Exceptions to the Economic Loss Doctrine

Economic Loss Doctrine

An economic loss refers to a financial loss and damages suffered by a person or entity, which arise from a defect in the qualitative nature of the product, service, or improvement that was bargained for. Generally, an economic loss is observed on assets (i.e., “the books”) rather than physical injury to a person or entity. The Economic Loss Doctrine can be a roadblock to subrogation. Exploration of exceptions to the doctrine can provide subrogation professionals with tools to navigate their way to recovery.

Illinois Economic Loss Doctrine

The doctrine sets out to bar recovery in tort for purely contractual losses, or frustrated economic expectations between two contracting parties. Under the Economic Loss Doctrine, or the Moorman Doctrine as it is known in Illinois, recovery for solely economic losses in relation to a product may not be had upon the tort theories of negligence or strict liability.

In Moorman, the plaintiff discovered a crack in a grain storage tank manufactured by the defendant. The damages were limited to the storage tank itself, and the plaintiff sought recovery in tort for the cost of repair and loss of use of the tank. The Illinois Supreme Court affirmed the dismissal of the tort claim, holding that a plaintiff may not recover in tort for solely economic losses. The basic rationale behind the holding in Moorman and numerous courts since is that contract law is designed to remedy losses relating to “disappointed expectations due to deterioration, internal breakdown or non accidental cause, whereas causes of action in tort are suited for personal injury or property damage resulting from a sudden or dangerous occurrence…”

Defining an economic loss

Defining economic loss is partially to blame for the confusion the doctrine is known for. Examples of an economic loss include inadequate value and costs of repair as well as replacement of the defective product and subsequent loss of profits. In our touchstone Moorman case, the shoddy grain storage tank did not live up to expectations and the court’s decision reflects that recourse for the damaged tank is a cause of action in contract, not tort. While the plaintiff in Moorman was not able to proceed in tort for those damages, the plaintiff did withstand the motion to dismiss under a breach of an express warranty. Pertaining to this article, we will focus on withstanding attacks utilizing the doctrine for tort claims and what damages, if any, may be recoverable.

Exceptions to the Economic Loss Doctrine

Similar to other doctrines there are exceptions. Illinois courts interpreting these exceptions have listed them accordingly:

  1. A sudden, calamitous, or dangerous occurrence coupled with physical harm to person or other property;
  2. Intentional misrepresentation; or
  3. Negligent misrepresentation by a defendant who is in the business of supplying information for the guidance of others in their business transactions.

The first of these exceptions is one that is commonly triggered. Had that same grain storage tank in Moorman not only cracked but also suddenly fallen over, damaging several nearby commercial vehicles, a cause of action in tort could withstand an Economic Loss Doctrine defense. The reason the action could withstand such a defense is because the sudden event of the tank toppling onto the nearby vehicles, or “other property”, is precisely what is contemplated in the first exception to the doctrine. This collateral damage is not something that the consumer who purchased the grain storage tank could reasonably account for in the transaction. Thus, a cause of action in tort is proper.

Other property

Another example of “other property” can be found in the case of Schuster Equipment Co. v. Design Electric Services, Inc. Schuster is an example of “other property” because the defendant argued the Economic Loss Doctrine prevented it from being held liable in tort as the defendant constructed and installed an electric service line that provided too much voltage to the plaintiff’s computer. This increase in voltage resulted in a fire inside the computer. The defendant argued that the electric service lines, and the computer, were part of a single electrical circuit and the computer could not be defined as “other property” to trigger the exception. The court rejected the defendant’s argument, holding that the computer was an appliance connected to the electrical circuit. In Schuster, the appellate court provided some guidelines as to where a consumer’s claim rightfully ends and where damage to “other property” begins.

The Schuster Equipment Co. case is often included in the “other property” analysis. While Schuster does not use the phrase “other property”, it does follow what is described as the “bargained for” approach. Addressing questions made in the Seventh Circuit Court of Appeals Trans States Airlines v. Pratt case, the Illinois Supreme Court employed in its opinion the “bargained for” approach. The plaintiff filed a claim in the federal district court against an engine manufacturer seeking damages under theories of negligence, breach of warranty, and strict liability. The relevant damages under review for purposes of “other property” were the failed engine as well as the damaged airframe of the plane.

Following exploration of the various approaches courts have taken, with respect to economic losses under tort theories of recovery, the Illinois Supreme Court chose to focus on the expectations of the parties to the transaction. The court held that the loss of the airframe is the type of damage one would reasonably expect as a direct consequence of a defective engine. However, most products are composed of smaller parts. The Economic Loss Doctrine’s main purpose would be frustrated if courts were to entertain “other property” as parts of a product. Courts are reluctant to broaden the exception as doing so would ignore the intended consumer protections that product liability law set out to accomplish.

Ohio Economic Loss Doctrine

Not all courts, however, follow the “bargained-for approach” in analyzing damage to “other-property” while still arriving at similar conclusions in their treatment of the Economic Loss Doctrine. The Ohio Supreme Court, for example, has held that the rules of warranty are best suited to govern the issue of recovery for commercial losses. Under Ohio law, “a product’s self-inflicted damage is by definition property damage.” In determining whether damage to the product constitutes economic loss, Ohio focuses not on the nature of the product and its components, but rather on the relationship between the parties. Where there is privity of contract and the parties have negotiated that contract from comparative bargaining positions, the parties are able to allocate the risk of all loss. This includes allocating the loss of the product.

