Economic Loss Doctrine Dooms Negligence CLaim

A federal court recently issued an interesting decision discussing the often-confusing economic loss doctrine.  See Schwabe North America, Inc. v. Cal-India Intl Foods, Inc., et al., No. 14-cv-00235 (E.D. Wis. 12/23/14).

Plaintiff Schwabe manufactures, sells and distributes a variety of dietary supplements, plant-based medicines and other healthcare products. Defendant manufactures and sells nutraceutical and industrial enzymes. The court recited that Schwabe contracted with defendant to provide certain enzymes to be incorporated in the manufacture and sale of Schwabe's dietary supplement products to distributors and consumers. Schwabe's complaint alleged defendant knew the enzymes would be used in this way, and that defendant warranted the enzymes met certain specifications. Upon receiving the enzymes, Schwabe did incorporate them into the products and distributed them to clients. According to the amended complaint, when defendant shipped the enzymes, they had been contaminated with chloramphenicol, which Schwabe alleged is "an antibiotic that poses a serious health danger to consumers."

Defendant apparently issued a 2013 recall for certain of its enzymes, including those that had been incorporated into Schwabe's products. Schwabe alleged it was then forced to recall its own affected products, causing losses, expenses and damages. Schwabe filed suit, alleging negligence, breach of warranty and a violation of Wis. Stat. § 100.18, which prohibits false and deceptive representations in connection with the sale of goods and services. The sole issue before the court was defendant's motion to dismiss the negligence claim.

Dismissal for failure to state a claim under Rule 12(b)(6) of the Federal Rules of Civil Procedure is proper "when the allegations in a complaint, however true, could not raise a claim of entitlement to relief." Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 558 (2007). To state a claim, a complaint must contain sufficient factual matter "that is plausible on its face." Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Twombly, 550 U.S. at 570).  

The issue before the court was whether Schwabe's negligence claim was barred by Wisconsin's economic loss doctrine, pursuant to which a commercial purchaser of a product cannot recover from a manufacturer, under the tort theories of negligence or strict products liability, damages that are solely economic in nature. See Daanen & Janssen, Inc. v. Cedarapids, Inc., 216 Wis. 2d 395, 400, 573 N.W.2d 842 (1998); see also Sunnyslope Grading, Inc. v. Miller, Bradford & Risberg, Inc., 148 Wis. 2d 910, 437 N.W.2d 213 (1989). The Wisconsin Supreme Court has identified three policies that underlie the economic loss doctrine:  application of the economic loss doctrine to tort actions between commercial parties is generally based on three policies, none of which is affected by the presence or absence of privity between the parties: (1) to maintain the fundamental distinction between tort law and contract law; (2) to protect commercial parties' freedom to allocate economic risk by contract; and (3) to encourage the party best situated to assess the risk of economic loss, the commercial purchaser, to assume, allocate, or insure against that risk.  

In this case, the court said the alleged losses at issue were economic in nature. This category of loss, sometimes called "commercial loss," Miller v. U.S. Steel Group, 902 F.2d 573, 574 (7th Cir. 1990), generally includes damages resulting from inadequate value because the product is inferior and does not work for the general purposes for which it was manufactured and sold. See Daanen, 216 Wis. 2d at 845, 573 N.W.2d 842. More specifically, economic loss includes costs of the replacement of and repair to the defective product, and lost profits attributable to the defect. Id.; see also Northridge Co. v. W.R. Grace & Co., 162 Wis. 2d 918, 926, 471 N.W.2d 179 (1991).

Conceptually, costs and expenses associated with recalling a defective product, which were at issue in this case, fit into the category of economic loss.  Indeed, the Seventh Circuit has held that recall expenses are an economic loss. See Rich Products Corp. v. Kemutec Inc., 241 F.3d 915 (7th Cir. 2001).

Schwabe argued that the economic loss doctrine did not bar its negligence claim because the defective product (the enzyme) caused damage to other property (the dietary supplement it was used in). Generally, the economic loss doctrine does not bar a commercial purchaser's claims based on personal injury or damage to property other than the product, or economic loss claims that are alleged in combination with non-economic losses. Plaintiff contended that its negligence claim fell within this "other property" exception to the economic loss doctrine.

