Thursday, January 20, 2011

The Limits of the Economic Loss Rule

The Economic Loss Rule has become a salient issue in Washington over the past few years, with a series of cases challenging assumptions about what people can expect when they enter into a contract.  The question, to which our Supreme Court has articulated an answer in several decisions, is to what extent can parties to a contract still look to tort remedies when they are dissatisfied with the outcome of their agreement?

The Economic Loss Rule has been understood to mean parties to a contract must allocate all risk of economic damages in the contract and, if they do not, the parties to the contract will not be able to use non-contract claims (i.e. tort claims) to recover economic damages (e.g. loss of profits, diminished value of item purchased).  Economic damages are to be distinguished, in this context, from actual physical harm.  The rule can become important even in non-commercial contexts; it has had major impacts for people buying a home, where a contract is used to define the terms of the transaction.  The application of the rule prohibiting tort remedies for economic damages, where a contract existed between the parties, was based largely Alejandre v. Bull, a 2007 decision of this state's Supreme Court.

However, in a pair of recent decisions our Supreme Court has clearly limited the application of the rule and shown that tort remedies are more broadly available than we previously thought possible.  Those cases, issued on November 4, 2010, were Eastwood v. Horse Harbor Fdn., Inc., and In re Affiliated FM Insurance Co, v. LTK Consulting Services, Inc.

The new statement of the Economic Loss Rule, put most simply, says that a plaintiff can recover its economic damages by way of a tort (non-contract) claim so long as that tort claim is based on a duty owed independently of any contract.  To avoid confusion, the Supreme Court suggested a new name for the rule: the Independent Duty Doctrine.  In the Eastwood case, that duty arose as a matter of statute in the context of the lease of a horse farm.  The Affiliated FM Insurance case involved a more general duty owed by an engineer performing work on the Seattle monorail.

The newly clarified rule requires a very nuanced application, as the Independent Duty Doctrine is not as simple as the above analysis might suggest.  Attorneys will find themselves making changes to some of the language they include in contracts, based on these recent cases, especially when they are helping clients to sell property or provide services with strictly-limited warranties.  For clients, it means that contract forms they have relied on in the past may need updating in order to provide them the best protection from unexpected claims.  In addition, the newly clarified rule requires attorneys to carefully consider tort duties, and discuss them with their clients, to an extent they may not have felt necessary based on older decisions.

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