Applying economic loss doctrine to Article 2 transactions: a doctrine at a loss.

• Author: Martin, Jennifer S.

INTRODUCTION

Modem application of the judicially-created economic loss doctrine redirects some purchasers of defective goods away from actions in tort for negligence or strict liability against a product manufacturer. The Uniform Commercial Code's (the "Code") premise of liberal supplementation necessitates harmonization of the Code's Article 2 remedy provisions with the common law economic loss doctrine when it comes to remedies for breach for sales of goods in these kinds of cases. (1) In most sale of goods cases, though, we view Article 2's remedies as the optimal system for compensation. The Article 2 framework allows for both limitations of remedies by the parties under section 2-719, (2) and for default remedies for a simple breach of warranty, which under section 2-714 (3) would entitle the purchaser to the difference in value between the faulty goods and the value of the goods as promised without the defects. (4)

Modern application of the economic loss doctrine has proven esoteric at times, as fittingly illustrated by the case of In re Chinese Manufactured Drywall Products Liability Litigation (the "Chinese Drywall Litigation"), (5) involving installation of defective Chinese drywall in certain homes built after Hurricanes Katrina and Rita. (6) The purchasers of the drywall fell into two categories, creating the potential for different treatment of similar claims involving the same defective drywall; the categories, depending on the type of purchase, were by: (1) those who purchased the Chinese drywall directly from the manufacturer and then installed it in their homes; and (2) those who purchased a home, which had been built (or rebuilt) with Chinese drywall. (7) Plaintiffs' claims included the defective drywall itself, along with damages to the home components and appliances as a result, and, in some cases, also the plaintiffs' health. (8)

The distributor defendants moved for dismissal of the plaintiffs' claims based on the economic loss doctrine under the laws of Florida, Mississippi, Alabama, and Louisiana. (9) Focusing on the specific product purchased by the buyer, rather than the products put into the marketplace by the seller, the defendants attempted to distinguish application of the economic loss doctrine on that basis. (10) As such, the defendants conceded that the doctrine did not act to bar the first category buyers' tort claims related to the home because the product purchased was the drywall, and not the home. (11) The court agreed that as to these first category claimants, the tort allegations related to other property and personal injury were allowable and not barred by the doctrine. (12)

The court, focusing on the economic loss doctrine as developed in Florida, also denied the defendants' motion to dismiss the claims brought by buyers in the second category--who purchased the homes that already contained the drywall. (13) The court did not determine whether the "product" purchased by each individual was the home, or the drywall, but nevertheless concluded that the economic loss rule does not preclude tort claims where a component functions appropriately, but there is a "showing of harm above and beyond disappointed economic expectations." (14) The court observed that the economic loss rule did not apply because the plaintiffs who purchased homes: (1) were not in privity of contract with the sellers of the drywall, and (2) the defective drywall created a "hazard to health and property." (15) Therefore, the tort claims of the buyers in both categories were allowed to proceed. (16)

The purpose of this Essay is to analyze the treatment and the types of tort and strict liability claims that courts are likely to redirect toward the Code's Article 2 remedies. (17) Part I of this Essay examines the typical application of the economic loss doctrine. (18) Part II considers the bargain policy underlying the Code that supports imposition of the economic loss doctrine in a variety of claims touching Article 2 matters. (19) Part III outlines how the principles of the economic loss doctrine are a limited vehicle for resolution of claims that lie at the outer edges of the bargain as envisioned by the parties. (20) Finally, Part IV conducts an exercise using the Chinese Drywall Litigation to demonstrate how characterizing claims made by aggrieved buyers is a more disciplined approach toward application of the economic loss doctrine. (21) Part IV further evaluates the application of the doctrine to other property claims, including the extent to which the parties may either actually or impliedly take into account certain claims when entering into the sale of goods. (22) This Essay concludes that modem application of the economic loss doctrine preserves the boundary between tort and contract, but should be subject to a less obscure approach that lends greater surety to parties and does not require judicial intervention in most cases. (23)

