Eastwood's Answer to Alejandre's Open Question: the Economic Loss Rule Should Not Bar Fraud Claims

• Publication year: 2021

EASTWOOD'S ANSWER TO ALEJANDRE'S OPEN QUESTION: THE ECONOMIC LOSS RULE SHOULD NOT BAR FRAUD CLAIMS

Katharine Heaton

Abstract: The economic loss rule is a judicially created doctrine that bars plaintiffs from suing in tort for purely economic losses when the entitlement to recovery arises only from a contract. In Alejandre v. Bull, the Washington State Supreme Court acknowledged that there are exceptions to the rule but explicitly declined to say whether it would recognize an exception for fraud. Washington's appellate courts answered Alejandre's open question, holding that the economic loss rule barred all fraud claims except for the narrow tort of fraudulent concealment. The appellate courts interpreted Alejandre broadly to apply the economic loss rule whenever the parties had a contractual relationship and the losses were purely economic. The Washington State Supreme Court responded to these appellate decisions in Eastwood v. Horse Harbor Foundation. In Eastwood, the Court explicitly rejected the appellate courts' broad view of Alejandre and held that the economic loss rule does not bar a plaintiff from bringing a tort claim where the tort duty is independent of the contract. This Comment argues that, in light of Eastwood, Washington's economic loss rule should not bar fraud claims because the duty not to commit fraud is independent of any contract.

INTRODUCTION

A newlywed couple awoke to violent shaking and a horrible cracking noise as their cliff-side home started falling into the sea. They had purchased the house just a few weeks earlier upon assurances that it was safe from landslides. When the newlyweds confronted the previous owner, he told them he had purposely built the house on low-cost fill even though he knew it was a landslide risk. He had lied about the risk to induce the newlyweds to buy his house. This is fraud. But under the Washington Court of Appeals holdings in Carlile v. Harbour Homes, Inc.(fn1) and Poulsbo Group, LLC v. Talon Development, LLC(fn2) the economic loss rule would bar the newlyweds from recovering damages for this obvious tort.

The doctrine that Washington courts once called the economic loss rule, and now call the independent duty doctrine, is a judicially created doctrine that bars plaintiffs from suing in tort for purely economic losses(fn3) when the entitlement to recovery arises only from a contract. (fn4) In Alejandre v. Bull,(fn5) the Washington State Supreme Court held that the economic loss rule barred a homebuyer from bringing tort claims against the seller unless the tort was a recognized exception to the rule.(fn6) The economic loss rule barred the plaintiffs' negligence claim in Alejandre; however, the Court recognized an exception to the economic loss rule that would have allowed the plaintiffs to bring a fraudulent concealment claim.(fn7) In a footnote, the Court mentioned that it was aware that some courts had found a broad exception to the economic loss rule that would allow plaintiffs to bring any fraud claim in tort, but the Court explicitly declined to say whether it would adopt such an exception.(fn8 ) Washington's appellate courts wrestled with how to interpret Alejandre(fn9) but ultimately decided that the economic loss rule barred all fraud claims except for fraudulent concealment.(fn10)

The Washington State Supreme Court clarified its economic loss rule in Eastwood v. Horse Harbor Foundation(fn11) In that case, the Court held that the economic loss rule does not bar a plaintiff from bringing a tort where the tort duty is independent of the contract.(fn12) To underscore this point, and to help alleviate the appellate court confusion, the Court abandoned the term "economic loss rule" and renamed it the "independent duty doctrine."(fn13) The Court did not, however, explicitly state whether tort damages for fraud could be recovered under the newly renamed doctrine.

This Comment argues that, contrary to the appellate court holdings in Carlile v. Harbour Homes, Inc.(fn14) and Poulsbo Group, LLC v. Talon Development, LLC,(fn15) Washington's economic loss rule should not bar fraud claims,(fn16) because the duty not to commit fraud is independent of any contract. Part I presents the origins of the economic loss rule and its underlying purpose. Part II discusses the variations in the rule and the three main approaches courts use to decide whether the rule bars fraud claims. Part III details the development and recent interpretation of the rule in Washington. Part IV argues that under Eastwood's independent duty doctrine, a plaintiff should be able to recover damages from fraud for three reasons. First, barring fraud claims would create an uncertain marketplace because it is impossible for contracting parties to bargain against the risk of fraud. Second, under the Uniform Commercial Code (UCC), fraud claims supplement contract law rather than subvert it. Finally, Carlile and Poulsbo were based on a misunderstanding of Alejandre and the tort of fraud. Because fraud is always independent of a contract, these cases should be overruled.

