What Holmes Can Teach Us About Economic Loss

By Peter Benson

Prof. Peter BensonThe "economic loss rule" categorically denies recovery for financial loss that is consequent upon damage to something which a plaintiff neither owns nor possesses.  Established more than a century ago, this rule was developed and pushed to its limits by the very courts that were responsible for the creation and the expansion of the modern law of negligence which overthrew and discredited traditional barriers to recovery. Moreover, until recently, the rule was generally and consistently applied across the major common law jurisdictions. Now, however, it has deeply divided the common law world, with American and English courts largely maintaining this traditional rule, and Canadian, Australian, and New Zealand courts allowing recovery if certain conditions are met. Few issues in the law of negligence are currently more contentious.

Consider the following simple fact pattern. Defendant, failing to use reasonable care, causes his vessel to careen into a bridge, seriously damaging it. As a result, the bridge must be closed for repairs. The Plaintiff has neither a property nor a possessory right in the bridge, but she is entitled under contract with the bridge owner to have sole use of it to transport its goods. During the period of closure, the Plaintiff must find an alternative method of transportation and can do so only at greater expense, thereby sustaining financial loss.

If the bridge owner sues the Defendant for the physical damage to the bridge, ordinary principles of liability for negligence may very well permit recovery. Moreover, if, as a result of the bridge closure, the bridge owner sustains additional expenses or loses rent under its contract with the Plaintiff, this is also recoverable in principle.

But what if the Plaintiff sues for her financial loss? The traditional position of the common law, first clearly set out in the late nineteenth century, is that the Plaintiff 's suit must fail in all circumstances, no matter how foreseeable its loss may have been.

The question is: supposing the Plaintiff's financial loss is foreseeable and the Defendant could have avoided it by exercising reasonable care, what might possibly justify the economic loss rule, particularly when the bridge owner may recover for the very same item of loss which is denied protection if suffered by the Plaintiff? Interestingly, both those courts upholding and those rejecting the rule give the same pragmatic answer: if recovery were always allowed for such losses, this could lead to escalating, ever-widening, open-ended liability, given the intricate inter-dependence of commercial interests in modern societies; and this result would be unfair to defendants and socially inefficient.

Implicitly, both sides share the same conception of liability which holds that a financial loss foreseeably caused by negligent conduct should in principle be recoverable. Both agree, therefore, that prima facie such losses should be compensated. Where they differ is in their assessment of the feasibility of fashioning and applying workable criteria that can ensure that recovery will not lead in particular circumstances to excessive and open-ended liability. In particular, Canadian and  Australian courts have allowed recovery where the "closeness," "directness," or "particular foreseeability" of the plaintiff's loss in relation to the defendant's negligence ensures that recovery will not produce this outcome. While American and English courts cannot reject the possibility of such qualifications in principle - given their conception of liability - they see them as unworkable and indeterminate.

The present division among jurisdictions reflects the inherent instability of their understanding of this issue. What both sides fail to see is that the decisions that fashioned the economic loss rule understood it on a completely different basis and that this other basis challenges the conception of liability which they currently presuppose.

The rationale for the rule is nowhere understood more clearly than by Oliver Wendell Holmes in his seminal 1927 U.S. Supreme Court decision in Robins Dry Dock v. Flint. In that opinion - which has influenced this area of negligence more than any other single common law decision - Holmes makes clear that the reason the Plaintiff's action (unlike the bridge owner's in our example) must fail is, not that the loss is unforeseeable or that recovery may have undesirable consequences, but rather that the Plaintiff does not have a claim to the use of the damaged thing (the bridge) that amounts to a right as against the Defendant. The fact that careless conduct causes foreseeable loss is not sufficient for liability. According to Holmes, it is also essential that the loss be in relation to something that comes under the Plaintiff's rights as against the Defendant.

In the bridge case, the Plaintiff 's only right to use the bridge is her contract right - but this is personal as against the bridge owner, not the Defendant. In the absence of a contractual right against the Defendant, the only way in which the Plaintiff can have a right exclusive of the Defendant is by having a property or possessory right "against the world." That is the reason the economic loss rule focuses on the absence of a property or possessory interest in the damaged thing as the decisive strike against the Plaintiff's complaint. The various qualifications proposed by Canadian and Australian courts that reject the rule do not, and cannot, meet this threshold requirement.

Thus understood, the economic loss rule supposes a conception of liability in which liability is imposed for wrongs, wrongs are violations of rights, and rights are, and can only be conceived of as, relative as between persons. To succeed, a Plaintiff must show that its loss is with respect to something from which it can, as a matter of rights, exclude the Defendant who then, but only then, can be under a duty of non-interference with respect to that thing. This requirement of a right and the conception of the relativity of rights makes the economic loss rule necessary. They also contain implicitly a whole theory of negligence which rejects the juridical salience of loss and negligent conduct unless these are with respect to claims of exclusive right by the Plaintiff against the Defendant.

This article was first published in the Spring 2005 issue of Nexus.