Claims for pure economic loss - Caparo test for negligent mi...

Learning Outcomes

This article explains the concept of pure economic loss and how it differs from consequential economic loss. It focuses on the exception allowing claims for pure economic loss caused by negligent misstatements, detailing the application of the Caparo test to establish a duty of care in such scenarios. In addition to the three-stage Caparo analysis (foreseeability, proximity and whether imposing a duty is fair, just and reasonable), it also synthesises the Hedley Byrne assumption-of-responsibility route, clarifying when it will be used instead of or alongside Caparo. It sets out the core indicators of proximity in negligent misstatement, including knowledge of purpose, communication to the claimant, actual and reasonable reliance, and the effect of disclaimers. It highlights policy constraints that limit duty (including floodgates and indeterminate liability, especially for widely distributed statements like audited accounts) and shows how the courts extend the negligent misstatement principles to the provision of professional services (for example, solicitors and valuers), explaining the impact of UCTA/CRA on exclusion clauses and disclaimers.

SQE1 Syllabus

For SQE1, you are required to understand the principles governing duty of care in negligence, particularly concerning claims for pure economic loss resulting from negligent misstatements. This involves applying specific legal tests and case law principles to practical scenarios, with a focus on the following syllabus points:

• Establishing a duty of care in negligence, particularly for pure economic loss.
• The requirements for liability arising from negligent misstatements.
• Application of the Caparo three-stage test to determine duty of care in this specific context.
• The concept of 'assumption of responsibility' and its relevance, stemming from Hedley Byrne.
• Distinguishing pure economic loss from consequential economic loss.
• The relationship and differences between the Caparo analysis and the Hedley Byrne assumption-of-responsibility framework, and when each is deployed.
• Proving reliance and its reasonableness, and the evidential consequences (for example, where the claimant would have acted the same way regardless of the statement).
• The legal effect of disclaimers and exclusion clauses on negligence claims, including controls under the Unfair Contract Terms Act 1977 and Consumer Rights Act 2015.
• Recognising policy limits (for example, floodgates and indeterminate liability) in broad informational contexts (audited accounts, market publications).

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Financial loss that arises directly as a consequence of physical damage to the claimant's property is best described as:
   1. Pure economic loss
   2. Indirect economic loss
   3. Consequential economic loss
   4. Non-pecuniary loss
2. The primary test used by English courts to determine if a duty of care is owed for pure economic loss caused by a negligent misstatement is found in which case?
   1. Donoghue v Stevenson
   2. Hedley Byrne & Co Ltd v Heller & Partners Ltd
   3. Caparo Industries plc v Dickman
   4. Spartan Steel & Alloys Ltd v Martin & Co (Contractors) Ltd

3. True or False? In claims for pure economic loss arising from negligent misstatement, establishing reasonable foreseeability of harm automatically means a duty of care is owed.

4. A 'special relationship', sufficient to establish proximity in a negligent misstatement claim, typically requires:
   1. A written contract between the parties.
   2. The defendant making a profit from the advice.
   3. An assumption of responsibility by the defendant and reasonable reliance by the claimant.
   4. Both parties operating in the same industry.

Introduction

In the tort of negligence, claimants can generally recover damages for personal injury and physical damage to property, along with any financial losses directly resulting from that physical damage. However, the courts are traditionally reluctant to allow recovery for 'pure economic loss' – financial loss suffered independently of any physical injury or property damage. This reluctance stems from policy concerns, primarily the desire to avoid indeterminate liability (the 'floodgates' argument) and to maintain a distinction between tort and contract law. Contract law is often considered the more appropriate vehicle for regulating purely economic expectations arising out of transactions, especially where parties can allocate risk through agreement.

Despite this general rule, exceptions exist. A significant exception arises where pure economic loss results from a negligent misstatement. Establishing liability in such cases requires demonstrating that the defendant owed the claimant a specific duty of care regarding the statement made. The leading test for establishing this duty is derived from the House of Lords decision in Caparo Industries plc v Dickman [1990] 2 AC 605 (HL). Alongside Caparo, the Hedley Byrne assumption-of-responsibility principle remains fundamental: where a defendant assumes responsibility to a claimant who reasonably relies on the statement or service, a duty of care can arise. Modern cases show these routes working in tandem: Hedley Byrne is often used to identify proximity through assumption of responsibility; Caparo frames the broader, incremental analysis and policy control.

Key Term: Pure economic loss
Financial loss suffered by a claimant that does not flow directly from physical injury to their person or damage to their property. Examples include loss of expected profit or diminution in value of an item acquired.

Key Term: Consequential economic loss
Financial loss that is a direct consequence of physical injury to the claimant or physical damage to the claimant's property. This type of loss is generally recoverable under standard negligence principles.