The "other property" exception, however, said the court, has been limited by Wisconsin courts by the related concept of the "integrated system." See Grams v. Milk Products, Inc., 2005 WI 112,  283 Wis. 2d 511, 699 N.W.2d 167 (2005).  Under the concept of an integrated system (which is not recognized in all states), if  the product at issue is a defective component in a larger system, the other components of that system are not regarded as other property in a legal sense, even if they are different property in a literal sense. Thus, in Bay Breeze Condominium Ass'n v. Norco Windows, Inc., for example, the Wisconsin Court of Appeals applied the "integrated system" concept to find that defective windows were simply "part of a single system or structure, having no function apart from the buildings for which they were manufactured." 2002 WI App 205, 257 Wis. 2d 511, 651 N.W.2d 738.

The same conclusion followed here, said the court. Like the defective windows in Bay Breeze, the contaminated enzymes in this case were merely a component of an integrated system—the supplements. Thus, the "other property" exception did not apply, said the court.

Schwabe attempted to avoid this conclusion by invoking the "disappointed expectations" test, which is yet another concept courts in Wisconsin (and elsewhere) have utilized in determining the scope of the economic loss doctrine.  But under this test, the exclusive remedy for a commercial product that causes property damage by failing to perform as expected is generally under contract since the parties can allocate the risk of such non-performance by contract. The court held it was within the parties' expectations in this case that if defendant supplied Schwabe with adulterated enzymes, its own dietary supplements would have to be recalled.

Schwabe's other argument against dismissal of its negligence claim was based on the claimed "public safety" exception to the economic loss doctrine. In support of its argument, Schwabe relied on Northridge v. W.R. Grace & Co., 162 Wis. 2d 918, 922, 471 N.W.2d 179 (1991). In Northridge the owners of two shopping malls sued the manufacturer of an asbestos insulation product in negligence and strict liability for the costs of inspecting, testing and removing the product, along with the diminished value of the malls caused by the contamination. Schwabe claims that in that case the court recognized a public safety exception to the economic loss doctrine that applies where the alleged negligence of the defendant creates a public health hazard.  However, Northridge does not create a broad public safety exception to the economic loss doctrine, said the court.  See also Wausau Tile, Inc. v. County Concrete Corp., 226 Wis. 2d 235, 264, 593 N.W.2d 445 (1999). That case was an "other property case," and the alleged health hazard to occupants of the mall viewed in the context of deciding whether the complaint alleged damage to property other than the product itself. 

Motion granted.

Federal Court Dismisses Device "Consumer" Claims

A federal court last month dimissed claims by plaintiffs concerning hip implants, with an analysis important for other consumer protection-type class action claims. Watkins v. Omni Life Science, Inc., 2010 WL 809820 (D.Mass. 2010).

Plaintiffs were recipients of the Apex Model Replacement Hip. Although neither plaintiff alleged an Apex Hip malfunction, they claimed that the allegedly relatively high rate of failure of the Apex Hip placed them and members of the proposed class at serious risk of future harm.  The failure rate was also alleged to have diminished the market value of their hip implants and those of the putative class members. Plaintiffs claimed that they would not have selected the model Hip over other alternative devices but for the representations made by the defendant manufacturer. Plaintiffs asserted claims for breach of implied warranty, breach of contract, unjust enrichment and constructive trust, violations of the Massachusetts consumer protection statute, and violations of the consumer protection laws of all other states (for the class).

Omni filed a motion to dismiss pursuant to Fed.R.Civ.P. 12(b)(6), arguing that no legally cognizable injury was pled in any of plaintiffs' claims. Plaintiffs' reply argument, as is typical, was a benefit of the bargain theory. Plaintiffs claimed that an accident-related injury or a manifested defect need not be shown as a predicate of recovery on their consumer claims. They claimed that their sufficient injuries consisted of: (1) the apprehension caused by the prospect of an increased risk of hip failure and (2) the extra money that they paid for an overvalued Apex Hip.

