The Negligent Misrepresentation Exception to Economic Loss Rule: The Information v. Tangible Product Dichotomy

The economic loss rule bars recovery in tort where the claim is essentially one for breach of contract.  Lincoln Park West Condominium Association v. Mann, Gin, Ebel & Frazier, 136 Ill.2d 302, 307 (1990)(economic loss rule generally).  “Economic loss” means (i) damages for inadequate value, (ii) costs of repair and replacement of the defective product, (iii) consequent loss of profits without any claim of personal injury or damage to other property or (iv) the diminution in the value of the product caused by its defect.   Id.

Where a contract governs the parties’ relationship, the proper remedy for a breach is generally a breach of contract action; not a negligence claim.  A crude example: plaintiff enters into contract for defendant to supply 50 pieces of computer hardware.  Defendant fails to do so.  Plaintiff’s remedy is a breach of contract suit; not a negligence action.

The main exceptions (meaning, situations where the economic loss rule won’t defeat a tort claim) to the economic loss rule are (1) the fraud exception: the claim is based on defendant’s fraudulent conduct; (2) the sudden or dangerous occurrence exception: plaintiff’s claim results from a calamitous event (like a flood or explosion); (3) the “extra-contractual” exception: attorneys and accountants owe clients fiduciary duties that go beyond the scope of the contract; and (4) the negligent misrepresentation exception: a tort claim will lie against a defendant who makes a negligent misrepresentation and who is in the business of providing information for the guidance of others in their business transactions. 

In Stewart Title Guaranty Company v. Inspection and Valuation International, Inc., 2013 WL 5587293 (N.D.Ill. 2013), the Court found that the negligent misrepresentation exception did not apply to deficient construction management services on a hotel renovation project.

The plaintiff – assignee of mortgage lender on hotel development – sued a construction manager for negligence in failing to properly monitor the hotel development.  A written contract required the construction manager to manage all aspects of the project.  The plaintiff alleged the defendant failed to properly supervise the project and misrepresented the project’s status, budget issues and quality of the work.

The defendant moved to dismiss the negligent misrepresentation claim based on the economic loss rule.  The defendant’s key argument was that since a written contract governed the parties’ relationship (the construction management contract), the plaintiff’s remedy was a breach of contract action; not a claim for negligence claim. 

Held: motion to dismiss granted.  Plaintiff’s negligent misrepresentation claim is barred by economic loss rule.

Why?

The negligent misrepresentation exception to the economic loss rule applies where (1) defendant is in business of supplying information for the guidance of others in their business dealings; (2) defendant provided information that constitutes a misrepresentation; (3) defendant supplied information for guidance in plaintiff’s business dealings.  *5.

The critical question in determining whether the exception applies is whether the parties’ relationship will culminate in the creation of a tangible product.  If it does, the economic loss rule will bar recovery.  If it doesn’t (meaning, the end product is intangible “services”), the plaintiff may have a viable negligence claim.  

The First District sided with the defendant and held that, as part of its contractual management duties, the defendant was hired to cull engineering and architectural drawings, plans and data and incorporate that information into a tangible product – namely, the renovated hotel.  Any information supplied by the defendant was incidental to and merged into the building itself. 

The Court rejected plaintiff’s argument that defendant was an information-producing “consultant” to the project whose main role was to “advise” the plaintiff.  The Court ruled that since any information provided by defendant was incorporated into the hotel structure, any information provided was insignificant.

Comments: Where the main purpose or end result of a given contract is a palpable product – as opposed to advice giving, consulting or information – the economic loss rule will apply and defeat a tort suit.  The Court does acknowledge though that in certain instances, a contract involving an architect, engineer or contractor – usually quintessential tangible product contracts – can meet the  negligent misrepresentation test if the contract is purely for consulting/advising. 

General Contractor’s Bankruptcy Filing Means Extra Time For Subcontractor To File Lien Suit

Section 34 of the Illinois Mechanics Lien Act (770 ILCS 60/34) presents a way for an owner to quickly dispose of a contractor’s lien recorded against his/her property. Typically, the owner serves the Section 34 notice and the contractor must either sue to foreclose its lien within 30 days or it loses the lien.

But what if after the owner sends a Section 34 notice, the general contractor (who hired the subcontractor) files bankruptcy before Section 34’s notice period ends?  Does the clock stop or does it keep running?

According to Lesniak v. Wesley’s Flooring, Inc., 2013 IL App (1st) 122146-U, the clock stops until the bankruptcy case is resolved.

