In Kansas, Policy, Not Privity, Dictates Whether The Economic Loss Doctrine Applies
In Rinehart, et. al. v. Morton Buildings, Inc., -- P.3d --, 2013 WL 3835833 (Kan. July 26, 2013), the Supreme Court of Kansas addressed the question of whether the economic loss doctrine (ELD) applied to bar a negligent misrepresentation claim by a party who was not in privity with the defendant, Morton Buildings, Inc. (Morton). Although the Court of Appeals of Kansas held that the doctrine did not apply because the plaintiff, Midwest Slitting, LLC (Midwest Slitting), was not in privity with Morton, the Supreme Court declined the invitation to adopt a bright-line rule based on the absence of privity. Rather, the Supreme Court held that the question of whether the ELD will bar a tort-based claim, such as a negligent misrepresentation claim, depends on whether the claim is based on a duty that arises independent of the contract at issue and whether applying the ELD will comport with the historical policy justifications for adopting the ELD. Applying this analysis, the Supreme Court held that the negligent misrepresentation claims at issue were not barred by the ELD.
In Reinhart, Kenneth and Beverly Reinhart (the “Reinharts”) contracted with Morton to purchase a pre-engineered building to serve as both their personal residence and the location for their company, Midwest Slitting. Although Morton knew that Midwest Slitting would be using the building, Midwest Slitting was not a party to the building contract.
After a dispute arose over the building’s quality, the Rineharts and Midwest Slitting filed suit against Morton. Midwest Slitting alleged, among other things, that Morton misrepresented that the building would be completed in a timely manner, accommodate Midwest Slitting’s need to relocate its operations, and meet or exceed all industry standards. The jury found for Midwest Slitting and awarded Midwest Slitting damages.
On appeal, Morton argued that, although it had no contract with Midwest Slitting, the ELD barred Midwest Slitting’s negligent misrepresentation claim. The Court of Appeals of Kansas, establishing a bright-line rule that the ELD does not apply when the parties lack contractual privity, held that the ELD did not apply because Midwest Slitting was not a party to the contract. The Supreme Court of Kansas rejected the use of privity as a bright-line test for determining the boundaries of the ELD.
In its analysis of the question of whether the ELD barred Midwest Slitting’s negligent misrepresentation claims, the Supreme Court discussed the historical underpinnings for the doctrine. As stated by the court, originally, the ELD simply prohibited a commercial buyer of defective goods from suing in negligence or strict liability when the only injury consisted of the damage to the product itself. Although the doctrine originally applied to commercial product liability claims, the doctrine’s scope has been expanded in many of jurisdictions to “preserve distinctions between tort and contract law.”
The ELD was addressed in East River S.S. Corp. v. Transamerica Delaval, 476 U.S. 858 (1986), a case that is often cited by courts in support of their application of the ELD. In East River, the Court, addressing a claim by a commercial buyer of defective goods, applied the ELD and provided three justifications for doing so: 1) the claimed losses were easily insured; 2) contract and warranty law are better suited to commercial controversies because they allow the parties to allocate their respective risks; and 3) imposing tort liability for economic losses suffered by parties not in privity with the manufacturer would sanction indefinite damages beyond the confines of the commercial contract.
While many jurisdictions, under the guise of preserving distinctions between contract and tort law, have extended the boundaries of the ELD beyond commercial product liability cases, the Supreme Court of Kansas held that Kansas does not use the ELD to enforce the boundary between contract and tort law. Rather, Kansas courts determine whether a claim arises in contract or in tort by analyzing the nature and substance of the facts alleged in the pleadings. “A breach of contract claim is the failure to perform a duty arising from a contract, and a tort claim is the violation of a duty imposed by law, independent of the contract.” Under this test, the initial question to be resolved in considering whether the ELD applies in a particular case is whether the defendant owed the plaintiff a duty imposed by law, independent of the contract.
With respect to the negligent misrepresentation claims at issue, the Supreme Court held that the defendant owed the plaintiff a duty that arose by operation of law, independent of any contract between the parties. Although the court found that Morton owed Midwest Slitting a duty that arose by operation of law, the court did not base its finding that the ELD did not apply solely on the presence of an independent duty. Instead, in addition to identifying an independent duty, the court analyzed whether applying the ELD to Midwest Slittings claims would further the policy justifications for the ELD. The court, analyzing the policy justifications established in East River, held that the ELD’s purposes were not furthered by its application to the facts of the case.
Discussing the ELD’s policy justifications, the Supreme Court found that Midwest Slitting’s negligent misrepresentations claims were not governed by the Uniform Commercial Code’s warranty law. The court also found that permitting negligent misrepresentation claims does not subject a defendant to unlimited liability. Rather, the scope of liability, by the claim’s very nature, is limited to situations where the defendant, in the course of the defendant’s business, has supplied information to guide others in business transactions. Moreover, the only people who can pursue such claims are those for whose benefit the defendant supplied the information and those people that the defendant intends to influence or who the defendant knows will be influenced by the transaction.
Based on the analysis in Reinhart, Kansas courts analyzing a defendant’s argument that the plaintiff’s claims are barred by the ELD should focus not on whether there is a contract between the plaintiff and the defendant but, rather, on whether the defendant owed the plaintiff a duty that arose independent of the contract at issue. Once the court finds that the defendant owed the plaintiff a duty that arose independent of the contract, Kansas courts should analyze whether applying the ELD furthers the purposes of the doctrine. This analysis should be based on the three policy justifications established in East River. If the ELD’s purposes are not furthered by the application of the doctrine to the facts of the case, the ELD should not apply.