First, the court said, although plaintiffs' claims were styled as contract and breach of warranty claims, they actually were tort allegations. A plaintiff cannot disguise a tort claim with mere contract langauge. In Massachusetts, the economic loss doctrine applies, and purely economic losses cannot be recovered in tort or product liability actions in the absence of personal injury or property damage. The court added that the economic loss rule applied to the plaintiffs' consumer protection act claims as well.

As tort claims, plaintiffs failed to allege sufficient injury. Apprehension of a heightened risk stemming from an allegedly defective product that has not failed or caused harm to this plaintiff is insufficient as a matter of law to support a claim. See Anderson v. W.R. Grace & Co., 628 F.Supp. 1219, 1231 n. 6 (D.Mass.1986) (“The weight of authority would deny plaintiffs a cause of action solely for increased risk because no ‘injury’ has occurred.”). Plaintiffs' overpayment argument was also based on a theory of economic loss that has no place in a tort context. See Iannacchino v. Ford Motor Co., 451 Mass. 623, 633, 888 N.E.2d 879 (2008).

To the extent an allegation sounding in fraud was underlying some of the claims, read in the aggregate, the court found that Omni's alleged misrepresentations, as pled, lacked the capacity to mislead consumers, acting reasonably under the circumstances, to act differently from the way they otherwise would have acted. Under Rule 9b, in alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake.  This was not done.

 

State Supreme Court Reverses Itself on Economic Loss Doctrine

Not long ago we blogged about the economic loss rule, noting that the doctrine had some variants among the states.  Recently, the South Carolina Supreme Court pulled back on an exception to the economic loss rule, concluding that its 2008 opinion expanding the ability to recover in tort for purely economic damages had been wrongly decided. Sapp v. Ford Motor Co., 2009 WL 4893648 (S.C., 12/21/09). Very refreshing to see a court recognize an issue quickly, and act promptly to correct the error.

Economic loss generally refers to damages that occur through the loss of the value or use of the goods sold or the cost of repair, when there has been no claim of personal injury or damage to property other than the product. The economic loss doctrine has held that such damages, a product injuring itself in essence, is a claim about a breach of the commercial relationship, and thus must be brought in contract/warranty, and not a tort claim sounding in negligence or strict liability. Most states have adopted some form of the economic loss rule, although with some variation in detail. Some carve out exceptions, and in South Carolina there has long been an exception for economic damage to a residence. The reasoning was that a home is often an individual's largest investment and different in kind from other manufactured goods. The courts also looked at the unequal bargaining power between builders and home purchasers.

But in Colleton Preparatory Academy Inc. v. Hoover Universal Inc., 379 S.C. 181, 666 S.E.2d 247 (S.C. 2008), the court seemed to expand the exception even farther, into commercial property.  In Colleton Prep, which concerned allegedly defective materials used in constructing a school building, the state court held that a tort suit could go forward even where only the product itself is damaged, if there is also a clear, serious and unreasonable risk of injury or death, as was the case in a school. The defense bar termed this a very surprising opinion, because it extended the seemingly narrow exception so far that it threatened to swallow the rule, appearing to create tort liability for mere potential harm or risk.

In Sapp, actually two cases consolidated for appeal, plaintiffs sued over allegedly defective cruise-control systems on Ford Motor Co. F-150 trucks, which allegedly caused fires. The lower courts dismissed the claims, saying that under the economic loss doctrine, tort recovery was not available because the damage was only to the allegedly defective products themselves. At oral argument on plaintiffs' appeal, they argued the new expanded exception, suggesting the truck fire created that clear and serious risk of injury. 

The supreme court seemed to recognize the problems it had created. The court recognized that
the exception for residences was a very narrow one.  And the court clarified it  no intention of the exception extending beyond residential real estate construction and into commercial real estate construction. "Such a progression was in error and we now correct that expansion. Much less did we intend the exception to the economic loss rule to be applied well beyond the scope of real estate construction in an ordinary products liability claim.” Accordingly, the court overruled Colleton Prep to the extent it could be read to expand the narrow exception to the economic loss rule beyond the residential builder context.

