Essay: Pure economic loss – when is it recoverable in tort?

This essay will explain what is meant by the term ‘pure economic loss’ and will discuss the rules applied by the courts to determine when pure economic loss, caused by negligence, is recoverable in tort. It will consider whether the restrictions currently in place for the recovery of pure economic loss are fair using decided cases to support the arguments made.
Pure economic loss can be defined as a financial detriment that can be seen on a balance sheet but not physically, and which has not arisen from some physical damage or injury. There are two main ways in which pure economic loss can occur. Firstly, due to an act by the defendant, and secondly due to a statement made by the defendant.
An example of pure economic loss due to an act, would be an internet company (A) trying to claim for loss of revenue because a utility company (B) cut through a power cable. In this instance the cutting through of the cable is not damage to A’s property and no injury has occurred, however the consequence of the cable being cut meant that A was not able to operate their business, and therefore lost revenue.
This is a very basic scenario, but there are many examples of pure economic loss in day-to-day life. Due to the potential for an almost limitless number of claimants and amounts, the courts have taken a very strict view on when an individual or business may make a claim for pure economic loss in the tort of Negligence, with the general rule stating that no duty of care is owed by a defendant to a claimant in such cases.
One instance where pure economic loss may occur is damage to a third party’s property. In this case, if property is damaged then a claim may be successful in the usual method for the value of the damage, but any additional costs incurred, such as hiring a replacement item or subsequent loss of profit would be counted as pure economic loss and not recoverable.
In the case of Spartan Steel & Alloys Ltd v Martin & Co (Contractors) Ltd [1973] 1 QB 27 the claimant was looking for damages to a melt that was in progress when the electricity went off, as well as loss of profits on all subsequent melts that they were unable to produce during that down time. Lord Denning held that Spartan Steel could only recover damages for the melt that was in progress at the time the electricity was cut and the resulting profit on that melt. However, they could not claim for loss of profit on the subsequent melts that they would usually have been able to produce in the time that the electricity was off as these were considered as pure economic loss. Lord Denning stated that “the question of recovering economic loss is one of policy”. In this instance, there was an insufficiently close relationship between the defendant and claimant and therefore no duty of care can be owed, and losses are not recoverable.
Pure economic loss may also arise where there has been no physical damage. In the case of Weller & Co v Foot & Mouth Disease Research Institute [1986] 1 QB 569 the defendant negligently released the foot and mouth disease, and the claimant (a local cattle market) was forced to close due to the outbreak and subsequently lost revenue. In this instance the courts held that the cattle market was unable to recover this loss. As it was not caused by physical damage, it was held to be pure economic loss, and therefore no duty of care was owed by the defendant.
Economic loss may also be caused when the claimant has received defective goods or property. In these cases, the general rule is that the claimant should be using the law of contract to recover damages however there are some successful cases which were bought where the claimant did not have a direct contract with the defendant.
In Anns v Merton London Borough Council [1978] AC 728 the tenants of a block of flats chose to sue the council, rather than the builders whom they had a contract with, when it was discovered the property was suffering structural damage caused by subsidence.
Their claim was the council had been negligent in approving the plans and/or failing to inspect the building works and that the inspector owed them a duty of care. It was held that the tenants could claim against the council, despite the lack of a contract, because the structural damage amounted to material damage to the property.
A further decision in the case of Junior Books v Veitchi Co Ltd [1983] 1 AC 520 concerning the recovery of a loss of profit from a sub-contractor rather than the main builders for a defective floor that was laid in a new-build factory supported the decision in Anns. Once again, the claimant could claim damages in view of property damage.
Both cases are controversial as traditionally property damage is only applicable when it relates to someone’s existing property. In both cases the property was new and it was the original that was defective. They were also key decisions in potentially opening the floodgates to unlimited claims, where a claimant need not have a relationship with the defendant. Finally, these decisions also undermined the role of contract law, blurring the lines with the law of tort. In 1991 however, the courts reviewed a claim for defective items in a landmark case for pure economic loss that was bought in similar circumstances to Anns.
Murphy v Brentwood District Council [1991] 1 AC 398 concerned the purchase of a new build house, where the ceiling and water pipes cracked due a defective foundation design. The house, unrepaired, was sold for £35,000 below the market value with repairs estimated at £45,000. Murphy looked to recover damages from the Council who approved the building plans based on negligent advice from an independent contractor.
In a complete contrast from the Anns case, the House of Lords found that the loss had to be considered as pure economic loss as the property was defective when it was acquired, resulting in the property having to be repaired or scrapped, either of which would lead to financial loss.
As this was pure economic loss, the defendant did not owe a duty of care to the claimant and therefore no damages would be awarded. This decision therefore overruled the earlier case of Anns v Merton LBC. The decision in Junior Books v Veitchi was distinguished from Murphy v Brentwood DC since there had been a ‘special relationship’ between the defendant and the claimant. Whilst there was no contract between the two parties, the defendant had been present at meetings with the claimant and the builders to discuss the flooring requirements.
Pure economic loss can also arise where no physical damage has been caused, but the loss resulted from a negligent statement rather than a negligent action. As with all claims of Negligence, for a claim to succeed a duty of care must first be established.
Originally, common law took the same view on negligent statements as it did with loss caused by negligent acts and omissions, in that a claimant has no right to damages (Candler v Crane Christmas & Co [1954] 2 KB 533). The case of Hedley Byrne & Co Ltd v Heller and Partners Ltd [1964] AC 465 fundamentally changed this position, creating an exception to the general rule that pure economic loss could not be recovered in tort if caused by negligent statement.
