Pure Financial Loss in Product

Liability Claims June 2016

Michael Harvey Partner, BLM London

T 020 7457 3574 E [email protected]

1

Liability to third parties for their pure financial loss in product liability claims

What do we mean by “Pure Financial Loss”?

What we mean by this is – “Pecuniary loss not consequential upon injury or damage”.

Insurers often refer to this as “financial loss”, but this is what is usually referred to in law as pure economic loss.

This concept is important because it determines what losses can and cannot be recovered by a claimant.

Pure economic loss is treated differently depending on whether the claim is one in tort or contract.

Essentially, there is a duty of care in tort to avoid causing your ‘neighbour’ physical injury or damage (per Donoghue v Stevenson), but no such duty to avoid causing pure economic loss; and pure economic loss is generally not recoverable in tort.

The reason for this is likely to be the fear that allowing claims in tort for pure economic loss might lead to a flood of claims.

It is therefore important to determine as early as possible what causes of action are available to the claimant.

1. Tort

Where a defective product has caused injury or physical damage a claimant will be able to recover both compensation for the injury or damage, as well as any economic loss consequential on that injury or damage.

For example, claimants who have suffered physical injury by a defective product can recover damages for their injuries (“Pain, Suffering and Loss of Amenity”), but also loss of earnings for any period they were unable to earn as a result of their injuries.

This is economic loss, but it is economic loss consequential on the injury, it is not pure economic loss.

By way of further example, where a building has been damaged, perhaps by a defective tumble dryer having caused a fire to the building, a claimant can recover damages/compensation for the damage to the building, but can also recover (for e.g.) lost rent or loss of profit for the period where the building is being repaired and is uninhabitable. Again, this is economic loss, but it is economic loss consequential upon damage, and is not pure economic loss.

“Damage”

Given that it is the presence or absence of physical injury or damage which determines whether an economic loss is consequential (and so recoverable) or pure (so not recoverable), it is important to be able to establish what is meant by “damage”.

This will often be obvious and cause no problems, but that is not always the case.

It must be physical damage to property other than the product which caused the damage.

2

An anomaly to this is:

Junior Books v Veitchi [1983]. A claim was brought by the claimant against the defendant specialist flooring sub- contractor who laid flooring in the claimant’s factory. The defendant failed to do this correctly, with the result that there was extensive cracking to the flooring. There was no contract between the claimant and the defendant, so the claimant brought a claim in negligence.

The court found that there was a special relationship between the claimant and the defendant, on the basis that the defendant was a specialist flooring contractor and had been present at numerous discussions with the claimant prior to laying the flooring. This gave rise to a duty of care, and the scope of the duty extended to avoiding causing the claimant pure economic loss.

This decision has been heavily criticised and pretty much confined to its own facts.

Junior Books is essentially not good law. Without formally overruling the Junior Books decision, the HL took the opportunity to re-state the position in the case of Murphy v Brentwood District Council [1991].

Murphy was a building damage case, but in his judgment Lord Bridge set out the position in negligence in relation to products.

In relation to products causing no injury or damage he said:

“…if a manufacturer produces and sells a product which is merely defective in quality, even to the extent that it is valueless for the purposes for which it is intended, the manufacturer’s liability at common law arises only under and by reference to the terms of any contract to which he is a party in reference to the product; the common law does not impose on him any liability in tort to persons to whom he owes no duty in contract but who, having acquired the product, suffers economic loss because the product is defective in quality”. [our emphasis]

In relation to products where there is as yet no damage but damage may be imminent, he said:

“If a dangerous defect in a product is discovered before it causes any personal injury or damage to property…the defect becomes merely a defect in quality…The loss sustained…is purely economic. It is recoverable against any party who owes the [loss sufferer] a relevant contractual duty. But it is not recoverable in tort in the absence of a special relationship of proximity…There is no such special relationship between the manufacturer of a product and a remote owner…” [our emphasis]

Examples of where the court held there was no damage to other property, just damage to the thing itself:

In Linklaters v McAlpine [2010] pipework carrying water in Linklaters’ offices corroded because of poorly applied insulating materials, which meant that the pipework and insulation had to be replaced, at considerable cost. The court held that the pipework and insulation around the pipework were components of the same product/installation (the insulated water pipework), on the basis that you couldn’t have the pipework carrying chilled water without insulation because to do so would itself have caused the pipe to corrode. The pipework and insulation was therefore one product; and so the court held that the corrosion damage was damage to the product itself, and was therefore pure economic loss and not recoverable.

