Have the conditions for recovering pure economic loss in tort been relaxed?

Pure economic loss can be recovered in tort so long as certain conditions are satisfied. In recent years the courts have suggested a relaxation of these conditions, thereby opening the door to certain categories of recoverable economic loss, but these remain to be exploited.

What is meant by "pure economic loss"? In essence, it is a loss that is purely financial. This can take the form of lost profits, the cost of replacing or repairing a defective building, or the defective item itself. The recoverability of pure economic loss in tort largely depends on which category of pure economic loss the loss falls in – but more on that in a moment.

The concept of "pure economic loss" is most relevant in tort. The reason for this is that the courts have recognised that the intention behind privity of contract is to provide for the recovery of identified losses by contracting parties and that contractual damages are designed to cover economic losses. The courts have been reluctant to impose a responsibility similar to a contractual responsibility where there is no contractual relationship between the parties. It is this reluctance that forms the underlying reasoning behind the courts allowing only limited categories of economic loss to be recovered in tort.

So, what are these categories of recoverable economic loss? Well, the courts' approach to claims for pure economic loss fall within two distinct lines of authorities, both based on the duty of care principle in Donoghue v Stephenson (1932): i.e. where the unreasonable conduct of the defendant causing foreseeable injury or damage provides the "legal nexus" between the defendant and the claimant that will give rise to a claim for economic loss. The first line of authorities relates to persons giving advice, particularly financial advice (Hedley Byrne v Heller (1964)); the second line of authorities concerns public bodies and professionals providing professional advice that results in the production of a tangible product (including architectural services).

To take the first category, i.e. the provision of advice, the courts have upheld claims for pure economic loss. The cases start with Hedley Byrne v Heller that laid down the essential pre-requisite to a claim for economic loss of a "sufficiently proximate relationship" between the claimant and defendant. Hedley Byrne v Heller concerned a financial adviser who gave negligent advice to a third party in circumstances where he knew that the third party would rely on the advice and the third party reasonably did so. In contrast, in Caparo v Dickman (1990) an advisor was found not to be liable for the economic loss sustained by a third party relying on negligently prepared accounts, as those accounts had not been prepared with the third parties in mind. There was not a "sufficiently proximate relationship" as the defendant was not aware that the third party was relying on the accounts for that particular transaction. In Spring v Guardian Assurance (1995), the court considered the concept of "reliance" further. The case concerned the provision of a negligently prepared reference to a future employer. The court held that, although the "advice" was not being supplied to the defendant (i.e. the potential employee), the defendant's reliance on the referee and the referee's knowledge of that reliance and assumption of responsibility therefore, was enough to constitute a "sufficient proximate relationship" between them to entitle the defendant to compensation for economic loss.

The courts' approach in such cases has remained consistent, as can be seen by the recent case of Commissioner of Police of the Metropolis v Lennon (2004) where the court held that the Metropolitan made an express assumption of responsibility for a particular loss upon which Mr Lennon relied.

So, how does this approach differ from the second line of authorities concerning the advice given by public bodies or professionals that results in a tangible product? Well, in those types of cases the courts have decided to carve up economic losses into separate categories, with only one of those categories of economic loss being recoverable in tort. In order to understand why this is one has to recognise that the court generally will not uphold claims for economic loss against contractors in building projects because they recognise that the contractual relationships in building projects are structured specifically so that there is no assumption of responsibility by a subcontractor direct to the building owner. If there was, i.e. by way of collateral warranties or rights under the Third Party Rights Act, then the recoverability or not of the economic losses would fall within the realm of the provisions of that specific contract.

The case of Murphy v Brentwood (1990) established the principle that one category of economic loss could be recovered: where a defect causes personal injury or damage to property other than the defective thing, i.e. a defectively designed wall. Accordingly, categories such as the reduction in value of the structure that is or contains a defect, the defective structure itself and a defect that creates an imminent threat of damage to property, are not recoverable economic losses in tort in such cases.

There have been two prominent departures from this reasoning which, however, have never been applied: the "complex structure theory" suggested by Lord Bridge in D&F Estates Ltd and Others v Church Commisioners for England and Others (1998), and the "nominated sub-contractor" exception. The "complex structure theory" envisages a defect in one part of a building, or structure, causing damage to another part. Where this occurs the claimant can in principle recover the cost of repairing the damage to the other part of the building, although not the original defect (which would still be regarded as an irrecoverable economic loss). The "complex structure theory" therefore extends the classification of "damage to another property" which is the only category of recoverable economic loss in such cases. The House of Lords in the later case of Murphy v Brentwood did not particularly take to this "complex structure theory". However, they did not go so far as to overrule this theory completely and therefore there is still an opening to claim economic losses where, for instance, different subcontractors are concerned with different parts of one building.

The "nominated sub-contractor" exception again concerns the closeness of the relationship between the sub-contractor and the building owner. The exception arose in the Scottish case of Junior Books Ltd v Veitchi Limited (1983). In that case, the court found that a nominated subcontractor was held to owe a duty in tort to the building owner for economic losses. The reason for this was because the courts found that the relationship between the nominated subcontractor and the building owner was sufficiently close to give rise to such a duty: the subcontractor had full knowledge of the building owner's requirements, the building owner relied on the subcontractor's expertise and the subcontractor knew that the owner was relying on his skill and experience. Accordingly, the relationship was as close as it could be short of an actual contractual relationship that would otherwise govern the recovery of economic losses. However, it is important to note that not only has Lord Brandon's dissenting judgment in Junior Books been given unqualified approval in the House of Lords, but the case has not yet been successfully been applied in English law (it has been followed in Singapore although on the basis of a two-stage proximity and policy consideration test that has not been applied in England).

For a few years the distinction between the two lines of authorities appeared to be clear (well, clear-ish if you consider the "complex structure theory" and Junior Books-exception anomalies!). Then came Henderson v Merrett Syndicates Ltd (1995) and the cat was thrown among the pigeons. Henderson v Merrett concerned

a claim for economic loss for negligent advice, which the court found was, on the same grounds as previous authorities, clearly recoverable. The court then went on to suggest that Hedley Byrne & Heller negligent-advice principles could be applied to the provision of any professional services and not just statements (a principle that has since been upheld (1998)). Further, Lord Goff of Chiveley stated that, if there is an "assumption of a responsibility, coupled with concomitant reliance", this may give rise to a tortuous duty irrespective whether there is a contractual relationship between the parties, so long as the terms of the contract do not preclude the claim for the particular loss.

This approach was considered, but not directly applied in Barclays Bank v Fairclough Building Ltd (No. 3) (1995). In Barclays the court found that pure economic loss was recoverable by a building owner from a sub-contractor. In order to do so, the court upheld the claim that the sub-contractor had a duty to the building owner in tort. The court was happy to do so as the duties in contract and tort were equivalent and to uphold the duty in tort would not undermine the contractual allocation of risk and responsibility. The Barclays case involved the extraordinary situation where the defendant wanted to be held liable in tort (so that it could run a contributory negligence claim in defence of a claim for breach of a strict contractual duty), albeit that the flip-side would be that it would be exposed to an economic loss claim.

Nonetheless, Henderson v Merrett has been applied as authority for asserting concurrent liability on the part of a defendant in tort, so long as there is sufficient assumption of responsibility and concomitant reliance (1995).

For further information please contact Emma Schaafsma on +44 (0)20 7367 2811 or at emma.schaafsma@cms-cmck.com