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.