3

In Bacardi v Thomas Hardy Packaging [2002] the defendant manufactured Bacardi Breezer by mixing carbon dioxide with Bacardi concentrate and water. The carbon dioxide was contaminated with benzene, a carcinogen, so the drinks had to be recalled and disposed of. The defendant brought a claim in contract against Messer, the party who supplied it with the contaminated carbon dioxide. The contract limited liability to liability for “direct physical damage to property” and excluded liability for losses of a “purely financial or economic nature”.

So although a contractual claim, the court still had to decide whether there had been physical damage to other property (the Bacardi Breezer).

The court found that there was no damage to the Bacardi Breezer. The reasoning, essentially, was that the contaminated carbon dioxide did not contaminate (and therefore damage) what would otherwise have been finished Bacardi Breezer, but in fact the finished Bacardi Breezer did not even exist until all the ingredients, including the carbon dioxide, were admixed together. It was only at that point that the product came into existence at all. It was simply a worthless product which had been defective from the moment of its creation. There had been no damage. The loss was purely economic.

Note: This is quite a controversial decision and there has been much debate about it. The outcome may possibly have been different if the claim had been put on the basis that the individual ingredients had been damaged by being contaminated when mixed with the carbon dioxide, causing loss of value in those ingredients – but the claim was brought only on the basis of damage to the finished Bacardi Breezer.

However, this is an illustration of the difficulties that can sometimes arise in ascertaining if there has been any physical damage to other property.

“Complex structure theory”

This is linked to the requirement for “damage to other property”. This essentially involves buildings, or structures, as the name suggests.

The issue arises where one part of the structure of the building damages other parts of the building.

Is this simply damage to the thing itself (the building as a whole), or can damage to another part of the same building be said to be damage to “other property”?

The high point for this theory was the case of D & F Estates v Church Commissioners for England in which it was held essentially that different parts of the structure could indeed amount to separate property for the purposes of assessing whether there has been damage to “other property” or whether the resulting loss is instead pure economic loss and irrecoverable.

In Broster v Galliard [2011] the defendant had constructed a terrace of six houses. The roof of the terrace lifted off during high winds as a result of the defendant’s failure to ensure the roof joists were adequately secured. The claimant’s claimed in tort against the defendant for the damage to their houses.

The defendant applied to strike out the claim on the basis that the damage was to the ‘thing itself’ and therefore an irrecoverable pure economic loss. The claimants relied upon the ‘complex structure theory’ to try to circumvent this defence arguing that each dwelling should be treated as distinct from the other and a defect in one could cause loss to another.

4

Mr Justice Akenhead rejected the complex structure theory and concurred with HHJ Humprey Lloyd QC’s judgment in Payne v John Setchell Ltd (2002) that “not only is the ‘complex structure’ exception no longer tenable but it is also clear that in approaching ‘another part of the property’ it is necessary to avoid any artificiality and to be realistic.”

Despite this, attempts are still sometimes made to raise the complex theory structure argument.

Damage to whose property?

As a general rule, it must be the claimant’s property that is damaged (or the claimant must at least have sufficient proprietary interest in the property damaged). If damage is to property owned by a third party any resulting loss cannot be recovered. This is called “the exclusionary rule”.

An example of this is the case of Spartan Steel v Martin [1973]. Here the defendant contractors (Martin) damaged an electricity cable under a road with the result that power to the claimant’s steel works was cut off for a period of time.

At the time of the power cut the claimant was in the middle of a steel “melt”, which had to be removed from the furnace and was rendered unusable. The claimant claimed damages for loss of profit on this melt, and also for loss of profit on four further “melts” it said it would have done during the period of the power cut.

The damage here was to an electricity cable owned by the Electricity Board, so there was no damage to any property owned by the claimant, and the claimant could therefore not recover, because it was pure economic loss.

Foreseeability and remoteness

Not all economic loss that is consequent upon physical damage or injury (and so is not pure economic loss) is recoverable in tort

It is only economic loss that is reasonably foreseeable as a consequence of the physical damage or injury, and that is not too remote, that will be recoverable.

