Tag: economic loss rule

High-Tech Sports Equipment Plaintiff Alleges Viable Fraud Claim Against Electronic Sensor Supplier (Newspin v. Arrow – Part II)

In Newspin Sports, LLC v. Arrow Electronics, Inc., 2018 WL 6295272, the Seventh Circuit affirmed the dismissal of plaintiff’s negligent misrepresentation claims but upheld its fraud claims.

Under New York law (the contract had a NY choice-of-law provision), a plaintiff alleging negligent misrepresentation must establish (1) a special, privity-like relationship that imposes a duty on the defendant to impart accurate information to the plaintiff, (2) information that was factually inaccurate, and (3) plaintiff’s reasonable reliance on the information.

New York’s economic loss rule softens the negligent misrepresentation theory, however. This rule prevents a plaintiff from recovering economic losses under a tort theory. Since the plaintiff’s alleged negligence damages – money it lost from the flawed electronic components – mirrored its breach of contract damages, the negligent misrepresentation claim was barred by the economic loss rule. [*10]

Plaintiff’s fraud claims fared better.  In New York, a fraud claim will not lie for a simple breach of contract.  That is, where the only “fraud” alleged is a defendant’s broken promise or lack of sincerity in making a promise, the fraud claim merely duplicates the breach of contract one.

To allege a fraud claim separate from a breach of contract, a plaintiff must establish (1) a legal duty separate from the duty to perform under a contract, or (2) demonstrate a misrepresentation collateral or extraneous to the contract, or (3) special damages caused by the misrepresentation that are not recoverable as contract damages. [*11] [32]-[33].

Applying these principles, the Court noted that the plaintiff alleged the defendant made present-tense factual representations concerning its experience, skill set and that its components met plaintiff’s specifications.  Taken together, these statements – if true – sufficiently pled a legal duty separate from the parties’ contractual relationship to state a colorable fraud claim.

The Court also rejected the defendant’s argument that the plaintiff’s fraud claims were subject to the UCC’s four-year limitations period governing sales of goods contracts.  Since the plaintiff’s fraud count differed from its breach of contract claim, Illinois’s five-year statute of limitations for common law fraud governed.  See 735 ILCS 5/13-205,  As a result, plaintiff’s 2017 filing date occurred within the five-year time limit and the fraud claim was timely. [*12] [35].

Afterwords:

The economic loss rule will bar a negligent misrepresentation claim where a plaintiff’s pleaded damages simply restate its breach of contract damages;

A fraud claim can survive a pleadings motion to dismiss so long as the predicate allegations go beyond the subject matter of the contract governing the parties’ relationship.

Law Firm’s Negligence Suit Against Bank Defeated By Account Agreement and UCC Article 4 (IL Law))

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In July 2013, the Third District appeals court affirmed dismissal of a law firm’s (Firm) negligence suit against a bank that charged back the firm’s account after a $350,000 check deposited by the Firm turned out to be counterfeit.  Rejecting the Firm’s negligence claim, the Court found that the terms of the parties’ account agreement and the specific provisions of UCC Article  4 (governing banks’ check handling practices) trumped any common law duties owed by the bank.

In Dixon, Laukitis and Downing v. Busey Bank, 2013 IL App (3d) 120832, the plaintiff Firm deposited a $350,000 check into its account at defendant bank.  The bank provisionally credited the Firm’s account in the amount of the deposit.  But before the check was finally paid, the firm made multiple withdrawals of nearly $300,000.  A few days later, when the check turned out to be counterfeit, it was returned uncollectible and the bank charged back the Firm’s account.   The Firm sued, alleging the bank breached its duty of care by failing to recognize and alert the Firm of the suspicious check.  The trial court granted the bank’s motion to dismiss.

Held: Affirmed.  Firm’s negligence claim is defeated by the account holder agreement and UCC Article 4 provisions governing banking practices.

Rules/Reasons:

In dismissing the Firm’s negligence suit, the Court cited a slew of statutory and common law rules which govern both the relationship between a bank and a customer and a bank’s check handling practices.  The key rules relied on by the Court:

– The UCC governs the relationship between a bank and its customers and a bank’s general check handling duties;

– If a check doesn’t settle (isn’t paid), the collecting bank has a superior right (to the owner) to a setoff of the unpaid check;

– UCC section 4-202 delineates a bank’s duties with respect to processing a check including presenting it, sending notice of dishonor or nonpayment, timely settling it and notifying a bank customer of any loss or delay within a reasonable time.  UCC 4-202(a), (b)

– If a bank makes provisional settlement of a check but doesn’t receive final payment, the bank can charge back the customer’s account.  UCC 4-214(a);

– A private agreement between a bank and its customer is valid as long as the terms aren’t manifestly unreasonable. UCC 4-103(a);

– The risk of loss of a check not settling is on the depositor until final settlement.  UCC 2-214(a)

– The relationship between a bank and its account holder is contractual in nature and one of creditor (bank) and debtor (account holder);

– An account holder agreement between a bank and its customer creates a binding contract;

– A collecting bank owes no duty to its customer to inspect a check that is later determined to be counterfeit or to remind its customer that it bears the risk of loss before a deposited check is finally settled

¶¶10-13, 18-19.

Applying these rules in the bank’s favor, the Court noted that the bank’s supporting affidavit contained testimony that there was nothing unusual that led the bank to question the check’s legitimacy and that the bank promptly informed the Firm when the check was returned unpaid.  Since the Firm failed to challenge the bank’s affidavit, and also cited no Article 4 duties or obligations to the account holder that the bank breached, the Firm’s negligence claim failed.  (¶¶ 18-19)

The Court also dismissed the Firm’s negligence claim based on the economic loss rule.  The parties’ relationship was based on a written contract (the account agreement) and the Firm sought to recover economic loss: namely, the $350,000 charge back from the fraudulent check.  The existence of a contract between the parties spelled defeat for the Firm’s negligence suit.

Take-aways: To sue a bank and win is difficult.  The UCC and common law provide an array of  steep standards a plaintiff must surmount and defenses for a bank that is sued by a customer for negligence.  A bank-customer account agreement and the provisions of UCC Articles 3 (negotiable instruments) and 4 (depository and collecting banks) will control over any common law duties owed to an account holder.

In hindsight, the Firm maybe should have premised its claims on specific violations of UCC Article 4 instead of general negligence allegations and also should have filed a counter-affidavit or other evidence to contest the bank officer’s statements.

 

 

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.