Foreseeability and the Economic Loss Rule-part I

• Publication year: 2004
• Pages: 81

33 Colo.Law. 81 Colorado Lawyer 2004.

2004, July, Pg. 81. Foreseeability and the Economic Loss Rule-Part I

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81

Vol. 33, No. 7, Pg. 81

The Colorado Lawyer
July 2004
Vol. 33, No. 7 [Page 81]

Specialty Law Columns
The Civil Litigator
Foreseeability and the Economic Loss Rule - Part I
by Craig K. Lawler

The Civil Litigator column addresses issues of importance and interest to litigators and trial lawyers practicing in Colorado courts. The Civil Litigator is published six times a year

Column Editor

Richard L. Gabriel of Holme Roberts & Owen LLP, Denver - (303) 861-7000, richard.gabriel@hro.com

About The Author

This month's article was written by Craig K. Lawler, Denver, an associate with Sherman & Howard LLC - (303) 297-2900, clawler@sah.com.

This two-part article examines the relationship between the policy rationales underlying the economic loss rule and independent duties based on the foreseeability of economic harm. It analyzes whether an independent duty is still good law, which is integral to holding that such a duty is an exception to the economic loss rule.

The simultaneous pursuit of contract and tort claims to recover economic loss has been a longstanding feature of Colorado law and has resulted in considerable "ambiguity and uncertainty" over the distinction between contract and tort law.1 In a pair of cases decided by the Colorado Supreme Court in 2000, Town of Alma v. AZCO Construction, Inc.2 and Grynberg v. Agri Tech, Inc.,3 the Court attempted to reduce the confusion by formally adopting the "economic loss rule," a judicially created rule of law that polices the boundary between tort and contract law. Simply stated, the economic loss rule requires that

a party suffering only economic loss from the breach of an express or implied contractual duty may not assert a tort claim for such a breach absent an independent duty of care under tort law.4

The Court joined a growing number of authorities in insisting that the focus of the economic loss rule should not be on the type of damages suffered, but on the source of the duty allegedly breached.5 The key inquiry in this approach is whether the duty allegedly breached arises from duties specified in contract and warranty or from an independent tort duty imposed by law. Given this focus, the Court explained that the economic loss rule would be more accurately designated as the "independent duty rule" instead of the "economic loss rule."6

This article examines the relationship between the policy rationales behind the economic loss rule and independent duties based on the foreseeability of economic harm. The article focuses primarily on negligence and strict liability claims. The tort of negligent misrepresentation, which raises its own peculiar issues, will not be addressed.7

Part I of this article provides an overview of the multiform nature of economic loss, the rationales behind the economic loss rule, and the lingering questions surrounding the "source of the duty" approach. Part II, which will appear in this column in September 2004, offers a survey of independent duties, mostly in the area of negligence, that permit recovery of economic loss primarily on the ground that the loss is foreseeable. Part II also provides an assessment of tensions among these independent duties, economic loss rule precedent, and the law of implied warranties.

Multiform Nature of Economic Loss

The application of the economic loss rule to particular areas of law often varies because few courts have fully analyzed the implications of the rule for other doctrines in tort and contract law.8 As several commentators have observed, there is no single, decisive justification for excluding the recovery of economic loss in tort, because the problem of economic loss is multiform rather than unitary in character.9 Several factors, discussed below, include the: (1) type of damage alleged; (2) tort alleged; (3) subject matter of the dispute and the attendant area of law; and (4) relationship between the parties in the action.

Type of Damage

The scope of the economic loss rule depends, in part, on the type of damage alleged. For purposes of the rule, "economic loss" is defined broadly as "damages other than physical harm to persons or property."10 At the least, it includes lost profits, diminution in value, and the cost of repairs or replacement.

Conceptually, economic loss can be further subdivided into two categories: (1) damages to the subject matter of the contract; and (2) consequential damages. Damages to the subject matter of the contract, even when that subject is property, generally are not recoverable in tort under the economic loss rule.11 However, consequential economic damages arising from physical injury or collateral damage to "other property" (not the subject matter of the contract) are still recoverable under the rule.

Type of Tort Action

Justification for the economic loss rule also depends on the type of tort alleged - whether an intentional tort, strict liability, tort to land (such as trespass and public nuisance), professional negligence, negligent misrepresentation, or negligence. For example, intentional torts, including varieties of fraud12 and interference with contract,13 have been recognized as independent duty exceptions to the economic loss rule. Presumably, this is because such conduct goes beyond legitimate economic self-interest and undermines the bargaining process for the allocation of risk in contract.

Subject Matter and
Area of Law

Application of the rule also varies according to the particular subject matter of the dispute and the area of law in which the dispute arises. Different rationales may apply in cases involving commercial goods, construction disputes, professional services, or the supply of financial or other information. To cite an example, negligent misrepresentation raises its own peculiar set of issues because the subject matter of the dispute, namely, information, is not easily excludable from use by third parties.

First- or Third-Party Plaintiff

Finally, the analysis of the application of the economic loss rule varies depending on the relationship between the parties.14 At one end of the spectrum, the plaintiff and defendant are first-parties to a contract or warranty, but instead of pursuing remedies under contract or warranty law, the plaintiff seeks to recover economic loss through negligence or other tort claims. At the other end of the spectrum, the plaintiff and defendant have no contractual relations and essentially were strangers when the defendant caused the alleged harm. In between are a variety of situations in which third-party plaintiffs and defendants come into contact by way of indirect contractual relationships.

Distinguishing First-Party and Third-Party Rules

Before reviewing the specific rationales underlying the economic loss rule, it is important to note that these rationales differ significantly depending on whether the plaintiff is a first-party to a contract or a third-party stranger with respect to the defendant.15 The two contexts have given rise to two legal rules that both go by the name "economic loss rule." As a shorthand, the rules can be designated the Seely Rule and the Robins Rule.

Seely Rule
(First-Party Plaintiff)

The more recent version of the economic loss rule, which grew out of products liability law, deals with the first-party context. The rule was first articulated in 1965 by the California Supreme Court in Seely v. White Motor Co.16 It was reiterated almost two decades later in the U.S. Supreme Court's opinion in East River Steamship v. Transamerica Delaval, Inc.17

According to the Seely Rule, a plaintiff who has a contract or warranty with a defendant may not assert negligence or strict liability claims to recover economic losses related to the subject matter of the contract or warranty. In other words, there is no action in tort for negligent performance of a contract18 or for product defects that result only in economic loss.19 This version of the economic loss rule was adopted by the Colorado Supreme Court in AZCO and Grynberg.20

Robins Rule
(Third-Party Plaintiff)

The older rule, associated with Justice Holmes's 1927 opinion in Robins Dry Dock & Repair Co. v. Flint,21 is a bright-line, "no recovery" rule that bars negligence claims for pure economic losses unconnected to physical injury of persons or property. The Robins Rule applies to all plaintiffs regardless of contractual privity with the defendant.

Colorado once followed a version of the third-party economic loss rule. In the 1955 case of Hartwich v. Crotty,22 the Colorado Supreme Court held that subsequent purchasers of a home who lacked privity with a developer and roofing subcontractor could not sue in negligence to recover economic damages related to leaks in the roof of their home. The Court noted that, as a general rule, completion of a contract ended any liability to third persons, except in the case "where there is danger to human life or personal injury."23

Hartwich was explicitly overruled by the Colorado Supreme Court nearly three decades later in a footnote to Cosmopolitan Homes, Inc. v. Weller.24 The Court held that, in the context of residential construction, a builder has an...