Evolution of the economic loss doctrine in information age disputes involving electronic data storage products.

• Author: Boggs, William S.

CERTAINTY is good for commerce, and the economic loss doctrine promotes certainty between manufacturers and consumers of products. The doctrine limits an injured party to contract--rather than tort--remedies when the injured party suffers only economic harm from a defective product (e.g., replacement costs or lost profits). Instead of exposing manufacturers to uncertain liability in tort, the economic loss doctrine upholds the bargaining process and the parties' allocation of risk. Moreover, because it promotes certainty, the economic loss doctrine remains viable as we continue to evolve from an industrial to an information based economy.

Without such a rule today, critical products would be unavailable at prices the average consumer could afford to pay. Some of the most important information age products are those which store large quantities of electronic data. In the last ten years, there have been tremendous innovations in both business use and consumer applications for electronic data storage products (e.g., data servers, mp3 players, digital video recorders, and digital cameras to name a few). This article examines the economic loss doctrine's evolution and consistent application in an information based economy, particularly in the data storage context.

Exceptions to the general rule often exist. One significant exception allows an injured party to sue for tort remedies when a defective product causes harm to "other property." Is a party who suffers data loss because of a defective storage device, like a crashed computer disk drive, limited to contractual remedies under the economic loss doctrine? Or may the party sue in tort for the value of the lost data because the data is "other property"? The courts addressing this issue hold that data lost when a hard drive, server, or other storage device fails is not "other property." Thus, the remedy for such a loss is a breach of contract claim, rather than a tort claim. Various policy reasons support these decisions and the fundamental fairness of these decisions. Data loss cases reflect a growing trend to preserve the distinction between the interests served by tort law and contract law.

1. The Economic Loss Doctrine Helps Keep Products Affordable for Average Consumers

   The analytical framework for the doctrine depends upon a practical balancing of manufacturers' and consumers' needs. Companies and individuals increasingly rely on hardware and software to preserve data. To meet this need, computer disk drive and server manufacturers are producing more powerful storage solutions.

   What types of damage claims might arise from the use or failure of these products? An electronic data storage system might cause personal injury by operating at an unsafe temperature. A consumer suffering personal injury from a product may clearly sue in tort. A less clear question of tort liability, however, arises when a defect in hardware or software causes damage to information stored in such products. For instance, a property damage claim may arise from a power outage or spike that corrupts data on a hard disk drive, or a manufacturing defect that causes the drive to fail, or failure of the drive due to normal wear and tear. Examples include individuals who lose all of their saved email files when a personal computer hard drive crashes or insurance companies that lose claims data when a server goes down.

   Is it fair, however, to apply the economic loss doctrine to prevent consumers who experience data loss from suing in tort? Consider the following hypothetical:

   Ms. Jane Torr-Shus purchases a Data Co. 300 gigabyte external hard disk drive at Drives R US for $379.95. Ms. Torr-Shus uses the drive to store her personal data, including pictures and music files. Mr. Warren Tee buys the same model drive to store his business files related to his real estate brokerage. A week later, Ms. Torr-Shus mistakenly erases all of the songs on her digital music player. While reloading the music files, her hard disk drive crashes and all her data is lost. Meanwhile, across town. Warren Tee's business files suffer the same fate when his drive also crashes. Unfortunately, neither Ms. Torr-Shus nor Warren Tee backed up their data stored on the drives. That same day, drive manufacturer Data Co. announces its financial results for the quarter. After accounting for Data Co.'s costs of $365 per drive, Data Co. produced a profit of about $15 per drive this quarter. Data Co.'s profit margin is razor thin. A few days later, Ms. Torr-Shus and Warren Tee meet with their respective attorneys. Ms. Torr-Shus, an avid watcher of a prime time television legal drama, believes she has claims for at least negligence and product liability. Warren Tee. on the other hand, is not sure he has effective tort claims. He remembers reading that Data Co.'s warranty policy is to repair or replace a defective drive and no more. At this point, both Ms. Torr-Shus and Mr. Tee are told by their lawyers about the economic loss doctrine and that courts have not treated lost data as "other property." Is denial of tort recovery for data loss a lair result under this hypothetical? Have courts drawn an arbitrary line and failed to value electronically stored information appropriately? A close inspection of these questions reveals that the overall societal benefits achieved by this rule outweigh the individual harm of denying tort recovery for data loss.