In Network Rail v Conarken [2011] Conarken’s lorries damaged Network Rail’s rail bridges, which led to closure of the railway lines whilst the bridges were repaired. As part of the contractual agreements between Network Rail and the train operators, Network Rail was liable to the train operators for compensation for the line closures (this compensation is known as “Schedule 8 payments”).

Network Rail claimed against Conarken for:

(1) the costs of repairing the damaged bridge; and (2) the Schedule 8 payments it had had to make to the train operators.

The losses at (1) were clearly recoverable, as they were for physical damage. The position in relation to the Schedule 8 payments was not so clear.

The court held that the Schedule 8 payments were recoverable. They were “demonstrably consequential” upon the physical damage, as they resulted directly from Network Rail having to close the lines which resulted directly from the physical damage to the bridge.

5

This might be thought surprising, on the basis that it was not foreseeable, at least not to the defendant, that Network Rail would have such contractual arrangements in place with the train operators; but essentially, the court found that the losses were sufficiently closely associated with the physical damage to be recoverable.

In giving judgment, Lord Justice Jackson summarised some of the principles relating to economic loss and foreseeability:

Economic loss which flows directly and foreseeably from physical damage may be recoverable. The test of foreseeability does not require the tortfeasor to have any detailed knowledge of the claimant’s business affairs or financial circumstances, so long as the general nature of the claimant’s loss is foreseeable. [our emphasis]

Loss of income following damage to income generating property is a recognised category of recoverable economic loss.

Loss of future business as a result of damage to property is a head of loss that lies at the “outer fringes of recoverability” and will be very much fact specific. Whether it is recoverable in any particular case will depend on the circumstances of the case and the relationship between the parties.

When you can recover for Pure Economic Loss – Negligent misstatement

The exception to the position that you cannot recover in tort for pure economic loss is where there is a “special relationship” between the parties and one of those parties places reliance upon the specialist advice of the other. This may give rise to a duty of care on the claimant to prevent the defendant suffering pure economic loss (that is, loss without any physical damage or injury).

The most well-known case on this is probably Hedley Byrne v Heller [1963]. Hedley Byrne was a firm of advertising agents, which placed a lot of orders for TV advertising on behalf of its client, Easipower. Hedley Byrne became concerned about Easipower’s credit-worthiness, so asked its own bank to seek a reference from Easipower’s bank, Heller. Heller gave a positive reference about Easipower’s finances, and Hedley Byrne relied on the reference and continued to extend credit to Easipower. Easipower then went into liquidation causing losses to Hedley Byrne.

Hedley Byrne claimed against Heller in negligence. At first instance and in the CA it was held that Heller owed Hedley Byrne no duty of care in the absence of a contractual or fiduciary relationship between them. The HL disagreed. Per Lord Morris:

“If someone possessed of a special skill undertakes, quite irrespective of contract, to apply that skill for the assistance of another person who relies upon such skill, a duty of care will arise…Furthermore, if…a person takes it upon himself to give information or advice to…another person who, as he knows or should know, will place reliance upon it, then a duty of care will arise.”

The scope of this in the product liability context is limited. Almost all the cases in which it has been held there was a special relationship sufficient to give rise to a duty of care not to cause pure economic loss have involved giving statements, references, or providing a service - not supplying a product. The decision in Junior Books (discussed above) sought to extend this duty (to avoid causing pure economic loss) to include acts as well as statements. But there is no such general principle and as discussed above, Lord Bridge made it clear in Murphy v Brentwood DC that there is no such special relationship between a manufacturer of a product and a remote owner.

6

2. Contract

As mentioned already, English law treats pure economic loss differently depending on whether the claim is in tort or in contract.

Damages for breach of contract are intended to restore the innocent party to the same position it would have been in had the contract been performed, so far as the award of money is able to do that.

There is no restriction on the kind of loss which is recoverable in contract.

Pure economic loss is recoverable, subject only to

(i) the terms of the particular contract (which might of course exclude or limit liability for pure economic loss);

(ii) “remoteness”

Remoteness – contractual claims

Pure economic loss cannot be recovered if it is too “remote”.

The rules on remoteness were laid down in the well-known case of Hadley v Baxendale (HL 1854).

The claimants were millers who contracted with the defendant carriers to take a broken mill shaft to repairers, as a template for a new shaft. The claimants did not have any spare mill shafts. Although the defendants had promised to deliver within a day they failed to do so and the new mill shaft was not delivered until much later. The claimants sued the defendants for breach of contract, for damages for loss of profits arising from the fact that the mill was out of action for longer than it should have been as a result of the defendant’s delay.

