Riding the choppy waters of East River: economic loss doctrine ten years later.

• Author: Fox, Reeder R.

It's an effective tool for defense counsel faced with tort counts in a commercial dispute, but it's also somewhat iffy

Since the U.S. Supreme Court's adoption of the economic loss doctrine in 1986 in East River Steamship Corp. v. Transamerica Delaval Inc.,(1) defendants have increased their assertions of the doctrine as a defense to tort claims. While the question whether a particular jurisdiction recognizes the economic loss rule is straightforward, issues relating to the applicability and scope of the doctrine are more uncertain and continue to evolve.

In those jurisdictions that have adopted the economic loss rule, the issues most often litigated include (1) whether the plaintiff sustained "economic loss" or "property" damage so as to remove the claim from the confines of the economic loss rule, (2) whether the doctrine extends beyond the sale of "goods" to include transactions for the procurement of "services," and (3) whether an exception to the doctrine should be made for claims of negligent misrepresentation.

The economic loss rule has become a significant weapon in defense counsel's arsenal, as plaintiffs step up their assertion of tort claims in an effort to avoid contract provisions that would limit their recoveries. In addition, despite the predictions of commentators that the doctrine was losing its "teeth," recent decisions in various jurisdictions have given it new life.(2)

The economic loss rule typically arises in commercial transaction disputes, product liability cases, construction disputes, and claims for property damage and professional negligence. It often is asserted in two contexts. In the first scenario, in which a party to a contract who has sustained only economic harm sues the other party to the contract not only for breach of contract and breach of warranty, but also for negligence and other tort claims. The defendant may seek dismissal of the tort claims under the economic loss rule and limit the claims to the remedies available under the contract. In the second scenario, in which a third party who has sustained economic harm sues a party to the contract for negligence and other tort-based claims, the plaintiff's entire claim will typically be barred--for example, a builder against an architect.

Under the economic loss doctrine, a plaintiff who suffers only monetary injury as a result of the conduct of another cannot recover those losses in tort. Instead, the claimant is limited to recovery under the law of contract.(3)

East River, the seminal case interpreting the economic loss doctrine, profoundly influenced the movement toward acceptance of the doctrine in the vast majority of jurisdictions.(4) In that case, the Supreme Court considered the doctrine in the context of an admiralty action in which the plaintiffs chartered supertankers that malfunctioned while at sea because of manufacturing and design defects in the turbines. The plaintiffs sued the manufacturer of the turbines under theories of negligence and strict liability. The Court rejected these claims, holding that "a manufacturer in a commercial relationship has no duty under either negligence or products liability theory to prevent a product from injuring itself." In reaching its decision, the Court reasoned that if products liability remedies "were to progress too far, contract law would drown in a sea of tort."

ECONOMIC LOSS DOCTRINE

1. Policy Considerations

   East River was decided largely on the basis of policies favoring contract over tort where the gravamen of the complaint is based on economic loss. The major policy considerations may be summarized as follows:

   First, the basic tenet of contract law is that contracting parties may bargain freely in allocating and limiting liability to each other, particularly commercial entities having relatively equal bargaining power. The Court stated:

   Contract law, and the law of warranty in

   particular, is well suited to commercial

   controversies . . . because the parties may set the

   terms of their own agreements. The manufacturer

   can restrict its liability, within limits,

   by disclaiming warranties or limiting

   remedies.... In exchange, the purchaser pays

   less for the product. Since a commercial

   situation generally does not involve large

   disparities in bargaining power, . . . we see no

   reason to intrude into the parties' allocation

   of the risk.(5)

   Second, the economic loss doctrine promotes efficiency and predictability in the commercial setting by establishing the boundaries of liability solely by reference to the contract. Absent some measure of certainty regarding the scope of a contracting party's exposure, it would be nearly impossible for the party to accurately price its goods or services. On this point, the Court stated:

   Permitting recovery for all foreseeable

   claims for purely economic loss could make

   a manufacturer liable for vast sums. It would

   be difficult for a manufacturer to take into

   account the expectations of persons downstream

   who encounter its product.(6)

   Third, the doctrine recognizes and preserves the distinction between contract and tort law. As the Sixth Circuit recently declared:

   Tort and contract law normally occupy

   distinct spheres. Tort law . . . governs the

   relationship between a consumer and a

   manufacturer, where it is impractical or impossible

   for the parties to negotiate either the terms of

   a sale or each party's duty to each other....

