A Rose by Any Other Name: The Economic Loss Rule and the Independent Duty Doctrine

There has been a lot of buzz about the recent Washington Supreme Court decision in Eastwood v. Horse Harbor Foundation, Inc., 241 P.3d 1256 (Wash. 2010) concerning the economic loss rule. Or, rather, what used to be the economic loss rule in the State of Washington, and which has now been re-named and re-vamped as the independent duty doctrine.

As we all know, the economic loss rule bars recovery in tort for purely economic losses caused by a defective product. In other words, without injury to a person or to personal property, there can be no recovery for pecuniary loss. Several jurisdictions, of which Washington used to be one, subscribe to a more liberal interpretation, finding that the rule barred liability in tort cases between parties who had entered into a contract. The theory behind this expansive approach is that the parties could have built the risk of the loss into the contract. That was approach taken by the Washington Supreme Court previously in Alejandre v. Bull, 153 P.3d 864 (Wash. 2007).

Enter Eastwood, which involved the failure of a tenant to maintain a horse farm and centered on the tortious waste of property. Instead of following their own lead, the Washington Supreme Court performed the legal equivalent of a 180 and renamed the doctrine the “independent duty doctrine,” which now focuses on whether some separate duty of care exists independent of the parties’ contractual relationship, rather than focusing on the harm that was suffered:

In sum, the economic loss rule does not bar recovery in tort when the defendant’s alleged misconduct implicates a tort duty that arises independently of the terms of the contract. In some circumstances, a plaintiff’s alleged harm is nothing more than a contractual breach or a difference in the profits, revenue, or costs that the plaintiff had expected from a business enterprise. In other circumstances, however, the harm is simultaneously the result of the defendant breaching an independent and concurrent tort duty. Thus, while the harm can be described as an economic loss, it is more than that: it is an injury remediable in tort. The test is not simply whether an injury is an economic loss arising from a breach of contract, but rather whether the injury is traceable also to a breach of a tort law duty of care arising independently of the contract. The court defines the duty of care and the risks of harm falling within the duty’s scope.

Opinions about the implications of the new rule run the gamut, including speculation whether it is a new rule at all, or simply a narrowing of the interpretation of the economic loss rule. Indeed, the Eastwood court itself, in a footnote, argued that it was not disturbing “[t]he general rule . . . that a party to a contract can limit liability for damages resulting from negligence.” There is also a difference of opinion as to whether the new approach in Washington is a more, or less, fact-intensive inquiry for a court to undertake.

The real question is, given the wide range of interpretations of the economic loss rule across the country, how many courts will follow Eastwood? Will other states continue to narrow the interpretation? For that matter, how many other states will rename the doctrine something else entirely? Furthermore, will this have any immediate effect on the way parties build risk into their contracts and agreements? At least in Washington, that might be a good idea.

Recent Florida Decision Related to Chinese Drywall Liability — Will it lead the way in other litigation?

On November 5, 2010, Judge Glenn Kelley of the 15th Judicial Circuit for Palm Beach County, Florida ruled in favor of defendant homebuilders on homeowners’ claims that Chinese drywall installed in their houses was defective resulting in economic loss and personal injuries. Bennett v. Centerline Homes Inc., No. 50 2009 CA 014458 (15th Jud. Circuit Fla.) [PDF].

The Wall Street Journal here provides a history of the issues that have resulted from the installation of Chinese-drywall in American homes and the resulting litigation associated with those problems. This article also provides a brief summary of the Bennett decision and poses the question whether it “could set a template for other judges to use to adjudicate drywall cases across the country.” Homebuilders hope so.

This court made several determinations that will be helpful to homebuilders in lawsuits around the country — that is if other courts will follow the principles applied by Judge Kelley. First, Judge Kelley provides that there are two applications of the economic loss rule in Florida — contractual privity economic loss rule and products liability economic loss rule. The Court found that the second, products liability economic loss rule, did not apply to the tort claims asserted by plaintiffs because it only applies where the defect in the product causes damage to the product but does not cause personal injury or damage to other property. Plaintiffs here assert the opposite — no damage to the drywall but personal injury and damage to other property. Despite this ruling, the Court did find that the first application of the economic loss rule — contractual privity economic loss rule — applied here. The Court found that since the damages sought by the homeowners arose out of the contract they entered with homebuilders, traditional contract damages must be applied to the economic losses suffered by the plaintiffs.

