What is in Fact Economic Loss

Let us begin with the question: What is in fact “economic loss” for which a party, individual or a company, is liable under law? The answer is:

Economic loss is the financial loss suffered by a party that is caused through a web of economic relationships in which the party is involved.

The economic loss rule states that a plaintiff cannot recover damages for a pure financial loss. The comparative study of the pure economic loss rule reveals that in different jurisdictions, the legal definitions of the rule frequently lump together diverse situations. The actual significance of the notion of economic loss varies considerably across Western legal systems. Legal doctrines provide little insight as to why liability should, or should not, be denied. On the other hand, economic models of liability provide some valuable guidance for classifying different categories of economic loss, and identifying cases in which denial of recovery for economic loss would lead to inefficient outcomes. A law and economics analysis shows that a key factor in determining the optimal scope of the economic loss rule is in the relationship between pure economic loss and social loss. Economic loss should be compensable in torts only to the extent that it corresponds to socially relevant loss. After identifying several factual categories, this paper characterizes the optimal level of liability with reference to the relevant economic and social loss components and the resulting optimal incentives to reduce risk. In a few situations, the application of the optimal liability rule finds obstacles in entrenched principles of civil liability. Generally, however, the legal applications of the economic loss rule are consistent with the ideal liability rule identified by the economic model.

LIABILITY FOR ECONOMIC LOSS

The topic of this thesis relates to the analysis of economic loss liability. In particular, it is concerned with the question of how the courts should approach the duty issue in a novel economic loss case. It is intended that the thesis involve a comparative analysis of the current approaches of the English, Australian, New Zealand and Canadian courts. The aim is to examine the Commonwealth courts treatment of economic loss with a view to identifying the most appropriate method of dealing with novel cases. It is, however, found that not one of the approaches presented by the appellate courts in these four jurisdictions could be described as the appropriate method for determining the duty question. The search for the model approach could not be confined to English, Australian, New Zealand and Canadian experiences. It is necessary to embark on a consideration of issues and concepts which were basic and fundamental to the common law. So what began as a comparative analysis also became a critical appraisal. In terms of structure, the thesis is divided into two parts. Part One presents the current approaches of the English, Australian, New Zealand and Canadian courts to determining the duty issue in a novel economic loss case. Using the analysis undertaken in the first part to set the context, the Part Two endeavours to present the appropriate approach. In the course of the analysis undertaken in Part One, it is seen that there are two principal areas of concern which must be addressed before a model approach can be presented. They can be summed up as follows:

The question of what is the appropriate doctrinal basis for the imposition of liability for economic loss and the development of the law relating to economic loss; and

The question of what is the role and relevance of policy considerations in determining the duty issue in an economic loss case.

The conclusion reached is that liability for the negligent infliction of economic loss must be imposed in accordance with a moral standard which underlies all negligence cases and the law must develop in a manner which ensures a consistent and coherent application of this standard. Accordingly, in most cases, the bounds of liability will be determined by moral or ethical considerations. The relevance of non ethical or public policy considerations as a determinant of liability is not denied. However, the circumstances in which such considerations will operate to override a determination that the plaintiff has a moral right to recover for the economic loss suffered are limited.

1.1 Pure Economic Loss in Negligence

This work deals with when compensation for the tort of negligence is considered to be the correct response to pure economic loss caused to the plaintiff by the defendant. It is known that English law has had problems dealing with cases of pure economic loss. A useful recent trend has been to emphasise that pure economic loss cases can be sub-divided into categories

where different policy issues might hold an impact. Professor Feldthusen [1] has suggested the following five categories:

Independent liability of Statutory Public Authorities;

Negligent Misstatement;

Negligent Performance of a Service;

Negligent Supply of Shoddy Goods or Structures;

Relational Economic Loss.

So far English judges have not followed this analysis. Indeed the most recent case law suggests that categories 2) and 3) overlap to some extent, and there is no liability for 1), 4) or 5). Nevertheless we should still heed the lesson that the factors which make pure economic loss cases difficult may not be the same in all cases.

