The Economic Loss Rule: An Under-Utilized But Not-So-Secret Weapon

In a decision issued on March 7, 2013, the Supreme Court of Florida reaffirmed Florida’s commitment to adherence to the economic loss rule in product liability litigation. In Tiara Condominium Association, Inc. v. Marsh & McLennan Companies, Inc. etc., et al., No. SC10-1022, the high court provides a helpful discussion of the origin and development of the economic loss rule. In summary, the economic loss rule is described as “the fundamental boundary between contract law, which is designed to enforce the expectancy interests of the parties, and tort law, which imposes a duty of reasonable care and thereby encourages citizens to avoid causing physical harm to others.” Thus, economic loss has been defined by Florida courts as “damage for inadequate value, costs of repair and replacement of the defective product, or consequent loss of profits – without any claim of personal injury or damage to other property.” In other words, economic losses are “disappointed economic expectations,” which are protected by contract law, rather than tort law.

Despite the rule’s underpinnings in the product liability context, the economic loss rule has also been applied to circumstances when the parties are in contractual privity and one party seeks to recover damages in tort for damages arising in contract.

In a product liability context, the economic loss rule was developed to protect manufacturers from liability for economic damage caused by a defective product beyond those damages provided by warranty law.  In discussing the development of economic loss rule principles, the Florida Supreme Court analyzed the California Supreme Court’s holding in Seely v. White Motor Co., 403 P.2d 145 (Cal. 1965). In Seely, the California Supreme Court held that the doctrine of strict liability in tort did not supplant causes of action for breach of express warranty.

In that case, the court was confronted with a situation in which plaintiff sought recovery for economic loss resulting from his purchase of a truck that failed to perform according to expectations. The court concluded that the strict liability doctrine was not intended to undermine the warranty provisions of sales or contract law, but was designed to govern the wholly separate and distinct problem of physical injuries caused by defective products. In East River Steamship Corp. v. Transamerica Delaval, Inc., 476 U.S. 858 (1986), the U.S. Supreme Court adopted the reasoning of Seely when it considered the issue of economic loss resulting from defective products in the context of admiralty.

According to the Supreme Court, when the damage is to the product itself, “the injury suffered – the failure of the product to function properly – is the essence of a warranty action, through which a contracting party can seek to recoup the benefit of its bargain.” Recognizing that the extending strict product liability law to cover economic damages would result in “contract law… drowning in a sea of tort,” the Supreme Court held that “the manufacturer in a commercial relationship has no duty either under a negligence or a strict products liability theory to prevent a product from injuring itself.” Thus, from the outset, the focus of the economic loss rule was directed to damages resulting from defects in the product itself.

In a  Client Alert, dated July 5, 2011, Stites & Harbison lawyers John L. Tate and Cassidy R. Rosenthal wrote about the Kentucky Supreme Court’s adoption of the economic loss rule in Giddings & Lewis, Inc. v. Industrial Risk Insurers (6/18/11). The Court unanimously held that “a manufacturer in a commercial relationship has no duty under a negligence or strict products liability theory to prevent a product from injuring itself.” The Court wrote: “We believe the parties’ allocation of risk by contract should control without disturbance by the courts via product liability theories.”

As discussed by Mr. Tate and Ms. Rosenthal, in Giddings & Lewis, the manufacturer sold a sophisticated machining center to an industrial concern. The parties set forth their mutual obligations in a detailed commercial contract. After seven years of continuous operation, and after the contract’s express warranty expired, the machining center malfunctioned in a spectacular fashion – throwing chunks of steel weighing thousands of pounds across the factory floor. The costs to repair the machining center and to get the business up and running again were almost $3 million. After reimbursing the machine’s owner for its losses, a consortium of insurance companies asserted a subrogation claim against the machining center’s manufacturer. With the warranty expired, the insurance companies sued in negligence, strict liability, negligent misrepresentation, and fraudulent misrepresentation. What could be more tortious conduct that this?  

Applying the economic loss doctrine, the Kentucky Supreme Court agreed with Mr. Tate holding that the purchaser could not recover from the manufacturer under any tort theory. The consortium was limited to contractual remedies, all of which expired years earlier.

Despite such groundbreaking decisions, is the economic loss rule  under-utilized in products liability and commercial litigation today?  Of course, if personal injury results from an alleged defect, the rule does not apply. However, not infrequently, complaints alleging damages arising from a defective product that purportedly caused economic loss sound in negligence or strict products liability. Are defense lawyers seeking dismissal of these tort claims on the basis of the economic loss rule as often as they should?.