Second, Judge Kelley dismissed plaintiffs’ claims for private nuisance because there is no case law relied on by plaintiffs that “support the contention that a nuisance may exist absent a defendant’s exercise of its property rights.” Third, Judge Kelley ruled that strict liability does not apply to improvements to real property as improvements to real property are not considered products and that homebuilders are not in the distributive chain of a product, thus cannot be held strictly liable. This last ruling may be the most significant and, if adopted by other courts in Chinese drywall cases, will work to the advantage of homebuilder defendants in these cases.

What is "Products Liability," Anyway?

This is the question that the Colorado Court of Appeals tried to answer in its recent decision, Carter v. Brighton Ford, Inc., No. 09CA1966, 2010 WL 4361379 (Colo. Ct. App. September 30, 2010). The plaintiff had bought what the Court described as a “high performance automobile” — a Ford Mustang — which contained components manufactured by Saleen, Inc., a company that had a joint manufacturing agreement with Ford. Immediately after buying this fine vehicle, the plaintiff purportedly experienced numerous problems with it.
While we recognize that Ford has come a long way in recent years, there is great debate amongst the contributors here at Abnormal Use. Is the Mustang a “high performance automobile,” as the Court suggests? But, we digress. Judge for yourself:

The plaintiff sued Ford for breach of implied warranty of merchantability and revocation of acceptance under the Colorado Uniform Commercial Code, sections 4-2-314 and 4-2-608, C.R.S. 2010, respectively, as well as claims against Ford and Saleen for violation of the Colorado Lemon Law, revocation, and breach of express and implied warranties. Ford was dismissed after the mechanical defects in the vehicle were determined to be attributable to modifications performed by Saleen. Saleen subsequently ceased operations, which defeated the plaintiff’s claims against Saleen for express warranty on Saleen components. Only the plaintiff’s claims against Ford for revocation and breach of implied warranty remained.
Ford moved for summary judgment, arguing that the plaintiff’s claims were product liability claims and therefore barred by the “innocent seller” statute. The trial court agreed and dismissed his remaining claims. The plaintiff appealed.

The Court of Appeals framed the issue before it as follows:

We are called upon to decide whether the trial court erred in ruling that a product liability action may be based upon a claim for breach of an implied warranty of merchantability and a claim for revocation of acceptance where the product was defective and the only damage suffered by the buyer was the economic loss of the product itself.

After analyzing the Colorado “innocent seller” statute, which bars a product liability suit against a seller unless the the seller is also the manufacturer. The statute does not prevent “other actions” against sellers. The trial court had held that the action against Ford was indeed a products liability action, since causes of action for breach of warranty are based on products liability law.
The court of appeals reversed, holding that “contract claims which seek only economic loss for a defective product without collateral damage or risk of harm to others do not constitute product liability actions.”
The value of the court’s decision itself, in my opinion, is not the decision itself, but the history of products liability law that the court recites in coming to its decision. The court does an excellent job of tracking the development of products liability through the strange marriage of contract and tort law. The court also gives concise summaries of the economic loss rule and the innocent seller doctrines, which several other jurisdictions follow as well. As a result, this decision is worth a read.

Product Liability Claim is Barred by the Economic Loss Doctrine

In New Jersey, where a sophisticated buyer enters into a contract with a sophisticated seller of an allegedly defective product that causes damage to the product itself as well as something other than the product, the buyer’s remedy against the seller may only be contractual. On February 5, 2010, the Third Circuit, in a diversity action, opined that the New Jersey Supreme Court would apply the economic loss doctrine, barring the product liability claims of a manufacturer of food and beverage items against the producer of the raw materials. Travelers Indemnity Co. v. Dammann & Co., No. 09-1225, 2010 WL 395915 (3d Cir. Feb. 5, 2010) [PDF].