In approaching this topic one might want to bear the following questions in mind:

What is the difference between “economic loss” and “property damage”? Are there different types of “pure economic loss”, some of which are more worthy of protection than others?

What is the difference between “statements” and “conduct”? What is the difference between providing a service and providing goods? Should these differences be legally significant?

What does it mean to say that a relationship is “best governed by contract”? Does it always mean the same thing? What is the “privity fallacy”?

What are the policy reasons for restricting recovery of pure economic loss in negligence? Are these reasons the same in each category of cases?

What is the role of the “assumption of responsibility” concept? Does it provide any guidance?

1.2 Designer’s Liability for Economic Losses

The 2001 case of Payne and Others -v- John Setchell Limited confirmed that (as a matter of policy) in the absence of contractual provision to the contrary, any person negligently performing work or services in the course of a construction process was ordinarily only liable for non-economic losses.

In the law of tort professionals have a duty to their clients to exercise the reasonable care and skill of a qualified person in the matter with which they are dealing. Professionals are negligent when they are proven to have fallen below this standard.

In the construction industry, non-economic losses are those losses caused by negligent design or construction that results in damage to other property or personal injury to individuals. As it is said in the beginning:

Economic loss is the financial loss suffered by a party that is caused through a web of economic relationships in which the party is involved.

Examples of economic losses include:

Those losses incurred where a negligent design results in a building being worth less than anticipated; and,

Where delay is caused to the contractor’s programme as a result of having to rectify a negligent design that results in the contractor failing to meet the project deadline and incurring losses to the employer.

1.3.1 Past Notions

In the Payne case, Payne claimed damages from Setchell for negligence for breach of duty for the design and installation of new raft foundations with fixed steel reinforcement for a cottage. The cottage was built in reliance upon a specification that was prepared by Setchell. Payne subsequently obtained a structural engineer’s report which stated that the raft foundations of the cottage had tilted, and that each required substantial underpinning. The Court ruled that Setchell was only liable for the diminution in value of the cottages measured by the cost of remedial works and not the further economic losses claimed by Payne.

Therefore, as a result of the decision in the Payne case, a designer was not liable to an employer for economic losses unless a contract, such as a collateral warranty, provided otherwise.

1.3.2 Present Notions

The Mirant Asia decision appears to have changed this. Ove Arup, a designer, was found to have breached its duty of care to Mirant Asia by negligently designing the foundations of a boiler house in the Ove Arup was found to be liable to Mirant Asia, the employer, for both economic and non-economic losses.

1.4 Designers

So the designer’s pre-notation position is clear, the negligent designer is liable in tort to the employer for economic losses. The negligent designer is also liable in tort to the employer for economic losses in those situations where the designer has single point responsibility and is effectively acting as contractor.

1.5 Contractors

What is the position of a contractor undertaking a construction project under the JCT (With Contractor’s Design) Contract? One interpretation of the decision in Mirant Asia is that the design and build contractor is not liable to the employer for economic loss because it is not considered to be a “professional” whereas the designer is. It seems unreasonable to make this distinction because the design process is as likely to be undertaken by contractors as by designers (be they architects or consultants).

Further, it is the standard practice in projects procured under a “Design and Build” Contract that the designer agrees to be novated from the employer to the contractor in return for the contractor assuming responsibility for the design and construction of the project. Following the decision in this case, the position may be that even though the contract has been novated the designer remains liable to the employer for economic losses whereas the contractor is not.

1.6 Engineers

What is the position of the engineer? Is the engineer considered a “professional” and therefore should it be treated in the same way as the designer once the contract has been novated? Like the designer, under a “Design and Build” Contract the engineer agrees to be novated to the contractor in return for the contractor assuming responsibility for its designs. Would the Courts impose a duty of care on the engineer to the employer for economic loss despite the fact the contractor has agreed to take responsibility for the engineer’s designs at novation? Unfortunately as a result of the Mirant Asia decision the position of the negligent designer or engineer, post-novation, is now unclear.

