Issue 83: Sep 2018
The Dominance of Contract over Tort Law in Pure Economic Loss Claims

contract_ripple_intro.jpgUnwarranted Consequences

The historical development of the tort of negligence was in the context of wrongful injuries to person or property. The seminal statement of Lord Atkin in Donoghue v Stevenson1 concerned acts or omissions causing injury to a neighbour. The protection of purely economic interests was the domain of contract law, or in some instances, quasi contract.

The earliest development of a tort claim in negligence for a purely economic loss was in the context of negligent statements. Statements rarely caused physical injury (except, for example, in instances of negligent medical advice to a patient) but negligent advice or information could cause widespread financial losses.

These historical understandings of the role of negligence law and contract resulted in the UK in a reluctance to permit the recovery of purely economic losses in any tort action for negligence, with the consequential development of a rule (exclusionary rule) excluding any recovery of economic loss unless that loss resulted from wrongful injury to the person or property of the plaintiff.

The development of a claim in tort for negligent statements causing purely financial loss under the Hedley Byrne principle was therefore to be seen as exceptional. Even more exceptional in the UK, was any instance of a successful claim for purely economic loss arising from a negligent act or omission (as was the case in Junior Books Ltd v Veitchi Co Ltd 2 which concerned negligent work by a sub-contractor which resulted in defective flooring and purely economic loss to the building owner, the latter successfully recovering its economic loss).

If the primary concern of negligence law was injury to person or property with or without resultant economic loss; and purely economic losses were the domain of contract law, how has this divide affected the development of tort law? It is suggested below that it has underpinned the dominance of contract law and negated tort actions in particular circumstances with some unwarranted and unjustified consequences. It is further suggested below that the subjugation of tort law to contract has been a policy choice and is not grounded in legal principle.

The Subjugation of Tort to Contract – Policy not Principle

If A has a contract with B to provide services or goods to B, and A negligently provides the services, or the goods are defective, the terms of the contract between A and B may determine the right of a third party (C) to sue in tort for purely economic loss caused by A’s negligence. (This scenario assumes that statutory consumer rights are not applicable and common law principles apply). Such has been the situation in claims for economic loss arising from latent defects in building structures.3

Assume in the above scenario that the contract between A and B requires A to build a structure to detailed specifications and in such a way that may cause latent defects. Further assume that A suggests a change to the specifications which would avert the potential risk of latent defects, but B wishing to save costs refuses, so A decides to proceed with the existing specifications (see the analogous facts in Woolcock Street Investments v CDG Pty Ltd 4 ). The risk of latent defects has shifted to B and the duty and liability on A (the builder) has been adjusted under the contract with B. B would be deemed to have accepted the risk of latent defects thereby relieving A of liability to B (whether in contract or concurrently in tort 5 ), by requiring the work to proceed with the existing specifications despite advice from A to change the specification to avoid the risk.

A and B under freedom of contract, are free to adjust rights and obligations as they wish. However, contract law controls only the rights and obligations of the parties to the contract. Tort law imposes general duties irrespective of contract, and there has been no adjustment of the duty and liability cast upon A to a third party (C), with respect to latent defects.

The disconformity between the liability of A to B and the liability of A to C, results from the underlying principles of contract law and tort. Consequently, any requirement of the law that there be conformity in the duty of A to B under the contract and A to C under tort law, ignores the separate principles of tort and contract and can only be justified on policy grounds. It is noteworthy that in the two most recent cases on latent defects in buildings in Australia there has been judicial recognition that disconformity between the contract duty to the original owner and the tort duty to a subsequent owner will not necessarily in every case bar tort recovery. 6

The policy justification for a requirement of conformity is that it would be an unwarranted interference with the legitimate right of the builder (A) to make financial gain and a disincentive to provide professional services if the duty and liability to a third party (C) was more extensive than the duty and liability to B under the original contract.

Another justification is simply that the parameters of the work to be done by A (the builder) are determined by the original contract and arise solely from the contract.

These are policy justifications and are not grounded in principle. The fact that A’s obligation to build a structure arose solely from a contract with B in no way prevents an independent tort duty to a third party (C). The contract between A and B (original owner) is merely the catalyst or vehicle for a positive sphere of activity by A. The fact that the obligation on A only arose from the contract has been held not to prevent a tort duty arising. 7 The contractual work to be performed may involve a foreseeable and likely danger to particular third parties. For instance, in the above scenario it may involve a potential economic loss to (C), a subsequent purchaser, should latent defects surface when C owns and occupies the building. More specifically, the contract between A and B, voluntarily entered into by A, has brought A into a relationship of neighbourhood with a potential third-party C, who may suffer damage from the work undertaken under the contract (the specifications).

What are the options for a party, required under a contract to perform some activity or work which that party can foresee may likely cause economic loss to a third party? They can refuse to enter the contract on those terms or seek an indemnity from the other contracting party against potential third party tort claims.

As was referred to by Kirby J in Woolcock, 8 if the policy of the law is to prevent any tort action where there is disconformity between the contractual duty of the professional to the first owner and the tort duty to a subsequent owner, and the contract requires potentially defective work, this will encourage sub-standard constructions and unprofessional work. The deterrent effect of tort law is negated. Such an outcome, it is suggested, is not outweighed or justified by an argument that to impose a tort liability on the professional, wider than that agreed to under the initial contract between the professional (eg builder) and first owner, is an unwarranted fetter on commercial activity and hinders the legitimate pursuit of financial gain.