Alderson B held that damages for breach of contract

“Should be such as may fairly and reasonably be considered either arising naturally, ie. according to the usual course of things, from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of the parties at the time they made the contract, as the probable result of the breach of it.”

Applying this to the facts of the case the court held the defendants were not liable for the loss of profits. The claimants’ loss did not arise “naturally” because the claimants might well have possessed a spare mill shaft; and neither was it in the contemplation of the parties because the defendants were unaware that the shaft entrusted to them was the only one which the claimants possessed. (It may have been different if the defendants had known this)

As a result, the loss of profits was too remote as a head of damages, in the circumstances.

These principles were re-stated by the CA in the case of Victoria Laundry v Newman Industries (1949) and later by the HL in the case known as The Heron II (1969) (and see also more recently the case of Transfield Shipping v Mercator (2008) ).

As a result of these cases, in terms of remoteness, there are two categories of pure economic loss which a claimant can recover for breach of contract:

7

Loss arising naturally from the breach, ie. in the ordinary course of things. (the party in breach of contract will be deemed to know what this loss would be, as a reasonable person);

(In relation to any special, abnormal or unusual financial losses), loss which could reasonably be supposed to have been within the reasonable contemplation of the parties at the time of the contract, as the probable result of the breach. Any financial loss that the claimant cannot bring within either of these two categories will be too remote and not recoverable.

The Victoria Laundry case is a good illustration of the effect of the remoteness rules:

The claimants were launderers and dyers. They wished to buy another boiler to allow them to expand their business and take on some particularly lucrative dyeing contracts. The defendant agreed to sell the boiler to the claimant. The defendant was aware that the boiler was for immediate use. Delivery was five months late and the claimants claimed the following loss of profits:

£16 per week for loss of the additional “normal” profits they would expect to have made with the new boiler; and

£262 per week representing the loss of the lucrative dyeing contracts.

The CA held that the defendant was liable for the normal loss of profit, but not for loss of profit in relation to the lucrative dyeing contracts which it did not know about and could not be taken to have known about. This loss was too remote. Remoteness here came down to the state of the defendant’s knowledge.

Summary

The main questions to ask yourself when faced with a claim which might include pure economic losses, are:

Is the claim in contract or tort? If contract, is the loss excluded by the contract terms, or is it too remote? If tort, was there injury or damage? If not, it is pure economic loss and not recoverable. If there was injury or damage, was it damage to property other than the product itself? Was it damage to the claimant’s own property? Was the economic loss consequential on that damage? Was the loss reasonably foreseeable as a consequence of the damage?

8

BLM offices

63 Temple Row Park Row House Birmingham 19-20 Park Row B2 5LS Leeds T +44 (0)121 643 8777 LS1 5JF F +44 (0)121 643 4909 T +44 (0)113 236 2002 F +44 (0)113 244 2002 4th Floor St Thomas Court Castle Chambers Thomas Lane 43 Castle Street Bristol Liverpool BS1 6JG L2 9SU T +44 (0)117 933 7700 T +44 (0)151 236 2002 F +44 (0)117 933 7777 F +44 (0)151 236 2585

21-22 Neptune Court Salisbury House Vanguard Way London Wall Cardiff London CF24 5PJ EC2M 5QN T +44 (0)29 2044 7667 T +44 (0)20 7638 2811 F +44 (0)29 2048 9041 F + 44 (0)20 7920 0361

Merrion Hall Gallery 4 Strand Road 12 Leadenhall Street Sandymount London Dublin 4 EC3V 1LP Ireland T +44 (0)20 7029 4240 T +353 (0)1 261 2150 F +44 (0)20 7816 5841 F +353 (0)1 261 2151 King’s House 18 Hanover Street 42 King Street West Edinburgh Manchester EH2 2EN M3 2NU T +44 (0)131 225 9855 T +44 (0)161 236 2002 F +44 (0)131 226 7677 F +44 (0)161 832 7956

13 Bath Street 2 Charlotte Place Glasgow Southampton G2 1HY SO14 0TB T +44 (0)141 353 2121 T +44 (0)23 8023 6464 F +44 (0)141 353 2181 F +44 (0)23 8023 6117

9