1.7 Practical advice

1.7.1 Drafting

The duties outlined above are only likely to be relevant in situations where,

There is no contract;

The contract is silent as to, or does not adequately define the relationship between the parties (in respect of liability for economic losses); or,

A contractual limitation date to make a claim has passed. Should a dispute arise, the precise wording of the contract could be very persuasive to a Court. Therefore, when drafting contracts designers should attempt to exclude liability for economic losses. This may not necessarily be acceptable to contractors or employers.

1.8 Disclaimer

A designer is unlikely to be found to be negligent, and therefore be liable to the contractor or employer for losses if his designs contain a disclaimer that the designs should not be relied upon. Once again such a disclaimer is unlikely to be acceptable to either a contractor or an employer.

MANUFACTURER’S LIABILITY AND THE ECONOMIC LOSS DOCTRINE

Historically, a manufacturer or seller of defective chattels was not liable to persons injured using the product unless a contractual relationship existed. The rule originated in England and operated to limit a manufacturer’s liability to immediate purchasers if a product turned out to be defective, dangerous or hazardous to health. The rule was known as the “privity limitation,” and was utilized in the U.S. until a famous New York court decision wiped it out in 1916. That court opinion ushered in the so-called consumer movement. Consumers could now sue manufacturers and hold them accountable for negligence in manufacturing faulty products as well as negligence in design. But, there are at least three situations that a particular farmer or rancher may face in which they will be limited in their ability to sue a manufacturer on a product liability claim:

Pre-emption under the Federal Insecticide, Fungicide and Rodenticide Act (which applies to the use and application of registered pesticides) [2] ;

When the buyer alters purchased products and alters them or when multiple component parts are purchased individually, but are then later combined to make a complete system; and

The “economic loss” doctrine. It’s that last exception that has hit the courts again recently involving a Michigan farmer.

Under the “economic loss” doctrine, product defects that damage only the product itself, or make the product useless and the losses are purely economic are not within the domain of product liability law. Most courts say that the rule applies equally to consumer as well as business purchasers. Thus, these types of cases are to be decided under contract law, with contract-based damages. The question is what the purchaser contracted for (if what was purchased was insured, the insurance company is liable for the loss).

The “economic loss” doctrine has led to some interesting insurance cases involving agricultural products in recent years, and a new case illustrates that insurance companies are still trying to pass the buck to the product seller. In one case from Kansas in 1999, a farmer bought a self-propelled combine and insured it against fire loss. The combine engine malfunctioned, triggering a fire which destroyed the combine. The farmer filed a claim with his insurance company and the company paid the claim, but then brought a subrogation action against the engine manufacturer to recover on the amount paid to the insured. The insurance company (Kansas Farm Bureau) said they shouldn’t ultimately have to take the loss because the engine wasn’t a component part of the combine. The trial court disagreed, holding that the engine in a self-propelled combine is a component part of the combine and that the insurer was liable on the claim. The economic loss doctrine applied to bar the tort liability of the manufacturer. The appellate court affirmed and the Kansas Supreme Court declined to hear the case.

A brand new case involves the same basic set of facts. A farmer bought a used John Deere tractor from an implement dealer and when he turned the cab’s exterior lights on, the tractor caught fire and was destroyed. The farmer had insured the tractor with the plaintiff and the plaintiff paid the farmer $136,500 after the farmer paid his $1,000 deductible. The plaintiff then sued John Deere to recover the money it had paid out under the policy. John Deere argued that the “economic loss” doctrine barred the plaintiff’s suit, but the plaintiff claimed the doctrine didn’t apply to unsophisticated consumer purchasers who lacked privity with the manufacturer. But, the court agreed with John Deere, noting that the “economic loss” doctrine applies based on the type of loss rather than whether privity is present. The court also said the doctrine applies to consumer transactions. So, the court dismissed the plaintiff’s complaints based in negligence and product liability with prejudice (that means that the plaintiff cannot file another case on those claims). The plaintiff’s claim based on breach of warranty continues, that’s a contract-based claim. (See Farm Bureau Insurance v. Deere Company, No. 1:08-CV-922, 2009 U.S. Dist. LEXIS 2595 (W.D. Mich. Jan. 14, 2009).