Understanding Pure Economic Loss

It is important to distinguish pure economic loss from other types of financial loss that are recoverable in negligence. The law generally recognises three recurring patterns:

• Economic loss caused by damage to someone else’s property (for example, interruption of utilities affecting third-party businesses). This is normally pure economic loss and not recoverable in tort.
• Economic loss consisting of the cost of remedying or replacing a defective product or structure acquired by the claimant. Following Murphy v Brentwood District Council [1991] 1 AC 398 (HL), this loss is pure economic loss and not recoverable in negligence, absent damage to other property or personal injury.
• Economic loss caused by negligent statements or representations. This can be recoverable where the relationship meets the proximity requirements identified in Hedley Byrne and Caparo.

The policy logic is that routine commercial expectations (quality, performance, value) are typically regulated by contracts and statutory regimes (for example, implied terms under the Sale of Goods Act and the Consumer Rights Act), whereas tort’s negligence rules are aimed at safety and damage control.

Worked Example 1.1

A power cable belonging to Utility Co is negligently damaged by Roadworks Ltd. As a result, the electricity supply to a nearby factory owned by Factory Ltd is cut off for several hours. During the power cut, machinery in the factory stops, causing molten metal (£1,000 value) currently being processed to solidify and become unusable. Furthermore, Factory Ltd is unable to complete four other batches of metal during the downtime, losing an anticipated profit of £5,000.

Which of Factory Ltd's losses represent pure economic loss?

Answer:
The loss of the solidified metal (£1,000) constitutes physical damage to property belonging to Factory Ltd. The lost profit on that specific batch would likely be consequential economic loss, flowing directly from the physical damage. However, the lost profit on the four future batches (£5,000) represents pure economic loss, as it does not stem from physical damage to Factory Ltd's property but from the interruption caused by damage to Utility Co's cable (a third party's property). Recovery for this £5,000 loss would be restricted under the general rules.

Building this distinction into analysis avoids conflating recoverable consequential financial loss with unrecoverable pure economic loss. A frequent exam trap is failing to identify whether the loss is connected to damage to the claimant's own property.

Key Term: Negligent misstatement
An inaccurate or misleading statement or advice given without reasonable care, which causes the recipient financial loss. Liability may arise if a duty of care exists under Hedley Byrne and Caparo, typically through assumption of responsibility and reasonable reliance.

Worked Example 1.2

A homeowner buys a new-build house. Two years later, serious cracking appears because the substructures were inadequately designed and built. The homeowner sells at a £40,000 loss and sues the local authority that approved the substructure plans.

Is this loss recoverable in negligence?

Answer:
In Murphy v Brentwood District Council, the House of Lords held that the cost of curing defects and the diminution in value of a defective structure are pure economic loss and not recoverable in negligence. Without damage to other property or personal injury, tort does not compensate the reduction in value of the defective asset itself. Contractual or statutory routes (for example, the Defective Premises Act for dwellings in defined circumstances) may provide remedies, but negligence generally does not.

Negligent Misstatement: The Hedley Byrne Principle

The basis for recovering pure economic loss caused by negligent statements was laid in Hedley Byrne & Co Ltd v Heller & Partners Ltd [1964] AC 465 (HL). In this case, the House of Lords established that a duty of care could arise where financial loss was caused by a negligent statement, provided there was a 'special relationship' between the party making the statement and the party relying on it. This typically involves an assumption of responsibility by the statement maker and reasonable reliance by the recipient. The bank avoided liability in Hedley Byrne because its reference was expressly provided “without responsibility”, which negated the assumption of responsibility.

The Hedley Byrne framework has been extended beyond statements to services. Professionals who undertake tasks for others (solicitors drafting wills, valuers preparing reports, managing agents administering investments) may owe duties in tort to those reasonably relying on their services, even absent contract.

Key Term: Assumption of responsibility
A voluntary undertaking by the defendant to exercise reasonable care toward the claimant in respect of a statement or service, knowing it will be used for a specific purpose by that claimant (or a limited, identifiable class). It is the basis of duty in negligent misstatement.

Key Term: Reasonable reliance
Reliance by the claimant that is reasonable in all the circumstances, given the purpose of the advice, the relationship between the parties, and the nature of the statement or service. Both actual reliance and the reasonableness of relying are required.

Key Term: Disclaimers
Statements limiting or excluding responsibility. In negligent misstatement, an effective disclaimer may prevent a duty from arising by negating any assumption of responsibility. In consumer and certain business contexts, the disclaimer’s effectiveness can be controlled by UCTA 1977 and CRA 2015.

Social or informal advice rarely creates a duty. The courts have been cautious about imposing liability in casual contexts. The exception in Chaudhury v Prabhaker was fact-specific; generally, the special relationship requires a more formal or professional setting, a known purpose, and a clear expectation of reliance.

