Exceptions to No Recovery for Pure Economic Loss

Exceptions to the Normal Position of No Recovery for Pure Economic Loss

Question

‘There are exceptions to the normal position of no recovery for pure economic loss in negligence. However, the common law approach to pure economic loss rests on an uneasy mixture of principle and policy, and lacks real clarity and consistency.’ Do you agree?

Answer

Under English law, litigants cannot claim damages for pure economic loss – economic loss independent of both negligently caused physical injury and economic loss consequential to such physical injury. One of the most notable cases illustrating this is Spartan Steel & Alloys Ltd v Martin & Co (Contractors) Ltd 1973,^[1] where the defendant’s employees had negligently damaged the power supply to the claimants’ furnace. The Court of Appeal held that while the claimants could recover damages for the reduction in value of the melt removed from the furnace, and the loss of profit from that melt which would have been earned had the electricity not been disrupted, but not the loss of profit from the four melts which the claimants would have placed in the furnace had the electricity not been disrupted. This rule is not without its exceptions, but its development through later case law reflects an inconsistent growth of an unprincipled law.

A subset of cases relating to defective properties, in particular, is illustrative of such problems in the law. Where negligence in workmanship causes defects in property, the first purchaser of the property can seek redress by relying on contractual warranties. However, the law was less clear when defects are detected under the ownership of subsequent purchasers who lack direct contractual rights against the builders. Initially, Lord Wilberforce’s speech in Anns v Merton London Borough Council was the leading authority in this area of law, establishing that a duty of care would exist in such cases if there was sufficient proximity between the parties based on foreseeability, and if there were no reasons militating against the existence of such a duty.^[2] While this was a fairly simple solution, the vagueness with which their Lordships discussed the basis for this decision caused further problems. The cause of action was said to only arise when there is ‘present or imminent danger to the health or safety of the persons occupying it’,^[3] but it was unclear if claimants were required to prove the existence of such danger in the two-step test. Lord Wilberforce also did not clarify whether the basis on which he found the existence of “material, physical damage” was the risk of personal injury, structural damage or damage to other property caused by structural damage. In other words, little recognition was given to the difference between the purchase of an item which was less valuable than previously thought by the consumer, and physical damage done to property owned by a claimant. It was therefore, unsurprising that the validity of Anns was doubted by the House of Lords in D & F Estates Ltd v Church Commissioners for England and Wales,^[4] where their Lordships held that the cost of repairing defective plaster was pure economic loss, and thus non-recoverable. However, it was not until 1990 that the development of the principle in Anns was brought to a halt. In Murphy v Brentwood District Council,^[5] the House of Lords chose to overrule its earlier decision in Anns, putting to rest the concept that pure proximity was sufficient to impose liability on a builder for pure economic loss sustained by successive purchasers of the property.

However, the restrictive approach taken in Murphy has prompted attempts to create exceptions to this blanket prohibition against recovery, the most notable being the ‘complex structure theory’. Under the theory, complex structures such as houses are deemed to be composites of distinct elements, and damage to one element of the structure caused by defects in another may give rise to a claim for physical damage. The theory was first raised in D & F Estates by Lord Oliver and Lord Bridge, and adopted by Recorder Jackson QC in Jacobs v Moreton.^[6] A number of problems quickly became apparent with the approach. Consumers purchase such property as a composite whole, and it would be wholly artificial to think of adjacent walls or rooms in a house as constituting separate buildings or forms of property capable of giving rise to distinct private law rights. Moreover, under the approach, contractors owe successive owners of the property a duty of reasonable care to prevent economic loss arising from damage to other parts of the property, and this duty is tied to the part of the house which the contractor supplied. As Sir Robin Cooke points out, this would mean that the smaller the portion of work provided by a contractor, the more likely it is that they will be responsible for any resulting damage to other parts of the property.^[7] It was on these bases that the Court of Appeal in Bellefield Computer Services Ltd v E Turner & Sons Ltd refused to apply the theory,^[8] and that HHJ Humphrey Lloyd QC in Payne v Setchell Ltd held that the approach was no longer tenable.^[9] However, neither D & F Estates nor Jacobs have been overruled despite the passages in Bellefield and Payne. As such, despite judicial criticism, the ‘complex structure’ theory remains good law, although it has fallen by the wayside in the last decade.

The desire to mitigate the harshness of rule against recovery for pure economic loss eventually led to the creation of an exception in Hedley Byrne & Co Ltd v Heller & Partners Ltd.^[10] In an uncharacteristic break from the traditionally restrictive approach to the imposition of liability in this area of law, the House of Lords held that there were certain circumstances in which defendants may owe claimants a duty of care in respect of pure economic loss, specifically where information or advice has been negligently provided. The Hedley Byrne exception requires the presence of two factors: an assumption of responsibility towards the claimant by the defendant, and reasonable reliance upon the advice or information by the claimant. Many have remarked upon the departure from traditional principles taken by the House, and the width of the language employed. Perhaps most notable is Tony Weir, who commented, somewhat uncharitably, that ‘[n]ever has there been such a judicial jamboree as Hedley Byrne where one almost has the feeling that their lordships had been on a trip to Mount Olympus and perhaps smoked a joint on the bus. Something certainly went to their heads, presumably not the merits of the claim, which they dismissed’^[11].