The Hedley Byrne case concerned an advertising firm (Hedley Byrne) who extended a line of credit to a third party, based on a reference provided by the third party’s bank (Heller). The credit reference was negligently misrepresentative, although not out of malice. The third party went out of business owing money to Hedley Byrne, who sought to recover the loss from Heller based on the misstatement supplied by them – stating that ‘but for’ the positive credit reference, they would not have extended a line of credit, and would not have lost money when they were unable to pay their debts.
In the initial hearings, the lower courts found in favour of Heller and Partners, relying on the common law position that pure economic loss was unrecoverable as Heller did not owe Hedley Byrne a duty of care. However, when the case was referred to the House of Lords, they decreed that a duty of care was owed. Ultimately though, no losses were recoverable as Heller had an effective disclaimer of liability.
The decision by the House of Lords in this case created the Hedley Byrne rule which has changed the way that negligent misstatements are now dealt with by the courts. The rule stated that a duty of care is owed if there is a special relationship between the claimant and defendant. The special relationship is defined as someone having a special skill, undertakes to apply that skill for the benefit of someone else, who relies on that skill; or a person who holds themselves out as possessing such a skill in circumstances where it is foreseeable that others would rely upon it.
Further to the relationship test, there are three elements to the duty which can only be satisfied if the claimant can show that they were relying on the defendant’s skill and judgement, and; the defendant knew, or ought to have known, that the claimant was relying on their skill and judgement, and; it was reasonable in the circumstances for the claimant to rely upon it.
If a claimant can prove the existence of a special relationship, and the satisfy the test of duty, then they are able to establish that they were owed a duty of care by the defendant. Of course, this is only the first step in any claim for Negligence. The claimant would still have to go on to prove that there was a breach of the duty, that there was causation and that the loss was one too remote before being successful in recovering any economic loss.
This was a huge shift in the legal landscape, and finally gave those who had lost out financially due to misstatement a way in which they could look to make a claim and recover some of their losses. After 1964, the Hedley Byrne rule continued to be applied in various cases, including;
Cornish v Midland Bank PLC [1985] 3 ALL ER 513, where a bank clerk negligently offered advised a client with regards to the implications of signing a second mortgage, leaving the claimant with very little money post-divorce.
Chaudhry v Prabhakar [1989] 1 WLR 29, in which a friend, who claimed to be knowledgeable about cars, recommended a vehicle stating it had not been in any accidents, despite it having obvious damage and the defendant not making any enquiries about how it came to be in that state. The claimants care was found to be unroadworthy due to damage caused in a previous accident.
Welton v North Cornwall District Council [1997] 1 WLR 570, where a guest house was subject to extensive refurbishment on the advice of an environmental health officer who negligently stated that should the work not be completed, the guest house would be shut down.
These cases all illustrated that normal people could now take action against councils and financial establishments who, by making negligent statements, had left them worse off. In Cornish and Welton, the claimants were looking to recover from institutions that had given them false information in the course of business. In Chaudhry however, there was some discussion that as the advice was not sought, or given, in a business context it contradicted the obiter dicta comments made in Hedley Byrne, but by finding in favour of the claimant, the courts created a new precedent that allowed similar claims to succeed. In all cases a special relationship was established, which led to a duty of care being owed by the defendant to the claimant.
In 1990 the case of Caparo Industries v Dickman [1990] 2 AC 605 further refined the Hedley Byrne rule, by restating the criteria required to establish a duty of care, and by providing a four stage test the proximity element.
Caparo stated that there should be a foreseeability of damage, a proximity of relationship and that it should be just and reasonable to impose a duty.
To establish proximity, all four elements must be met:
• The advisor knew the purpose for which the advice was required
• The adviser knew that the advice would be communicated to the advisee, either specifically or as a member of an ascertainable class
• The adviser knew that the advisee was likely to act on the advice without further independent inquiry
• The advice was acted on by the advisee to his detriment
Two subsequent similar cases involving takeovers used this new definition, and resulted in two different outcomes. The case of James McNaughton v Hicks Anderson [1991] 2 QB 295 found the defendant did not owe a duty of care as they were not aware that their hastily drawn up and inaccurate accounts would be passed onto a potential bidder for a takeover. Conversely, the case of Morgan Crucible v Hill Samuel [1991] CH 295 found in favour of the claimant, stating that as their name and the nature of the transaction was known to the defendant, a duty of care was owed.
There have been further cases where the rules have been extended as the Hedley Byrne/Caparo tests have not been met. These include the former employer / former employee relationship (Spring v Guardian Assurance plc [1994] 3 WLR 354) and the solicitor / potential beneficiaries’ relationship (White v Jones [1995] 2 WLR 187).
These extensions have gone past the original scope of negligent statements to include the negligent provision of services, principally creating two tests to establish a special relationship – Hedley Byrne/Caparo in relation to negligent statements, or the assumption of responsibility when looking at the provision of services.
As with all claims in tort, there is always the option of a defence, and in pure economic loss cases, the most common defence is that of a disclaimer. In recent decades, statutory limitations on defendants attempting to exclude liability for negligence now exist within the Unfair Contract Terms Act 1977 which requires any exclusion for liability of pure economic loss to meet the reasonableness test (s.11) and the Consumer Rights Act 2015 (s.62).
It is fair to say that the development of case law has led to the creation of avenues for claims which, prior to 1964, would have been completely unrecoverable, as well as protection against unfair disclaimers purporting to absolve defendants of any liability. This should be viewed as an acceptable compromise which provides recourse for those who have suffered negligence through statement or provision of service, without leaving the wider public open to unlimited and potentially spurious claims.