Vulnerability and Purely Economic Loss

Vulnerability in the context of purely economic loss claims for negligence currently means that any right to sue in tort will be extinguished and subjugated to a right or potential right to sue in contract for that loss.

In the High Court of Australia, in the two most recent decisions on latent defects in buildings, 9 vulnerability has meant that a claimant for economic loss in tort must prove that it could not have protected itself from such economic loss under contract by, for instance, seeking a warranty of quality for latent defects from the seller. If the claimant in tort fails to produce any evidence on the point, the claimant has not proved vulnerability and the tort claim is barred. Of course, if there is a warranty given to the claimant under a contract against such economic loss, there is no vulnerability and any tort claim is extinguished.

This is purely a policy decision of the law to subjugate a tort claim to rights in contract. This policy decision has its genesis in and is underpinned by the historical divide, discussed in the Introduction, between the protection from physical damage to person or property which is the domain of torts, and purely economic interests which are the domain of contract.

Is the policy justified on balance, or are there negative consequences from denying a tort action which would outweigh the application of the policy?

As Kirby J has noted, why should a claimant in tort reasonably anticipate the need for a warranty of quality (eg freedom from latent defects) in relation to professional work? As his Honour has also noted, there is no evidence of any such commercial practice. It is unrealistic to expect a party to anticipate in every contract, the possibility of unprofessional work by someone not a party to the contract and be required to seek an indemnity. 10 Furthermore, as McLachlin J stated in Canadian National Railway Co v Norsk Pacific Steamship Co Ltd 11 (a case where the railway company, which had a contract for use of a railway bridge with the bridge owner, sued a negligent third party in tort for the railway company’s economic loss suffered as a result of an inability to use the bridge due to the third party damaging the bridge) where it was argued the railway company could have sought an indemnity or warranty under the contract with the bridge owner against negligent damage to the bridge, that it is unlikely a party such as the bridge owner will grant an indemnity ‘against the negligence of those over whom they have no control’. 12 McLachlin J, in the same case, stated that a contractual allocation of risk rests on ‘questionable assumptions’. It assumes that ‘all parties to a transaction share an equality of bargaining power which will result in the effective allocation of risk’. Her Honour further stated that ‘it overlooks the historical centrality of personal fault or delict and the role this may have in curbing negligent conduct and thus limiting the harm done to innocent parties, not all of whom are large enterprises capable of maximising their economic situation’. 13

Finally, the defence of caveat emptor in the context of a negligence action against a tortfeasor who is not a party to any contract with the claimant, is irrelevant. It would only be relevant if the claim was against the other party to the contract. 14

It is suggested that the current interpretation of vulnerability whereby claimants in tort for purely economic loss will fail unless they establish they could not have protected themselves under contract, results in unjustified and commercially unrealistic expectations. It further negates the deterrent effect of tort in curbing unprofessional conduct.

Conclusion

While the courts have acknowledged that protection of purely economic interests is not solely the domain of contract law and have developed discrete categories in negligence where recovery of purely economic loss is appropriate, there are still unwarranted and unjustified fetters placed on the tort of negligence as the appropriate vehicle for the recovery of purely economic loss.

The propensity of economic loss to manifest at one or more removes (the ripple effect) and thereby expose a tortfeasor to indeterminate liability, has rightly restricted the categories of successful claims in tort. But absence any such threat to the defendant, there are no justifiable reasons for restricting recovery in tort for these economic losses.

Further there is no reason in policy to subjugate tort to contractual rights where the normal principles of foreseeability of likely harm from careless conduct are present, simply because the loss claimed is purely economic.

Policy, not principles of law, currently restrict tort actions for purely economic loss by giving unwarranted precedence to contract as the appropriate domain of economic interests. This policy has produced detrimental and unwarranted outcomes, unfairly restricting the recovery of economic losses in tort and imposing commercially unrealistic requirements on claimants.

Dr Norman Katter *

 

Footnotes

* LL.B, LL.M, PhD Barrister-at-Law

 

  1. [1932] AC 562 at 580
  2. [1983] 1 AC 520
  3. Brookfield Multiplex Ltd v Owners Corporation Strata Plan [2014] HCA 36; Woolcock Street Investments Pty Ltd v CDG Pty Ltd [2004] HCA 16
  4. [2004] HCA 16
  5. Bryan v Maloney [1995] HCA 17 at para 10
  6. Brookfield Multiplex Ltd v Owners Corporation Strata Plan [2014] HCA 36 per French CJ; Woolcock Street Investments Pty Ltd v CDG Pty Ltd [2004] HCA 16
  7. See the unanimous judgment of the Supreme Court of Canada given by Le Dain J in Central & Eastern Trust Co v Rafuse [1986] 2 SCR 147 at 204-205; approved by the High Court of Australia in Bryan v Maloney (1995) 182 CLR 609 at 628
  8. [2004] HCA 16 at paras. 133,134
  9. Brookfield Multiplex Ltd v Owners Corporation Strata Plan [2014] HCA 36; Woolcock Street Investments Pty Ltd v CDG Pty Ltd [2004] HCA 16
  10. Woolcock Street Investments Pty Ltd v CDG Pty Ltd [2004] HCA 16 at paras. 169-171, 178 per Kirby J
  11. [1992] 1 SCR 1021
  12. Ibid at 1158 1160
  13. Ibid
  14. Woolcock Street Investments Pty Ltd v CDG Pty Ltd [2004] HCA 16 at para 178