The confusion in the law governing the Hedley Byrne exception is best seen in light of subsequent cases applying and extending the principle arguably in a direction that the House of Lords could not have foreseen in 1964. In Smith v Eric S Bush (A Firm); Harris and Another v Wyre Forest District Council,^[12] the House of Lords considered whether valuers engaged by the purchaser’s mortgagee would owe a duty of care to the purchaser of property, and applied the Hedley Byrne exception during the course of their considerations. Smith uneasily applies the notions of assumption of responsibility and reliance raised in the older case. The paradigm Hedley Byrne scenario involves provision of information by a tortfeasor directly to the claimant, who then relies on that information and suffers economic loss as a consequence. However, no representations were made by the defendant valuers to both claimants – the surveys were prepared for the mortgagees in each case. In fact, the valuer’s report was never read by the purchaser in Harris, who acted in reliance not on the contents of the report, but on the fact that the mortgagee was prepared to lend the requested sum, which he took to mean that the house was worth the proposed purchase price. The House of Lords in the joined appeals nevertheless found that a duty of care existed in both cases. Given the lack of representations, it is difficult to determine the basis for assumption of responsibility as laid down in Hedley Byrne. Lord Templeman in Smith based his decision on the notion that the relationship between the valuers and the purchasers were akin to a contract, but it is unlikely that this tripartite arrangement was within the contemplation of Lord Devlin in Hedley Byrne when he used the phrase ‘equivalent to contract’.^[13] In Hedley Byrne, the parties knew each other and the defendants had no contractual obligation to provide information to any other party; there was no contractual relationship between the valuers and the claimants in Smith. Moreover, as the claimant in Harris did not even read the report, it is difficult to see how he could be said to have placed reasonable reliance upon the contents of that report.

Smith also raises some concerns in relation to characterisation of damage suffered by the claimants. Comparison between D & F Estates and Smith reveals a number of similarities. Factually, both cases involve property with latent defects which caused no separate physical damage, and were between parties with no direct contractual relationship. The nature of these cases was such that there were no concerns of opening the floodgates to indeterminate claims, nor of the claims being of indeterminate sums. However, while the latent defect in D & F Estates was held to be non-recoverable pure economic loss, both valuers in Smith were found liable to the claimants for the economic loss suffered as a result of negligently prepared surveys overstating the value of property with latent defects. As Jane Stapleton notes,^[14] there appear to be different ‘pockets’ of liability determination with different levels of favourability to parties, but under which cases with substantially similar facts may fit. D & F Estates was dealt with under the pocket governing defective property, but Smith was treated as a case under the negligent misstatement pocket, which is often more favourable for the claimant. This begs the question of whether such an approach is principled and desirable in the long run.

The confusion is likely to continue for some time. In 1990, the House of Lords in Caparo Industries plc v Dickman refused to follow the trend for expansion, and held that a negligent auditor owed no duty of care in respect of pure economic loss to existing shareholders or potential investors. Expressing dissatisfaction at the assumption of responsibility tests, their Lordships formulated a three-stage test to determine the existence of a duty of care: the damage must be foreseeable, the relationship between the parties must be sufficiently proximate, and it must be fair, just and reasonable to impose a duty of care. The interrelation between the tests caused considerable confusion,^[15] and was only partially resolved by the House of Lords in Customs and Excise Commissioners v Barclays Bank plc.^[16] Faced with a choice between the Hedley Byrne approach, the three-stage Caparo test and an incremental approach to case law, the court in Customs and Excise Commissioners held that the correct approach was to apply Hedley Byrne, and if no duty arose under this test, to apply Caparo. As such, the contractor performing maintenance work to a building was held to have assumed responsibility which invited reliance by the claimant. Despite the significance of this case, some later cases do not appear to have followed suit. In Robinson v P E Jones (Contractors) Ltd,^[17] after applying the assumption of responsibility test, the Court of Appeal found that the defendant builder owed no duty of care to the claimant purchaser in respect of defects in the house. The three-stage Caparo test was not applied, and no reference was made to Customs and Excise Commissioners. It is difficult to reconcile the two – if a contractor performing maintenance work is deemed to have assumed responsibility which attracts reliance, then a contractor performing building work should logically have assumed responsibility as well.

The desire to mitigate the effects of the blanket ban in Murphy is understandable. In Bellefield, negligent construction by the defendant builder caused the building to be more prone to extensive fire damage, but the Court of Appeal after applying D & F Estates held that the claimant may recover for damage to its possessions within the building, but not the additional fire damage to the building – a decision which even Schiemann LJ in the case considered ‘odd’.^[18] However, judicial development of exceptions to the rule against recovery for pure economic loss has thus far been riddled with inconsistencies, due in no small part to the twin desires to find exceptions to the blanket prohibition in Murphy and conform to existing principles of law.

Bibliography

Footnotes

^[1] [1973] QB 27.

^[2] [1978] AC 728.

^[3] Ibid, at 761.

^[4] [1989] AC 177.

^[5] [1991] 1 AC 398.

^[6] (1994) 72 BLR 92.

^[7] Robin Cooke, An Impossible Distinction (1991) 107 LQR 46.

^[8] (2000) 2 TCLR 759.

^[9] (2001) 3 TLR 26.

^[10] [1964] AC 465.

^[11] Tony Weir, ‘Errare Humanum Est’ in Peter Birks (ed), Frontiers of Liability (Vol. 2, OUP 1994) at p.105(n).

^[12] [1990] 1 AC 831.

^[13] Hedley Byrne n(10), at 528-529, where Lord Devlin quoted the words of Lord Shaw in Nocton v Lord Ashburton [1914] AC 932 at 972.

^[14] Jane Stapleton, Duty of Care and Economic Loss: A Wider Agenda (1991) 107 LQR 249.

^[15] Merrett v Babb [2001] QB 1174

^[16] [2007] 1 AC 181

^[17] [2012] QB 44

^[18] Bellefield n(8) at 763