EXCEPTION TO ECONOMIC LOSS RULE

3.1 Tort Liability and Repair Contractors

With regard to construction defect claims resulting from faulty installation or defective materials, property owners have traditionally sought relief based on breach of contract and negligence claims. Recent cases have held, however, that negligence claims cannot be asserted given that construction defects arguably result in economic losses versus property damage and are, therefore, precluded by the “economic loss rule.”

Given the above, contractors under contract with an owner can effectively limit, or manage, their risk within the terms of the contract and (arguably) need not worry about claims in negligence. Furthermore, and with regard to subsequent purchasers with whom there is no contract, the economic loss rule precludes negligence claims and the absence of a contract (arguably) precludes all contract-based claims.

However, there is an exception to the economic loss rule (the “other property” exception) that provides that contractors/subcontractors who perform repairs, renovations or improvements to existing structures (which arguably includes the original contractor who returns to repair defects in its work) will possibly be subject to tort-based liability (regardless of whether the claim is asserted by the original owner or a subsequent purchaser) if the repairs, renovations or improvements cause damage to the existing structure.

PURE ECONOMIC LOSS

Here I would like to achieve two goals with this project. First, I want to present an overview of the various legal systems with regard to their position on “pure economic loss” (is it a specific issue? and if so: how is it dealt with?). Second, I aimed at analyzing the arguments and legal reasoning put forward to restrict or exclude claims for pure economic loss altogether. The analysis had to be threefold:

A comparative legal analysis

A law and economics analysis and

An analysis from the insurance practice angle.

Furthermore, some specific topics have been dealt with in more detailed contributions (e.g. prospectus liability, auditor’s liability).

4.1 Pure Economic Loss and Possible Approaches

Although there is no common definition of “pure economic loss”, it is generally understood to deal with matters of tortious liability for loss that is neither consequential upon death nor personal injury of the claiming victim nor upon the infringement of the victim’s property. But other than that, the various topics that are dealt with under the heading of “pure economic loss” seem to have little in common. The concept of “pure economic loss” covers very dissimilar subjects such as liability for negligent statements (on which the plaintiff reasonably relied), ricochet damage to third parties in case of personal injury, and liability for inducing (or profiting from) breach of contract. “Pure economic loss”covers a wide variety of legal problems that are not dealt with in a homogenous way in the various legal systems.

Nevertheless, the following main categories seem to fit under the umbrella of “Pure Economic Loss”:

Pure Economic Loss related to damage to objects or persons:

A factory that suffers a production halt due to a power cut is said to suffer pure economic loss if the power cut does not result in physical damage to the factory’s machinery. The damage to the power cable is of course of a physical nature, but this damage is – generally speaking – not suffered by the factory but by the owner (the Power Company). Can the factory claim for the loss of profits even if its machinery is not damaged?

Inflicting death or injury will result in financial loss to the primary victim, but it will also cause relational losses, e.g., the victim’s family members may suffer loss of income, an employer suffers loss of turnover, money lenders will suffer loss on instalments et cetera. Can all or some of these ‘third party victims’ claim from the liable party?

Pure Economic Loss by reliance:

An investor that relies upon the certified balance sheet of a company suffers pure economic loss if his investment in the company turns out to be a bad investment. Can he claim from the negligent accountant that audited the accounts (assuming that this negligence in fact caused the reliance and the bad investment)?

A buyer of a house relies upon a survey report, which turns out to be negligently drafted. Should there really be a difference in liability of the surveyor dependent on whether there was a contract between the buyer and the surveyor or not (e.g. because the report was commissioned by the seller)?

How do the legal systems respond?

