Tag: economic loss doctrine

Economic Loss Rule Requires Reversal of $2.7M Damage Verdict In Furniture Maker’s Lawsuit- 7th Circuit

In a case that invokes Hadley v. Baxendale** – the storied British Court of Exchequer case published just three years after Moby-Dick (“Call me ‘Wikipedia’ guy?”) and is a stalwart of all first year Contracts courses across the land – the Seventh Circuit reversed a multi-million dollar judgment for a furniture maker.

The plaintiff in JMB Manufacturing, Inc. v. Child Craft, LLC, sued the defendant furniture manufacturer for failing to pay for about $90,000 worth of wood products it ordered.  The furniture maker in turn countersued for breach of contract and negligent misrepresentation versus the wood supplier and its President alleging that the defective wood products caused the furniture maker to go out of business – resulting in millions of dollars in damages.

The trial court entered a $2.7M money judgment for the furniture maker on its counterclaims after a bench trial.

The Seventh Circuit reversed the judgment for the counter-plaintiff based on Indiana’s economic loss rule.  

Indiana follows the economic loss doctrine which posits that “there is no liability in tort for pure economic loss caused unintentionally.”  Pure economic loss means monetary loss that is not accompanied with any property damage (to other property) or personal injury.  The rule is based on the principal that contract law is better suited than tort law to handle economic loss lawsuits.  The economic loss rule prevents a commercial party from recovering losses under a tort theory where the party could have protected itself from those losses by negotiating a contractual warranty or indemnification term.

Recognized exceptions to the economic loss rule in Indiana include claims for negligent misrepresentation, where there is no privity of contract between a plaintiff and defendant and where there is a special or fiduciary relationship between a plaintiff and defendant. 

The court focused on the negligent misrepresentation exception – which is bottomed on the principle that a plaintiff should be protected where it reasonably relies on advice provided by a defendant who is in the business of supplying information. (p. 17).

The furniture maker counter-plaintiff’s negligent misrepresentation claim versus the corporate president defendant failed based on the agent of a disclosed principal rule.  Since all statements concerning the moisture content of the wood imputed to the counter-defendant’s president were made in his capacity as an agent of the corporate plaintiff/counter-defendant, the negligent misrepresentation claim failed.

The court also declined to find that there was a special relationship between the parties that took this case outside the scope of the economic loss rule.  Under Indiana law, a garden-variety contractual relationship cannot be bootstrapped into a special relationship just because one side to the agreement has more formal training than the other in the contract’s subject matter.

Lastly, the court declined to find that the corporate officer defendant was in the business of providing information.  Any information supplied to the counter-plaintiff was ancillary to the main purpose of the contract – the supply of wood products.

In the end, the court found that the counter-plaintiff negotiated for protection against defective wood products by inserting a contract term entitling it to $30/hour in labor costs for re-working deficient products.  The court found that the counter-plaintiff’s damages should have been capped at the amount representing man hours expended in reconfiguring the damaged wood times $30/hour – an amount that totaled $11,000. (pp. 9-17, 24).

Take-aways:

1/ This case provides a good statement of the economic loss rule as well as its philosophical underpinnings.  It’s clear that where two commercially sophisticated parties are involved, the court will require them to bargain for advantageous contract terms that protect them from defective goods or other contingencies;

2/ Where a corporate officer acts unintentionally (i.e. is negligent only), his actions will not bind his corporate employer under the agent of a disclosed principal rule;

3/ A basic contractual relationship between two merchants won’t qualify as a “special relationship” that will take the contract outside the limits of Indiana’s economic loss rule.