The procedural posture of this case would likely bore you and create a lot of extra reading to get the important lesson from this case across to you. That said, I will only briefly recite the basic underlying facts of this case. Dammann is a producer of raw foods, including vanilla beans. Dammann sold IFF vanilla beans, by written contract, for incorporation into IFF’s food and beverage flavoring. IFF incorporated Dammann’s beans into its vanilla extract only later to find out that the beans were contaminated with mercury. As a result, IFF filed claims against Dammann for breach of express warranty, breach of implied warranty, and product liability.

The New Jersey District Court reasoned that IFF’s product liability claim sounded in contract and therefore, the economic loss doctrine barred the application of the New Jersey Product Liability Act to IFF’s claim. IFF appealed. On appeal, the Third Circuit had to determine whether, under New Jersey law, the economic loss doctrine barred claims such as IFF’s claim. The Court stated that no New Jersey case had specifically decided the sort of claim IFF alleged, which involved a defective product, the vanilla bean, and damage to other property, IFF’s flavoring products contaminated with mercury.

The Court found that there were two schools of thought resolving this question. The majority employs some variation of the following test:

Tort remedies are unavailable for property damage experienced by the owner where the damage was a foreseeable result of a defect at the time the parties contractually determined their respective exposure to risk, regardless whether the damage was to the goods themselves or to other property.

On the other hand, the minority test differentiates between damage to the product itself and other property. The Court held that the New Jersey Supreme Court would likely join the majority and apply the economic loss doctrine to bar IFF’s claim. The Court reasoned this way because New Jersey precedent consistently held that “contract law [was] better suited to resolve disputes between parties where a plaintiff alleges direct and consequential losses that were within the contemplation of sophisticated business entities with equal bargaining power and that could have been the subject of their negotiations.” Further, the Court found that IFF alleged damages, including scrapping of contaminated finished flavoring, claims from customers, testing costs, plant cleaning costs, and lost profits were purely economic damages.

Practitioners should be aware of both the majority and minority rules on this issue and be on the look out to see if the New Jersey Supreme Court resolves this issue as the Third Circuit predicted it would rule in this matter.

South Carolina Supreme Court Retreats from Economic Loss Rule Exceptions

Last month, the South Carolina Supreme Court retreated from some exceptions it had previously carved out of the economic loss rule and strongly suggested the possibility that it will find no further exceptions to the rule. In Sapp & Smith v. Ford Motor Co., — S.E.2d —-, No. 26754 (S.C. Dec. 21, 2009), the Court began this new direction by noting that South Carolina continues to follow the economic loss rule in products liability cases:

‘The economic loss rule is a creation of the modern law of products liability. Under the rule, there is no tort liability for a product defect if the damage suffered by the plaintiff is only to the product itself.’ Kennedy v. Columbia Lumber & Mfg. Co., 299 S.C. 335, 341, 384 S.E.2d 730, 734 (1989). In other words, tort liability only lies where there is damage done to other property or personal injury.

Id. In the past, South Carolina courts have developed an exception to the rule for construction of residential homes. See Kennedy, 299 S.C. at 341, 384 S.E.2d at 734. Some of the reasons for the exception were: a home is typically the single largest investment of an individual, a home is a completely different type of manufactured good, and the sale of a home involves inherently unequal bargaining power between the parties. Two years ago, in Colleton Preparatory Acad,, Inc. v. Hoover Universal Inc., 379 S.C. 181, 666 S.E.2d 247 (2008), the court seemed to extend this exception to the construction of commercial buildings, as well.

In Sapp, the plaintiffs involved in the consolidated appeal had each purchased used Ford trucks. The trucks allegedly had a design defect with their cruise control mechanism, which in turn caused the trucks to catch fire. In each case, there was neither a personal injury claim nor a property damage claim (other than to the trucks themselves). Further, in each respective case, the plaintiffs lost at the trial court level due to the court’s application of the economic loss rule. On appeal, each plaintiff argued that the exception outlined in Colleton applied to their cases, and thus, their claims should not be barred by the economic loss rule. The court disagreed, holding that that the economic loss rule barred both plaintiffs’ claims.

The Sapp court went on to overrule the expansion of the exception initially created in Kennedy. In so doing, it expressly overruled Colleton to the extent it expanded the narrow exception to the economic loss rule beyond the residential builder context as pronounced by Kennedy.