For some claims, the economic loss doctrine can be a roadblockto subrogation. Exploring exceptions to thedoctrine can provide subrogation professionals with the tools tonavigate their way to recovery. An economic loss refers to afinancial loss and damages suffered by a person or entity, whicharise from a defect in the qualitative nature of a product, serviceor improvement. Generally, an economic loss is observed on assetsrather than physical injury to a person or entity.

Illinois economic loss doctrine or the Moormandoctrine

The doctrine sets out to bar recovery in tort for purelycontractual losses or frustrated economic expectations between twocontracting parties. Under the economic loss doctrine or theMoorman doctrine as it is known in Illinois, recovery for solelyeconomic losses in relation to a product may not be had upon thetort theories of negligence or strict liability.

In Moorman, the plaintiff discovered a crack in a grain storagetank manufactured by the defendant. The damages were limited to thestorage tank itself, and the plaintiff sought recovery in tort forthe cost of repair and loss of use of the tank. The IllinoisSupreme Court affirmed the dismissal of the tort claim, holdingthat a plaintiff may not recover in tort for solely economiclosses.

The basic rationale behind the holding in Moorman and numerouscourts since is that contract law is designed to remedy lossesrelating to “disappointed expectations due to deterioration,internal breakdown or non-accidental cause, whereas causes ofaction in tort are suited for personal injury or property damageresulting from a sudden or dangerous occurrence…”

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There are exceptions to the economic loss doctrine includinga sudden calamitous event or an intentional misrepresentation.(Photo: Shutterstock) 

Defining an economic loss

Defining economic loss is partially to blame for the confusionwith the doctrine. Examples of an economic loss include inadequatevalue and costs of repair, as well as replacement of the defectiveproduct and subsequent loss of profits. In our touchstone Moormancase, the shoddy grain storage tank did not live up to expectationsand the court's decision reflects that recourse for the damagedtank is a cause of action in contract, not tort.

While the plaintiff in Moorman was not able to proceed in tortfor those damages, the plaintiff did withstand the motion todismiss under a breach of an express warranty. This article focuseson withstanding attacks utilizing the doctrine for tort claims andwhat damages, if any, may be recoverable.

There are exceptions and Illinois courts interpreting theseexceptions have identified them as:

• A sudden, calamitous or dangerous occurrence coupled withphysical harm to person or other property;

• Intentional misrepresentation; or

• Negligent misrepresentation by a defendant who is in thebusiness of supplying information for the guidance of others intheir business transactions.

Collateral damage caused by the grain storage tank inMoorman would have mitigated the loss doctrine defense. (Photo:Shutterstock)

Exceptions to the Illinois economic lossdoctrine

The first of these exceptions is one that is commonly triggered.Had that same grain storage tank in Moorman not only cracked butalso suddenly fallen over, damaging several nearby commercialvehicles, a cause of action in tort could withstand an economicloss doctrine defense. The reason the action could withstand such adefense is because the sudden event of the tank toppling onto thenearby vehicles or “other property” is precisely what iscontemplated in the first exception to the doctrine. Thiscollateral damage is not something that the consumer who purchasedthe grain storage tank could reasonably account for in thetransaction. Thus, a cause of action in tort is proper.

Another example of “other property” can be found in the case ofSchuster Equipment Co. v. Design Electric Services, Inc. Here, thedefendant argued the economic loss doctrine prevented it from beingheld liable in tort as the defendant constructed and installed anelectric service line that provided too much voltage to theplaintiff's computer. This increase in voltage resulted in a fireinside the computer.

The defendant argued that the electric service lines and thecomputer were part of a single electrical circuit and the computercould not be defined as “other property” to trigger the exception.The court rejected the defendant's argument, holding that thecomputer was an appliance connected to the electrical circuit. InSchuster, the appellate court provided some guidelines as to wherea consumer's claim rightfully ends and where damage to “otherproperty” begins.

While Schuster does not use the phrase “other property,” it doesfollow what is described as the “bargained for” approach.Addressing questions made in the Seventh Circuit Court of AppealsTrans States Airlines v. Pratt case, the Illinois Supreme Courtemployed in its opinion the “bargained for” approach. The plaintifffiled a claim in the federal district court against an enginemanufacturer seeking damages under theories of negligence, breachof warranty and strict liability. The relevant damages under reviewfor purposes of “other property” were the failed engine as well asthe damaged airframe of the plane.

Following exploration of the various approaches courts havetaken with respect to economic losses under tort theories ofrecovery, the Illinois Supreme Court chose to focus on theexpectations of the parties to the transaction. The court held thatthe loss of the airframe is the type of damage one would reasonablyexpect as a direct consequence of a defective engine. However, mostproducts are composed of smaller parts. The Economic LossDoctrine's main purpose would be frustrated if courts were toentertain “other property” as parts of a product. Courts arereluctant to broaden the exception as doing so would ignore theintended consumer protections that product liability law set out toaccomplish.

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The Wisconsin Court of Appeals held that the economic lossdoctrine applies where a commercial purchaser buys used equipmentcontaining a defective replacement part that causes damage to theequipment, and results in repair costs and loss of business income.(Photo: Shutterstock)

Ohio economic loss doctrine

Not all courts, however, follow the “bargained-for approach” inanalyzing damage to “other-property” while still arriving atsimilar conclusions in their treatment of the Economic LossDoctrine. The Ohio Supreme Court, for example, has held that therules of warranty are best suited to govern the issue of recoveryfor commercial losses.