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** Hadley v. Baxendale is the seminal breach of contract case that involves consequential damages.  The case stands for the proposition that the non-breaching party’s recoverable damages must be foreseeable (ex: if X fails to deliver widgets to Y and Y loses a $1M account as a result, X normally wouldn’t be responsible for the $1M loss (unless Y made it clear to X that if X breached, Y would lose the account, e.g.) [https://en.wikipedia.org/wiki/Hadley_v_Baxendale]

Fraud, Economic Loss and Contractual Integration Clauses (And More): Illinois Fed Court Provides Primer

Plaintiff purchased the defendant’s nation-wide network of auto collision centers as part of a complicated $32.5M asset purchase agreement (APA).   A dispute arose when the plaintiff paid $9.5M to a paint supply company and creditor of the defendant in order to consummate the APA.  The plaintiff argued that the defendant breached the APA by not satisfying the paint supply debt and securing a release from the paint supplier before the APA’s closing date.  Plaintiff sued on various tort and contract theories.  Defendant countersued for reformation, rescission and breach of contract.  Both parties moved to dismiss.

In granting the bulk of the defendant’s motion to dismiss, the court in Boyd Group, Inc. v. D’Orazio, 2015 WL 3463625 (N.D.Ill. 2015) examines the interplay among several recurring commercial litigation issues including the economic loss doctrine as it applies to negligent misrepresentation claims, the impact of a contractual integration clause, and the pleading requirements for fraud in Illinois.

The court dismissed the breach of contract claim based on the APA’s integration clause.  Where parties insert an integration clause into their contract, they are manifesting their intent to guard against conflicting interpretations that could result from extrinsic evidence.  If a contract has a clear integration clause, the court cannot consider anything beyond the “four corners” of the contract and may not address evidence that relates to the parties’ understanding before or at the time the contract was signed.1

Here, the plaintiff’s breach of contract claim was based in part on e-mails authored by the defendant the same day the APA was signed.  Since the APA integration clause clearly provided that the APA was constituted the entire agreement between the parties, the court found that the defendant’s e-mails couldn’t be considered to vary the plain language of the APA.2.

The plaintiff’s negligent misrepresentation claim was defeated by the economic loss doctrine, which posits that where a written contract governs the parties’ relationship, a plaintiff’s remedy is one for breach of contract, not one sounding in tort.  An exception to this rule is where the defendant is in the business of providing information for the guidance of others in their business transactions.

Case law examples of businesses that the law deems information suppliers (for purposes of the negligent misrepresentation/economic loss rule) include stockbrokers, real estate brokers and terminate inspectors.  Conversely, businesses whose main product is not information include property developers, builders and manufacturers.

Here, the in-the-business exception (to the economic loss rule) didn’t apply since defendant operated car collision repair businesses.  He did not supply information for others’ business guidance.  The court found the defendant more akin to a manufacturer of a product and that any information he furnished was ancillary to his main collision repair business.3

The one claim that did survive the motion to dismiss was plaintiff’s fraud claim.  To plead common law fraud under Illinois law, the plaintiff must establish (1) a false statement of material fact, (2) defendant’s knowledge the statement was false, (3) defendant’s intent to induce action by the plaintiff, (4) plaintiff’s reliance on the truth of the statement, and (5) damages resulting from reliance on the statement.  Fraud requires heightened pleading specificity and it must be more than a simple breach of contract.  A fraud claim must also involve present or past facts; statements of future intent or promises aren’t actionable. 4

The plaintiff’s complaint allegations that the defendant factually represented to the plaintiff that he was in the process of securing the release of the paint supply contract as an inducement for plaintiff to enter into the APA were sufficiently factual to state a fraud claim under Federal pleading rules.

Afterwords:

  • The economic loss rule bars negligent misrepresentation claim where the defendant’s main business is providing a tangible product rather than information;
  • A clearly drafted integration clause will prevent a party to a written contract from introducing evidence (here, emails) that alters a contract’s plain meaning;
  • The failure of a condition precedent won’t equate to a breach of contract where the party being sued isn’t responsible for the condition precedent;
  • A plaintiff successfully can plead fraud where it involves a statement concerning a present or past fact, not a future one.

References:
1.  2015 WL 3463625, * 7

2. Id.

3. Id. at * 11

4. Id. at **8-9