1. LIMITING ARTICLE 2 CLAIMANTS TO CONTRACTUAL REMEDIES

   I begin by defining the "economic loss rule" and explaining its application in typical cases. The economic loss rule limits the recovery of an owner of a product who suffers purely monetary harm to the product itself to Article 2 (contract) damages, but the rule does allow the product owner to assert tort claims against a manufacturer for personal injuries caused by a defect in the product. (24) Justice Traynor explained the rationale for this rule in the renowned case of Seely v. White Motor Company: (25)

   The distinction that the law has drawn between tort recovery for physical injuries and warranty recovery for economic loss is not arbitrary and does not rest on the "luck" of one plaintiff in having an accident causing physical injury. The distinction rests, rather, on an understanding of the nature of the responsibility a manufacturer must undertake in distributing his products. He can appropriately be held liable for physical injuries caused by defects by requiring his goods to match a standard of safety defined in terms of conditions that create unreasonable risks of harm. He cannot be held for the level of performance of his products in the consumer's business unless he agrees that the product was designed to meet the consumer's demands. A consumer should not be charged at the will of the manufacturer with bearing the risk of physical injury when he buys a product on the market. He can, however, be fairly charged with the risk that the product will not match his economic expectations unless the manufacturer agrees that it will. Even in actions for negligence, a manufacturer's liability is limited to damages for physical injuries and there is no recovery for economic loss alone. (26) Fundamentally, the economic loss doctrine recognizes that parties to a sales transaction have made a voluntary bargain where the parties themselves either expressly allocated the risk of losses from defective products, or impliedly did so through the gap-filling provisions of Article 2. (27) The doctrine, in its simplest iteration, requires that the Code resolve cases involving "economic loss," and that tort law resolve claims for "non-economic loss." (28)

   The economic loss doctrine attempts to segregate claims from defective goods by characterizing those claims as arising under Article 2. (29) The three variables that are present in these troubled sales are typically damage to the product itself, personal injury, and damage to other property. (30) A claimant with economic damages, which arose solely from a defective product, is limited to Article 2 remedies ("economic loss case"). (31) A claimant with economic damages from the defective product plus personal injury is limited to Article 2 claims for the former losses, but may potentially have tort claims for the latter ("economic loss case coupled with personal injury"). (32) A claimant with economic damages that arise from the defective product plus injury to other property is limited to only Article 2 claims for the former losses, but may potentially have economic and tort claims for the latter ("economic loss case coupled with other property losses"). (33) There is also the potential for combination of all three variables in any given case.

   Although this rubric has a formalistic tone akin to a concrete tool for ready categorization of all claims presented in all cases, categorization has value where appropriate benchmarks are describable and accompanied by other factors. The economic loss case represents the classic situation whereby the claimant is traditionally compensated by any warranty on the product. (34) The economic loss case coupled with personal injury represents the situation whereby the public policy favors protection of consumers from dangerous products. (35) The economic loss case coupled with other property loss represents the situation whereby the damage is not restricted to only the product, indicating a claim involving more than just the customer's disappointed expectations. (36) The varying public policies underlying these categories, and whether tort claims are permitted, ultimately depend upon the connection to the precise bargain entered into by the parties. Accordingly, these classifications present limitations in their application in some cases. Yet, the basic categories surely carry value in a variety of traditional applications, allowing courts to readily determine whether tort claims are present or whether a claimant is limited to Article 2 remedies.

   The Chinese Drywall Litigation presents a useful illustration of some of the elements of the rubric in application. (37) An individual's claims related solely to the failure of the defective drywall would, in the simplest iteration, constitute an economic loss case properly resolvable by Article 2. An individual with claims related to the failure of the defective drywall and who also, as an example, complained of physical afflictions such as headaches, nosebleeds, and difficulty breathing...