In South Carolina, as in many states, the purpose of the economic loss rule is to define the line between recovery in tort and recovery in contract. In the context of products liability law, when a defective product only damages itself, the only concrete and measurable damages are the diminution in the value of the product, cost of repair, and consequential damages resulting from the product's failure. Stated differently, the consumer has only suffered an economic loss. When only damage is to the product itself, what has happened is the consumer's expectations have not been met, and he has lost the benefit of the bargain. Accordingly, where a product damages only itself, tort law provides no remedy and the action lies in contract; but when personal injury or other property damage occurs, a tort remedy may be appropriate.  The traditional economic loss rule provides a more stable framework and results in a more just and predictable outcome in product liability cases.

State Court Reaffirms Economic Loss Doctrine

The Pennsylvania Supreme Court last week issued an interesting little opinion on the economic loss doctrine. Excavation Technologies, Inc. v. Columbia Gas Company Of Pennsylvania, No. 32 WAP 2008 (Pa. S.Ct. Dec. 29, 2009).

In the context of products liability actions, economic loss generally refers to damages that occur through the loss of the value or use of the goods sold or the cost of repair, when there has been no claim of personal injury or damage to property other than the product. The economic loss doctrine has held that such damages, a product injuring itself in essence, is a claim about a breach of the commercial relationship, and thus must be brought in contract/warranty, and not a tort claim sounding in negligence or strict liability. As the Pennsylvania court put it, the economic loss doctrine provides, “no cause of action exists for negligence that results solely in economic damages unaccompanied by physical injury or property damage.” Adams v. Copper Beach Townhomes Communities, 816 A.2d 301, 305 (Pa. Super. 2003).

The theory is that tort policy concerns with safety are less present when a product damages only itself; damage to only the product really means that the product has not met customer expectations, a natural warranty claim; that warrant y law is best suited to deal with disagreements over product quality, as the parties can negotiate the terms, within limits, of warranty scope, remedies, etc.; and warranty law with its built-in limits on privity and the requirement of forseeability of consequential damages better reflects society’s traditional concern with the fulfillment of reasonable economic expectations. Tort law, on the other hand, protects a product consumer’s interest in being free of injury regardless of the existence of any direct agreement with the product maker.

Most states have adopted some form of the economic loss rule, although with some variation in detail. Some carve out exceptions for sudden calamitous events (that feel like a tort?), or where there is a “special relationship” (isn’t that special?) between the parties, or in a post-sale duty to warn tort claim. This case involved another possible exception. Appellant sued appellee on a theory of negligent misrepresentation under § 552 of the Restatement (Second) of Torts, which generally holds that one who, in the course of his business, profession or employment, or in any other transaction in which he has a pecuniary interest, supplies false information for the guidance of others in their business transactions, is subject to liability for pecuniary loss caused to them by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or communicating the information. The state Supreme Court granted an appeal to determine whether § 552 imposes tort liability for economic losses to a contractor caused when a gas utility company fails to mark or improperly marks the location of gas lines.

The Court acknowledged that some lower courts had noted an exception for claims of negligent misrepresentation under § 552, which allows such claims to evade dismissal even if they assert purely economic losses. Bilt-Rite Contractors, Inc. v. Architectural Studio, 866 A.2d 270 (Pa. 2005) (finding negligent misrepresentation claim against architect for economic loss viable under § 552). But the economic loss doctrine is well-established in tort law, said the court. See Aikens v. Baltimore and Ohio Railroad Company, 501 A.2d 277, 278-79 (Pa. Super. 1985) (roots of economic loss doctrine first recognized in Robins Dry Dock and Repair Company v. Flint, 275 U.S. 303 (1927)).  The court distinguished Bilt-Rite as a case involving someone who is in the business of giving information for pecuniary gain, and rejected tort liability for anyone not a professional information provider, including one who is under a public duty to give the information (thus rejecting Section 3 of § 552).

This will help prevent plaintiffs from dressing up warranty claims against typical product sellers as negligent misrepresentation claims evading the doctrine of economic loss.  Readers of MassTortDefense know that it does often matter whether a plaintiff can proceed in tort:  warranty claims may involve defenses like privity and puffing and reliance; there may be limitations on remedies, disclaimers on warranties; a different statute of limitations and accrual date.