falling down and delay and disruption).
It’s all money to the contractor.
By speaking about this in the context of the economic loss rule courts sometimes conceal what is at stake.
When researching how the case law in your jurisdiction has allowed or
disallowed economic damages in negligence you should find it helpful to keep in
mind the different purposes of tort and contract law, and to clearly separate
in your mind the concepts of foreseeable injury, duty, proximate cause, and the
economic loss rule … even if the courts don’t always do so.
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