   To understand why the courts have ruled this way, it helps to consider the implications of such a rule for both manufacturers and consumers. First, a practical problem exists with respect to how to value intangible property, such as personal information, family photos, and other items that may have subjective value only.

   Second, a societal judgment is implicated when balancing manufacturers' and consumers' expectations because the economic loss doctrine protects manufacturers from indeterminate or unlimited liability. In theory, this results in lower prices for consumers and encourages manufacturers to make new products. It also helps make such products more widely available and affordable to small businesses and individuals, rather than just to large corporations that can afford to pay for otherwise prohibitively expensive data storage and manipulation capabilities. (1)

   Third, the economic loss doctrine provides certainty regarding liability that applies equally to both manufacturers and consumers. Manufacturers can plan appropriately for potential liability and assess their risks. (2) Consumers similarly can assess their risks and seek other forms of protection, such as insurance policies to cover lost data. (3) Moreover, the rule encourages consumers to follow a consistent procedure of creating safe backups for important data.

   In the hypothetical, data loss suffered by Warren Tee and Jane Torr-Shus, both consumers (and society at large) ultimately benefit from application of the economic loss rule to their situations. Although data losses are unfortunate at the individual level, such losses are avoidable and are offset by the opportunity for consumers to purchase powerful storage systems at reasonable prices.

   2. The Economic Loss Doctrine Separates the Interests Served by Tort Law and Contract Law

      Why is the economic loss rule important? Traditionally, the rule served to maintain the distinction between tort law and contract law. The primary purpose of tort law is to address injury to the person while the primary purpose of contract law is to uphold contracting parties' economic expectations. (4) What does the economic loss rule do? Examples of economic loss include replacement costs for the defective product and lost profits attributable to the out of service product. The economic loss rule precludes tort recovery when manufacturers sell a defective product that results in no bodily injury and no harm to other property, but instead causes only. economic loss to the buyer of that product. (5) In other words, an aggrieved person cannot sue for tort claims when the product damages only itself. The rule has allowed manufacturers to limit use of tort law as a means of circumventing contract provisions that address liability questions up front.

      1. Seely v. White Motor Co. Provides the Framework for Applying the Rule to Data Loss Cases

         In Seely v. White Motor Co., the leading economic loss case, the plaintiff purchased a heavy duty truck that bounced violently during operation, causing the truck to overturn and become damaged. The California Supreme Court held that the economic loss doctrine precludes tort recovery where the consumer suffers only failed "economic expectations." (6) In other words, there was no duty in tort to prevent economic loss. If, however, the consumer suffers personal injuries or injury to other property, tort theories are available as remedies. The court held that Seely was only entitled to contractual warranty remedies and could not maintain an action for strict liability because his only damages were the cost of repair and lost profits associated with the failure of the truck to function as warranted.

         The major policy considerations behind the Seely decision included: (1) to promote predictability by applying the rules of warranty to limit liability; (2) to recognize and preserve the distinction between warranty law and tort law; (3) to assure that consumers bear the risk that the product will not perform up to their economic expectations because they are free to find a product which fulfills their needs; and (4) to prevent society as a whole from paying for the business needs (i.e. subjective expectations) of individual consumers. (7)

         The principles set forth by the Seely court are still applicable today in the data storage context where consumers' economic expectations regarding mass storage devices must be balanced against marketplace realities faced by drive manufacturers.

      2. Today's Majority View: Contract Law Should Not Be Rendered Meaningless by...