The subcontractor defendant was hired by a general contractor to do flooring work on plaintiff’s Chicago residence.

After completing the flooring work, the subcontractor liened the home to secure payment.  The homeowners sent the subcontractor a Section 34 notice.  The general contractor filed for bankruptcy protection during the 30-day notice period.

When the subcontractor failed to sue, the homeowners sued the sub to quash its lien.

The trial court granted plaintiffs’ summary judgment motion on the basis that defendant subcontractor failed to file suit within Section 34’s thirty-day period forfeited its lien. 

Held: Summary judgment for homeowners affirmed; but for a different reason.  

Reasoning:

The Court held that the general contractor’s bankruptcy filing does toll the subcontractor’s 30-day period to file suit.  This is because of the automatic stay that applies once a party files bankruptcy. 

Since a general contractor is a necessary party to a subcontractor’s lien action (770 ILCS 60/28), the subcontractor would violate the automatic stay by suing to foreclose its lien after the general contractor filed bankruptcy.  ¶¶ 20-23.  The subcontractor must wait until the general contractor’s bankruptcy stay ends or is lifted to sue on its lien. 

But the Court did affirm summary judgment for the plaintiffs-homeowners under Section 5 of the Act (770 ILCS 60/5).  Section 5 aims to protect an owner from paying twice for the same work.  It requires the owner to demand from the contractor – prior to payment – a sworn statement that details all subcontractors who worked on a given project.  ¶ 14. 

Section 5 imposes a reciprocal duty on the contractor to provide an owner with a sworn statement as a condition to payment.  An owner is entitled to rely on a contractor’s affidavit when making payment and is insulated from unknown subcontractor claims so long as the owner had no knowledge the contractor’s affidavit is false. ¶ 24; 770 ILCS 60/27. 

Here, the bankrupt general contractor provided the plaintiffs with sworn statements that failed to list defendant/sub’s identity or amounts owed it.  Moreover, according to the plaintiffs’ uncontested affidavit, they never received notice of subcontractor’s lien until several months after they paid the general contractor in full.  The Court found that because plaintiffs had fully paid the contractor and had a zero balance on the prime contract  when they received the sub’s lien notice, the sub’s lien claim was invalid.  ¶ 26.

Take-aways:

1/ A general contractor’s bankruptcy stays a subcontractor’s 30-day time period to sue on his lien after receiving a Section 34 notice;

2/ Subcontractors must be vigilant to ensure a general contractor is providing an owner with accurate sworn statement information.

Contractual Exculpatory Provisions and Procedural and Substantive Unconscionability – Some Illinois Bullet-Points

Exculpatory and limitation of damages provisions are staples of commercial transactions; especially in the service contract setting.  The former shields a contracting party from all liability (“if something goes wrong, I’m not responsible”), while the latter caps a party’s monetary damages (“if something goes wrong, my maximum liability is $100”).

For decades, cases across the land have grappled with the validity and enforceability of these contract terms.  Generally, whether a given disclaimer is upheld comes down to a fact-specific analysis of the terms’ prominence and text size (can you find it?) along with the nuances of the parties’ relationship. (is a dominant person taking advantage of a more vulnerable person?)

 Exculpatory Provisions

Illinois favors freedom of contract and exculpatory provisions are generally enforceable unless (1) it’s against public policy to do so or (2) there is something in the social relationship of the parties which weighs against enforcing the term.

Exculpatory terms are not favored and must be strictly construed against the benefitting party, especially where that party drafted the contract.

An exculpatory clause violates public policy where (1) the contract involves an employer-employee relationship, (2) is between the public and those charged with a public duty (i.e. a common carrier or utility), or (3) there is a disparity in bargaining power between the parties so that freedom of choice is lacking.

Courts also look at whether Disclaimers are unconscionable.  Procedural unconscionability applies where the disclaimer is hard to find, buried or hidden.

A contract term is substantively unconscionable where it’s blatantly one-sided and completely favors one party at the expense of the other.

 Illinois’ Construction Contract Indemnification for Negligence Act, 740 ILCS 35/1 posits that agreements to indemnify against a contractor’s negligence are void as against public policy. 

Illinois Disclaimer rules glaringly reflect the importance of pre-contract negotiation.  Parties are free to allocate risks as they see fit and where they are both sophisticated commercial entities, freedom of contract rules prevail and exculpatory clauses will be upheld – save for any public policy reasons against their enforcement.