Under Ohio law, “a product's self-inflicted damage is bydefinition property damage.” In determining whether damage to theproduct constitutes economic loss, Ohio focuses not on the natureof the product and its components, but rather on the relationshipbetween the parties. Where there is privity of contract and theparties have negotiated that contract from comparative bargainingpositions, the parties are able to allocate the risk of all loss,including the loss of the product.

Wisconsin economic loss doctrine

Wisconsin also adheres to the majority principles of theeconomic loss doctrine among state courts. In a third-party suit,the plaintiff suffered damage to its printing press when adefective replacement part manufactured by the defendant failed.The Wisconsin Court of Appeals held that the economic loss doctrineapplies where a commercial purchaser buys used equipment containinga 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 theEconomic Loss Doctrine, which means that damage by a defectivecomponent of an integrated system to either the system as a wholeor other system components is not damage to “other property” thatwould impede the application of the economic loss doctrine.

Related: Printing in 3D: Who's liable for productfailures?

In Chicago Heights Venture v. Dynamit Nobel of America,Inc., the owners said the cause of action arose from defectiveroofing materials. (Photo: Shutterstock)

Sudden and calamitous event

The search for what constitutes “other property” may be anexercise in futility if it is not coupled with a sudden andcalamitous event. Fires, explosions and pipes bursting are obviousexamples of sudden and calamitous events. A more useful analysisfor a subrogation professional is what courts have determined tofall outside the exception.

The Seventh Circuit encountered the first exception to theeconomic loss doctrine on appeal in Chicago Heights Venture v.Dynamit Nobel of America, Inc., 782 F.2d 723 (7th Cir. 1986). Inthat case, owners of apartment buildings appealed the dismissal ofsome claims and the granting of summary judgment on others relatedto a cause of action arising from damage to apartment buildingscaused by allegedly defective roofing materials. These roofingmaterials were made by appellee manufacturers and mounted byappellee installers. Of note in their opinion was theinterpretation of whether the occurrence(s) in question could beclassified as a sudden event and pursued under theories ofnegligence or strict liability.

The building owners described two occurrences. The firstoccurred in 1978 when the roofing material tore away from the roofof each building. The second occurred in 1979 when the same roofingmaterial entirely separated from the roof and fell to the groundduring a windstorm. The building owners also alleged that becauseof the two occurrences, water leaked into the buildings damagingceilings and walls of the lower floors. Allegations were also madethat the ripping force of the first occurrence resulted in bricksloosening from each of the buildings.

While the court entertained the notion of charitably readingsome of the claimed damages as “other property,” the courtinevitably holds the alleged damage to be incidental to thesurrounding parts of the property. The court's analysis thenshifted to the nature of the occurrence. While the building ownerappellants stressed the sudden nature of the two incidents thatspanned over nine months, the court found that the facts were bestcharacterized as that of deterioration as opposed to the sudden andcalamitous occurrences envisioned to trigger the economic lossdoctrine's first exception.

Misrepresentation

Intentional misrepresentation and negligent misrepresentation bya defendant who is in the business of supplying information for theguidance of others in transactions are the next two exceptions tothe economic loss doctrine. Fraud is an intentional tort, and whilethere are some nuanced interpretations in a minority of states inrelation to economic losses, the majority of states, includingIllinois, find it actionable as a tort regardless of whether thecontract losses are economic.

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In Rozny v. Marnul, a surveyor provided aninaccurate survey, which led to a finding of negligentmisrepresentation. (Photo: Shutterstock)

Negligent misrepresentation

The Illinois Supreme Court's analysis in Rozny v. Marnul isstill held as a seminal case for negligent misrepresentation. InRozny, the plaintiff sought recovery in tortious misrepresentationfor the preparation of an inaccurate survey by the defendantsurveyor. The Supreme Court deemed the loss as occurring to an“intangible economic interest” and noted that recovery for such aloss, when the loss arose from negligent performance of a privatecontract, was permissible when the class of potential plaintiffswas small and it was undesirable to leave the innocent partywithout remedy.

The Rozny case and many others like it involve parties that werenot in direct privity of contract. The defendant surveyor providedthe inaccurate survey and sold the “subject” real property to abuilder 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 ofwarranty claim by plaintiffs, the court turned to tort, which doesnot require privity. The following factors were deemed important tothe court in finding negligent misrepresentation:

• The “absolute guarantee for accuracy” appearing on the face ofthe inaccurate plat;

• The defendant's knowledge that the plat would be relied on bythird parties, including the plaintiff;

• The fact that potential liability was restricted to a smallgroup;

• The absence of proof that copies of a corrected plat weredelivered to anyone;

• The undesirability of requiring an innocent reliant party tocarry the burden of a surveyor's professional mistake; and

• The fact that allowing recovery by a reliable user whoseultimate use was foreseeable would promote cautionary techniques bysurveyors.

Following the Rozny opinion, a new requirement was injected intothe analysis by the First District in Black, Jackson & SimmonsInsurance Brokerage, Inc. v. International Business Machines Corp.The requirement states the defendant must be in the business ofsupplying information for the guidance of others in their businesstransactions.

The economic loss doctrine has a storied past with varyinginterpretation which is why having an understanding of its mainprinciples can salvage a claim.

Kevin F. Keeley ([email protected]) is an associateattorney with civil litigation law firm Keis George LLP, practicesprimarily subrogation and insurance defense.