Pure economic loss and negligent misrepresentation to third parties

Black-letter propositions

1. 01

   As a general rule, a tort to the person or property of one party does not make the tortfeasor liable to another merely because the injured party was under a contract with that other; Robins Dry Dock denied charterers recovery for the loss of a ship's use caused by damage to its propeller.

2. 02

   A commercial buyer whose defective product injures only itself, causing purely economic loss, has no tort claim in negligence or strict liability under East River; that claim is a warranty claim, and tort recovery is for damage to other property or for physical injury.

3. 03

   Seely v. White Motor rests the line on the nature of the manufacturer's responsibility: a maker is liable in tort for physical injuries caused by defects but is liable for the level of a product's performance in the buyer's business only to the extent it agreed.

4. 04

   Some courts allow recovery for economic loss without privity when a special relationship exists, weighing the extent the transaction was intended to affect the plaintiff, foreseeability, certainty of injury, closeness of the connection, moral blame, and the policy of preventing future harm.

5. 05

   Courts take three approaches to negligent misrepresentation by auditors: near-privity under Ultramares and Credit Alliance, reasonable foreseeability of reliance, and Restatement (Second) of Torts section 552, which limits liability to a limited group the supplier intends to reach in a transaction it intends to influence.

6. 06

   Fraud is treated more broadly than negligence: California allows an auditor to be liable to reasonably foreseeable third persons for intentional fraud, though it limits negligent misrepresentation liability to section 552 plaintiffs.

Use this attack sequence under time

Common wrong turns

• Damage to the defective product itself is economic loss, but damage to other property is ordinary property damage recoverable in tort.
• A negligent misstatement to a class of unknown investors usually does not create liability under section 552 or near-privity, though fraud may.
• Foreseeable financial harm alone does not create a tort duty to every affected business.

Worked example

A negligent contractor cuts a power line while working for a landlord, and the tenant of a neighboring building loses a week of restaurant sales because the power fails.

Practice this topic

The general rule against purely economic recovery

In Robins Dry Dock and Repair Co. v. Flint, the Supreme Court considered charterers who lost the use of a ship because a dry dock's negligence damaged its propeller. The Court observed that a tort to the person or property of one man does not, as a general rule, make the tortfeasor liable to another merely because the injured person was under a contract with that other. The charterers' loss arose only through their contract with the owners, and the wrong to the propeller was a wrong only to those to whom it belonged.

In East River Steamship Corp. v. Transamerica Delaval, the Court held that no products-liability claim lies in admiralty when a commercial party alleges injury only to the product itself resulting in purely economic loss, whether the claim is stated in negligence or strict liability. It explained that such a claim is most naturally understood as a warranty claim, and it contrasted the traditional case in which a defective product damages other property.

Why tort and warranty differ

The California Supreme Court reached a similar line in Seely v. White Motor Co. A buyer whose truck did not perform sought lost profits and a refund. The court said that a manufacturer can be held liable in tort for physical injuries caused by defects because it must meet a standard of safety defined by conditions that create unreasonable risks of harm. It cannot be held for the level of performance of its products in the consumer's business unless it agrees that the product was designed to meet the buyer's demands.

The court described the rules of warranty as functioning well in a commercial setting, where they determine the quality the manufacturer promises and thereby the quality it must deliver.

Special relationships and auditors' liability

In J'Aire Corp. v. Gregory, the California Supreme Court allowed a restaurant tenant to sue a contractor whose delay in renovating the premises hurt its business, although the contract was with the owner. It applied six criteria: the extent to which the transaction was intended to affect the plaintiff, the foreseeability of harm, the certainty of injury, the closeness of the connection between conduct and injury, the moral blame, and the policy of preventing future harm.

Bily v. Arthur Young & Co. surveys auditors' liability to third parties for negligent audit reports. It describes three schools of thought. The near-privity approach follows Cardozo's opinion in Ultramares and Credit Alliance. A handful of jurisdictions allow recovery from auditors for reasonably foreseeable reliance. The third approach follows section 552 of the Restatement (Second) of Torts, under which a supplier of information is liable for negligence to a limited group for whose benefit and guidance it intends to supply the information, in a transaction it intends the information to influence. California adopted section 552 and also held that an auditor may be liable to reasonably foreseeable third persons for intentional fraud.

Frequently asked questions