The European legal systems seem to respond to the problem of “Pure Economic Loss” in very different ways. There seem to be three possible responses:

Claims for pure economic loss are barred altogether in tort law (i.e. the exclusionary rule),

Claims for pure economic loss are dealt with as any other claim (notably any claim for death, personal injury or damage to physical objects), or

Claims for pure economic loss are allowed in principle, but in practice the thresholds do turn out to be higher than in case of death, personal injury or damage to physical objects (e.g. the threshold of causation seems to be higher).

Any combination of responses is possible, and, admittedly, there are other approaches as well. For example, where strict application of the exclusionary rule in tort leads to a clearly unsatisfactory outcome, some legal systems tend to broaden the scope of contract law to reach reasonable results. And sometimes there are specific statutory provisions (e.g. on auditor’s liability, prospectus liability) that fill the gap left by the exclusionary rule.

PRINCIPLES OF EUROPEAN TORT LAW

The founders of the European Centre of Tort and Insurance Law, the European Group on Tort Law, are pursuing the most ambitious project: the drafting of “Principles of European Tort Law”. The aim of this broadly-based comparative research is to create the foundation for discussing a future harmonisation of the law of tort in the European Union, above all with respect to a possible codification of European Private Law. Further, the “Principles” shall form a stimulus for both academics and practitioners and could serve as a guideline for national legal systems, thereby leading to gradual legal harmonisation. Finally, the present isolated tort law regulations, which are at times themselves contradictory, requires a uniform concept from the European Union.

In order to attain the necessary overview of the various legal systems, written country reports on the tort law questions to be examined have been prepared. These individual country reports address abstract issues as well as hypothetical cases. This methodology takes into account the legal systems of most of the countries of the European Union, some Eastern European countries, as well as Switzerland, which is currently involved in a reform of the law of tort. This work is positively supplemented by contributions from the legal systems of the USA, Israel, and South Africa. South Africa in particular, with its mixed system based on continental and English law, can provide valuable experience concerning legal harmonisation. With regard to the eastern expansion of the European Union, a co-operation with these countries in the fields of legal integration is of particular significance.

These country reports are supplemented by a comparative report in which the similarities and differences between the tort law regulations in the individual countries are presented. This basis forms the starting point for the drafting of the Principles which could be acceptable for all of the legal systems examined. Due to the diversity of the legal systems under question, it is rarely the case that, in this work, uniform regulations already exist. Rather, existing solutions require further development, or even new solutions have to be sought.

TORT LAW AND LIABILITY INSURANCE

Already for a longer period of time the mutual instruments of tort and insurance had considered as highly important. A project in which these interdependencies between liability law and insurance would be examined more closely had been on the agenda of the Centre for a longer period of time. It is definitely a project and topic which is of high importance.

Indeed, one has often heard claims that the expanding liability law, which we can notice today in Europe, would to a large extent be due to the increasing possibilities of insurance. Hence, this argument holds that insurability leads to increased liability. Some even hold that in specific cases a judge would take into account the specific availability of insurance when deciding a case. Assurance oblige, this is sometimes referred to.

Mutual dependencies between tort and insurance should, however, not necessarily give rise to an expansion of liability. Indeed, in some cases pleas can also be heard in favour of a limitation of liability, in order to keep a risk insurable. Thus one can hear some people explicitly argue that insurability should be an argument that one should take into account to determine the scope of liability. Some have even argued in favour of financial caps (limits on liability) because unlimited liability would be uninsurable.

Although these issues are definitely highly topical and important, both from an academic as well as from a policy perspective, it is less easy to determine how a project examining these specific issues should be set up. More specifically, the question arises how these issues could be examined in a comparative perspective.

Indeed, one problem is that many practising lawyers, insurers, and academics may have a “feeling” that tort law and insurance are mutually dependent upon each other, as was sketched above. However, very often these types of dependencies might not appear in the texts produced. Therefore it may be less easy to determine to what extent e.g. in a specific case the judge actually did take into account the availability of insurance when deciding the liability issue. This project in that respect is thus different from the ones dealt with so far by the Centre.