   Contract law operates on the premise that

   commercial actors . . . will be able to allocate

   the risks and costs of a product's potential

   nonperformance.(7)

   The economic loss doctrine is, therefore, "the fundamental boundary between contract law, which is designed to enforce expectancy interests of the parties, and tort law, which imposes a duty of care and thereby encourages citizens to avoid causing physical harm to others."(8)

2. Courts Rejecting Doctrine

   A minority of jurisdictions has declined to apply the economic loss doctrine. They permit plaintiffs to assert claims of strict liability and negligence regardless of the type of harm. In the consumer context, the rationale in support of strict liability focuses on the disparity in bargaining power between a typical consumer and the manufacturer. For instance, in Thompson v. Nebraska Mobile Homes Corp., the Supreme Court of Montana voiced its skepticism over the ability of warranty law to protect the consumer, stating: "Warranties are easily disclaimed. Negligence is difficult, if not impossible to prove. The consumer does not generally have large damages to attract the attention of lawyers who must handle these cases on a contingent fee."(9)

   More recently, the Montana Supreme Court has affirmed its rejection of the economic loss doctrine in the commercial context, holding that a third-party contractor may recover purely economic loss from a project engineer where the plaintiff was within a foreseeable class of plaintiffs who were at risk in relying on the information supplied.(10)

3. Deviations from East River

   Even jurisdictions that have adopted the economic loss doctrine have occasionally crafted limited exceptions to, or deviations from, the it, at least as it is set forth in East River.

   1. "Sudden and Calamitous" Exception

      Some jurisdictions permit tort recovery for economic loss where the defect causes a product to fail in a "sudden and calamitous manner."(11) When characterizing an event as sudden and calamitous, the focus is on "the suddenness of the occurrence of an event--the point when the injury occurs."(12) Examples include the failure of brakes on a truck,(13) an implosion of a grain storage tank(14) and a roof collapse.(15)

      However, even in these jurisdictions, courts have occasionally been reluctant to find that the exception applies where economic loss is the result of qualitative defects. Thus, in Chicago Heights Venture v. Dynamit Nobel of America, the Seventh Circuit, applying Illinois law, held that the exception was inapplicable to a roof's collapse in a windstorm, noting:

      Fairly read, the complaint alleges a

      malfunction over time which necessarily, given

      the nature of the product, manifested itself

      most acutely in times of adverse weather.

      Since it was necessarily attached to the

      structure, its malfunction necessarily caused

      incidental damage to the surrounding parts of the

      structure. The gravamen of the complaint--simply

      stated--is that the roof did not work.(16)

   2. Unreasonable Risk of Death/Personal Injury Exception

      Several jurisdictions permit recovery in tort if the defect creates a serious risk of death or personal injury.(17) In Washington Water Power Co. v. Graybar Electrical Co., the Washington Supreme Court rejected the East River approach in favor of a "risk of harm analysis," reasoning that, "if "manufacturers can contract successfully around liabilities for product injuries, a principal deterrent to unsafe practices--the threat of legal liability--will be lost."(18) In a more recent case, however, the Washington Supreme Court applied the East River approach to a suit involving admiralty claims.(19)

4. Application to Non-commercial Disputes

   A recurring issue facing the courts is whether the East River doctrine may be extended to non-commercial disputes, such as consumer transactions. In Jones v. General Motors Corp., the Superior Court of Pennsylvania denied tort recovery to an individual whose pick-up truck caught fire as a result of a malfunction, holding that the economic loss doctrine's rationale could not be limited to plaintiffs who were commercial entities. The court declared:

   Regardless of whether a consumer is an

   commercial entity or an individual, a

   manufacturer's warranty as to the quality of

   its product is a bargained for condition of

   sale, the effect of which must not be

   undermined. If a consumer were entitled to bang

   an action under both contract and tort law

   where the only damage alleged is to the

   product, any limitation of the manufacturer's

   liability pursuant to warranty would have

   little or no...