Wisconsin Economic Loss Doctrine

Wisconsin also adheres to the majority principles of the Economic Loss Doctrine among state courts. In a third party suit, the plaintiff suffered damage to its printing press when a defective replacement part, manufactured by the defendant, failed. The Wisconsin Court of Appeals held that the Economic Loss Doctrine applies where a commercial purchaser buys used equipment containing a defective replacement part that causes damage to the equipment and results in repair costs and loss of business income.

Wisconsin takes the “integrated systems” approach to the Economic Loss Doctrine, which means that damage by a defective component of an integrated system, to either the system as a whole or other system components, is not damage to “other property” that would impede the application of the Economic Loss Doctrine.

Sudden and calamitous event

The search for what constitutes “other property” may be an exercise in futility if it is not coupled with a sudden and calamitous event. Fires, explosions, and pipes bursting are obvious examples of sudden and calamitous events. A more useful analysis for a subrogation professional is what courts have determined to fall outside the exception.

The Seventh Circuit encountered the first exception to the Economic Loss Doctrine on appeal in Chicago Heights Venture v. Dynamit Nobel of America, Inc., 782 F.2d 723 (7th Cir. 1986). In that case, owners of apartment buildings appealed the dismissal of some claims and the granting of summary judgment on remaining claims related to a cause of action arising from damage to apartment buildings caused by allegedly defective roofing materials. These roofing materials were made by appellee manufacturers and mounted by appellee installers. Of note in their opinion was the interpretation of whether the occurrence(s) in question could be classified as a sudden event and pursued under theories of negligence and/or strict liability.

The building owners described two occurrences. The first occurred in 1978 when the roofing material tore away from the roof of each building. The second occurred in 1979 when the same roofing material entirely separated from the roof and fell to the ground during a windstorm. The building owners also alleged that because of the two occurrences, water leaked into the buildings damaging ceilings and walls of the lower floors. Allegations were also made that the ripping force of the first occurrence resulted in bricks loosening from each of the buildings.

While the court entertained the notion of charitably reading some of the claimed damages as “other property”, the court inevitably holds the alleged damage to be incidental to the surrounding parts of the property. The court’s analysis then shifts to the nature of the occurrence. While the building owner appellants stressed the sudden nature of the two incidents that spanned over nine months, one of which involved a windstorm, the court found that the facts were best characterized as that of deterioration as opposed to the sudden and calamitous occurrences envisioned to trigger the Economic Loss Doctrine first exception.

Intentional misrepresentation in Illinois

Intentional misrepresentation and negligent misrepresentation by a defendant who is in the business of supplying information for the guidance of others in transactions are the next two exceptions to the Economic Loss Doctrine outlined in Illinois Moorman. Fraud is an intentional tort, and while there are some nuanced interpretations in a minority of states in its relation to economic losses, the majority of states including Illinois find it actionable as a tort regardless of whether the contract losses are economic.

Negligent misrepresentation in Illinois

The Illinois Supreme Court’s analysis in Rozny v. Marnul is still held as Illinois seminal case for negligent misrepresentation. In Rozny, the plaintiff sought recovery in tortious misrepresentation for the preparation of an inaccurate survey by the defendant surveyor. The Supreme Court deemed the loss as occurring to an “intangible economic interest” and noted that recovery for such a loss, when the loss arose from negligent performance of a private contract, was permissible when the class of potential plaintiffs was small and it was undesirable to leave the innocent party without remedy.

Rozny v. Marnul

The Rozny case and many other cases like it involve parties that were not in direct privity of contract. The defendant surveyor provided the inaccurate survey and sold the “subject” real property to a builder who subsequently sold the real property to the plaintiff. As opposed to the court creating what it described as an “artificial” relationship between the parties to allow a breach of warranty claim by plaintiffs, the court turned to tort, which does not require privity. The following factors were deemed important to the court in finding negligent misrepresentation:

  1. The “absolute guarantee for accuracy” appearing on the face of the inaccurate plat;
  2. The defendant’s knowledge that the plat would be relied on by third parties, including the plaintiff;
  3. The fact that potential liability was restricted to a small group;
  4. The absence of proof that copies of a corrected plat were delivered to anyone;
  5. The undesirability of requiring an innocent reliant party to carry the burden of a surveyor’s professional mistake; and
  6. The fact that allowing recovery by a reliable user whose ultimate use was foreseeable would promote cautionary techniques by surveyors.
Subrogation attorneys

Following the Rozny opinion, a new requirement was injected into the analysis by the First District in Black, Jackson & Simmons Insurance Brokerage, Inc. v. International Business Machines Corp. The requirement states the defendant must be in the business of supplying information for the guidance of others in their business transactions. The Economic Loss Doctrine has a storied past with varying interpretation which is why having an understanding of its main principles can salvage a claim. To learn more the Economic Loss Doctrine or the Illinois Moorman Doctrine, contact one of our Illinois subrogation attorneys.