I. COURTS DEVELOPED THE ECONOMIC LOSS RULE TO KEEP TORT LAW FROM CIRCUMVENTING CONTRACT LAW

To understand the economic loss rule, it is instructive to understand its origins. Although some believe that the economic loss rule first developed in the context of products liability in the 1960s,(fn17) the historical roots of the rule run much deeper.(fn18) As far back as the nineteenth century, plaintiffs have tried to cast their contract claims as torts to avoid being denied recovery because of technical contract law reasons, such as an expired statute of limitations or the lack of privity between the parties.(fn19) For as long as plaintiffs have tried to subvert negotiated contract terms with tort law, judges have been hostile to the use of tort claims to recover purely economic losses.(fn20) As a result, judges developed the economic loss rule to police the boundary between tort and contract and "ensure that contract claims are resolved by contract law."(fn21)

To separate contract claims from tort claims, the economic loss rule bars a plaintiff from bringing a tort claim when the matter would be better resolved in contract. (fn22) The critical distinction between tort law and contract law is the source of the duty.(fn23) Contractual duties arise from agreements between the parties.(fn24) The key assumption in contract law is that in the course of bargaining, contracting parties are able to allocate risks and costs.(fn25) For example, a buyer can choose to insist on additional warranties or to assume a greater risk in exchange for a lower price.(fn26) The role of contract law is to protect against the loss one party to a contract suffers when the other party fails to perform the bargained-for promise.(fn27)

In contrast, tort duties arise from policy considerations. (fn28) For example, the duty not to engage in fraud to induce the other party to contract comes from common sense, policy considerations, and case precedent.(fn29) Unlike a warranty claim in contract law, the duty not to engage in fraud exists regardless of whether the contract is ultimately formed.(fn30) Moreover, the tort duty may not be waived because parties cannot reasonably contemplate the risk of fraud.(fn31) Tort law governs only the narrow subset of buyer-seller relationships where it is impractical, or impossible, to negotiate either the terms of a sale or each party's duty to the other.(fn32)

Despite the distinction between contract duties and tort duties, both a contract claim and a tort claim can arise from the same, or closely related, conduct. (fn33) For example, a contract may require one party to deliver cows that are free of infection; thus, failure to do so would be a breach of contract.(fn34) Under that contract, the defendant may be acting negligently by failing to test the cows when a reasonable person would have done so.(fn35) Thus, the same action-failing to test the cows before delivery-gives rise to two claims: breach of contract and negligence.(fn36 ) Despite the fact that misrepresentations are fundamentally different from broken promises,(fn37) a party's assertion of fact can also serve as that party's implied promise to give some kind of satisfaction if the fact proves to be false.(fn38) Thus, it can be difficult to distinguish between fraud (an intentional misrepresentation), remedied in tort, and a broken promise, remedied in contract.(fn39)

Because a tort claim and a contract claim can arise from the same conduct, plaintiffs may be able to articulate their contract claims as tort claims. (fn40) Casting a claim under tort law provides at least three advantages over contract law.(fn41) First, contract law generally limits recovery to parties in privity of contract.(fn42) On the other hand, tort law generally allows any injured party to recover.(fn43) Second, a plaintiff may be able to bring a tort claim long after the statute of limitations has run on the analogous contract claim because, in tort law, the statute of limitations begins to run only after the plaintiff knew or should have known of the injury.(fn44) Third, nearly every state allows punitive damages for fraud, while contract law limits remedies to the benefit of the bargain.(fn45) Given all the benefits of tort law for plaintiffs, courts developed the economic loss rule to prevent plaintiffs from using...