6.1 EU and Pure Economic Loss

EU through ECTIL [3] would like to achieve two goals with this project. First, want to present an overview of the various legal systems with regard to their position on “pure economic loss” (is it a specific issue? and if so: how is it dealt with?). Second, aim at analyzing the arguments and legal reasoning put forward to restrict or exclude claims for pure economic loss altogether. The analysis had to be threefold: (1) a comparative legal analysis, (2) a law and economics analysis and (3) an analysis from the insurance practice angle. Furthermore, some specific topics have to be dealt with in more detailed contributions (e.g. prospectus liability, auditor’s liability).

6.2 Liability for and Insurability of Biomedical Research with Human Subjects in a Comparative Perspective

The Health Research and Development Council of the Netherlands, the research agency of the Dutch Ministry of Health, Welfare and Sport, has issued this research project concerning the possibilities and the limitations of the way biomedical research with human beings is actually insured in the Netherlands.

Part of this study is a comparative research concerning the liability for biomedical research involving human subjects and its insurability in Belgium, England, Germany, France, Spain, Sweden and Switzerland and the actual functioning of the liability and insurance systems in these countries, as far as information is available. Within the framework of this comparative research, these issues have been addressed by several country reports. Particular concern has also been given to insurance and economic aspects.

6.3 The Impact of Social Security on Tort Law

This study gives valuable insights into the complex interaction between social security law and private tort law. It is based on reports from eleven European countries, namely Austria, England, France, Germany, Greece, the Netherlands, Italy, Switzerland, Spain and Sweden. Leading experts from these jurisdictions provide a comprehensive overview of the social security systems in their countries and identify the important differences between social security and tort law compensation in the field of personal injuries.

The interrelation between both branches of law is reviewed with respect, e.g., to accidents in the occupational sphere, contributory negligence, recourse actions and bulk agreements between public and private insurance schemes. An extensive comparative report highlights the European perspective and the general interplay between social security law and tort law. The legal perspective is supplemented by an economical analysis of both systems.

6.4 Damages for Non-Pecuniary Loss in a Comparative Perspective

How should loss, which cannot be expressed in money, be compensated? How should pain be financially assessed? Questions which are increasingly gaining significance. This study focuses on bodily injury, non-pecuniary loss and compensation in an overview of the various provisions in Europe written by leading international experts as authors.

At the centre is non-pecuniary loss. These losses, not measurable in money, are examined in country reports written by leading international experts. These reports are supplemented by a comprehensive comparative report and a discussion concerning the harmonisation or standardisation of compensation for non-pecuniary loss.

The questions of to what extent the various European legal systems have general principles in the area of non-pecuniary loss or whether there are rather special provisions for certain circumstances are dealt with. In this context the study examines how far the presence of such special provisions allows conclusions concerning the position or the significance of non-pecuniary loss in the various legal systems.

Whether, and to what extent compensation of non-pecuniary loss is seen as a necessary function or is only regarded as secondary in comparison to compensation for loss of income and expenses is also analysed. Special significance is given to the admissibility, in principle, of and the provisions relating to the compensation of non-pecuniary loss in the case of bodily injury.

6.5 Employers’ Liability and Workers’ Compensation

The European Centre of Tort and Insurance Law (ECTIL) with support by the Institute for European Tort Law embarked already in 2009 on a Comparative Project on Employers’ Liability and Workers’ Compensation. The study – conducted in English and led by Ken Oliphant (Institute for European Tort Law, Vienna) and Gerhard Wagner (University of Bonn) – will consist of reports from Austria, Australia, Denmark, France, Germany, Italy, Japan, the Netherlands, Poland, Rumania, the United States of America and the United Kingdom. With regard to content the study will focus on the compensation of occupational diseases and accidents. Issues like discrimination, moral or sexual harassment and other damages claims of employees against their employer will be dealt with in the reports for countries where these issues ar