Constraints of the Floodgates Principle

What is the distinction between consequential economic loss and pure economic loss in negligence?

Negligence represents the breach of a duty of care which results in damage caused to another. There are two kinds of economic loss in negligence: consequential economic loss and pure economic loss. The fundamental distinction is that the first one comes into place where there is damage to property and financial loss, whilst the second results only in financial losses. On one hand, case law study uses the ‘’Spartan Steel & Alloys v Martin & Co Ltd [1973]’’ to underline what consequential economic loss implies and what damages can be recovered. Martin & Co Ltd were doing excavator works on the claimant’s ground and negligently cut off a power cable which resulted in the factory being deprived from electricity for fifteen hours. The steel which at that moment was in the furnace was rendered unusable and no further shipments could be done in that day. Spartan Steel claimed for the cost of the spoilt metal and for the profits which normally could have been made on sales. The claim was successful because there had been both a physical damage and a parasitic economic loss. Nonetheless, their second claim – for the lost profits on the melts that could have been processed during that day – was unsuccessful, because it had to do with pure economic loss (any purely financial loss arising from defective performance is not generally recoverable) and also, it did not result from any damage to the claimant’s property. On the other hand, pure economic loss implies that there is no physical damage, only financial loss. An example is the case of ‘Hedley Byrne v Heller [1964]’. The claimant, an advertising agency, asked their local bank, National Provincial, to check the financial position and credit-worthiness of Easipower Ltd, one of their customers. A letter was sent from Heller & Partners Ltd, the customer’s bank, headed ‘”without responsibility on the part of this bank’ that Easipower were ‘good for its business arrangements’. When Easipower went insolvent, Hedley Byrne claimed for the financial loss of 17,000 GBP on contracts. A duty of care arose because there was a ‘special relationship’ between the parties amounting to a ‘reasonable reliance’ by the plaintiff on the information provided by the defendant. Since Heller had a disclaimer of responsibility and there was therefore no liability. This case established the doctrine of negligent misrepresentation, but the disclaimer effectively barred the claim.

How does the “floodgates” principle constrain the right of claimants to claim for damages for pure economic loss in negligence?

The ‘’floodgates’’ principle arises from what is usually said than what is done (or omitted to be done) and it applies to economic loss caused by negligent misstatements. If no liability can be imposed, stricter conditions apply, such as: lack of proximity of C to negligent act, damage too remote, potentially indeterminate number of claimants. This principles constrains the rights of claimants in the way that they need to prove that D owed them a duty of care and the duty was breached; the Law does not want to burden the D with liability ‘’in an indeterminate amount for an indeterminate time to an indeterminate class’’. Also, there is a transmissible warranty of quality in absence of any contract. Taking as an example the ‘’Hedley Byrne v Heller [1963]’’ case, which deals with pure economic loss, we can see that it was limited by ‘floodgates’ because: a statement may have more far-reaching effects than a negligent act – Easipower’s local bank wrote in the letter that they have no responsibility for the advice they were giving regarding the company’s financial situation. In addition, the party making the statement – in our case, Heller & Partners Ltd – must have specialist knowledge/expertise in order to give reliable advice, which must be given in circumstances that make it reasonable.

Question 2

Describe the extent of an accountant’s liability to non-clients through the cases of:

Hedley Byrne v Heller (1963)

Caparo Industries v Dickman (1990)

Royal Bank of Scotland plc v Bannerman Johnson Maclay (2003)

An accountant’s liability has to do with professional negligence, but the same conditions apply. There is liability for all forms of damage including pure economic loss. The duty arises from the claimant’s close relationship to or reliance on the defendants. Still, the duty is generally limited because a negligent statement is likely to have more far-reaching effects than a negligent act. In the case of accountants, their misstatements could affect not only the company and the shareholders, but also stakeholders (e.g. investors, creditors, etc) and they could suffer from legal charges because of this. In the ‘Hedley Byrne v Heller’ case, the D-an advertising agency was given a reference from a client’s bank which incorrectly represented the client’s creditworthiness. Trusting this, the agency mounted a campaign for the defendant, but was not paid when the customer-Easipower- went insolvent. The House of Lord described this as a ‘special relationship’ between the D and C, or ‘quasi-fiduciary’ in character and ‘akin to contract’. The bank’s disclaimer prevented such a relationship existing between the parties and was a factor preventing imposition of a duty of care; therefore, the claimant’s reliance was not reasonably foreseeable and the claim was unsuccessful. Nonetheless, what is stated in a disclaimer is very important. In the Caparo Industries v Dickman (1990) case, the D- an accountancy firm which had audited the C’s annual accounts made a negligent error and the claimant, who was both a shareholder and an investor, bought more shares on the strength of the accounts and consequently suffered a loss. The House of Lords stated that a duty of care was owed only to the company and its shareholders, not to potential investors. Although the foreseeability test was passed, the lack of proximity between auditors and potential investors made the claim fail, concluding that there was no liability, in the end. There was no sufficient proximity between the claimants and the defendants, and secondly the accounts were produced for informational purpose and for the shareholders to manage directing the company, not for advising them as to further speculation. In the case of ‘Royal Bank of Scotland plc v Bannerman Johnson Maclay (2003)’, the Ds were auditors of a company (X) that went into receivership with debts owing to the C. It was claimed that, due to a fraud (by X), the accounts of previous years had misstated the financial position of the company and that the C negligently did not detect it. The claim succeeded on the basis that Bannerman Johnstone Maclay knew the use to which the information would be put and that D intended to rely on it for the known purpose. But, the House of Lords stated that, for a duty of care to exist, there must be an express assumption of responsibility to the third party by the auditor. Therefore, this decision confirms and stresses that it is possible for a duty of care to be established even in the absence of such an intention by the advice-giver, provided that there was actual or deemed knowledge that the information was likely to be relied upon by the third party for a known purpose.