The Caparo Test for Negligent Misstatement

While Hedley Byrne opened the door, the current test for determining the existence of a duty of care in novel situations, including negligent misstatement causing pure economic loss, is the three-stage test set out in Caparo Industries plc v Dickman. This requires the court to consider:

1. Foreseeability: Was the economic loss suffered by the claimant reasonably foreseeable as a consequence of the defendant's statement being inaccurate?
2. Proximity: Was there a sufficiently proximate relationship between the claimant and the defendant?
3. Fair, Just, and Reasonable: Is it fair, just, and reasonable in all the circumstances to impose a duty of care on the defendant?

Courts proceed incrementally and by analogy. If an established category exists (for example, surveyor to purchaser, solicitor to beneficiary), they apply that rather than using Caparo afresh. Otherwise, Caparo helps police the boundaries of duty.

Foreseeability of Harm

The first stage requires that the defendant should reasonably have foreseen that the specific claimant (or a member of an identifiable class to which the claimant belongs) would rely on the statement and suffer the type of economic loss that occurred if the statement was negligent. General foreseeability of some investor relying on published information is not enough by itself; specificity matters. For example, audited accounts are prepared for a statutory purpose (reporting to shareholders), not to guide acquisitions by potential investors, so relying investors lack the necessary proximity even though loss might be foreseeable.

Proximity and the 'Special Relationship'

This is often the most significant stage in negligent misstatement claims. Proximity here signifies more than mere physical closeness; it involves a legal closeness often characterised by the 'special relationship' identified in Hedley Byrne. Key factors indicating proximity include:

• The defendant knew the specific purpose for which the statement/advice was required.
• The defendant knew the statement would be communicated to the claimant (specifically or as part of a limited, identifiable group).
• The defendant knew the claimant was likely to rely on the statement for that purpose without independent inquiry.
• The claimant did, in fact, rely on the statement to their detriment.
• The reliance was reasonable for that purpose in the circumstances.

Essentially, these factors point towards an assumption of responsibility by the defendant towards the claimant regarding the accuracy of the statement. These indicators were distilled in subsequent cases, including James McNaughton Paper Group Ltd v Hicks Anderson & Co, and they regularly feature in problem-solving: ask what the advice was for, who it was for, what the maker knew, and whether reliance was foreseeable, actual and reasonable.

Key Term: Special relationship
A relationship between the maker of a statement and the recipient where the maker assumes responsibility for the accuracy of the statement, knowing the recipient will rely on it for a specific purpose, and where such reliance is reasonable.

Assumption-of-responsibility duties extend to services. In Henderson v Merrett Syndicates Ltd, managing agents owed duties in tort to those whose investments they administered. In White v Jones, a solicitor owed a duty to intended beneficiaries of a will, reflecting assumption of responsibility to a small class of foreseeable claimants. Valuers engaged by lenders routinely owe duties to purchasers where it is foreseeable that the report will be shown to the purchaser and relied upon (see below).

Disclaimers can neutralise proximity by negating assumption of responsibility. However, disclaimers are not a panacea: in consumer contexts like residential valuations, broad disclaimers may be ineffective under UCTA because they fail the reasonableness test, leaving the duty intact.

Fair, Just, and Reasonable

This final stage involves broader policy considerations. The court asks whether imposing a duty is appropriate in the wider public interest. Factors might include:

• The potential for indeterminate liability (the 'floodgates' concern). Would imposing a duty open the defendant up to claims from an unmanageably large number of people?
• The existence of alternative remedies (for example, in contract or statute).
• The potential impact on the defendant's profession or field of activity and the statutory purpose of the information provided.
• Whether the defendant is a public body acting under statutory powers, and whether recognising a duty would distort public functions.

In Caparo itself, the House of Lords held it would not be fair, just, and reasonable to impose a duty of care on company auditors towards potential investors relying on audited accounts, due to the risk of indeterminate liability and the statutory context of audits. Similarly, in Customs & Excise Commissioners v Barclays Bank, the absence of assumption of responsibility and proximity, combined with policy concerns, led to no duty where a bank failed to implement a freezing order; the bank was a passive recipient of a court order, not a voluntary adviser assuming responsibility to the commissioners.

Worked Example 1.3

An accountant prepares draft accounts for Company X, knowing they are urgently needed for a meeting with Company X's bank manager to discuss an overdraft facility. The accountant negligently overstates Company X's profits. The bank manager relies on these draft accounts and grants the overdraft. Company X subsequently fails, and the bank is unable to recover the overdraft amount.

Does the accountant owe a duty of care to the bank?

Answer:
Applying Caparo:

• Foreseeability: It is reasonably foreseeable that the bank would rely on the accounts for the purpose of the overdraft decision and suffer loss if they were inaccurate.
• Proximity: There appears to be sufficient proximity. The accountant knew the specific purpose (bank meeting for overdraft) and knew the accounts would be communicated to the bank for this purpose. The bank's reliance seems likely and reasonable given the context. This points towards an assumption of responsibility.
• Fair, Just, and Reasonable: Imposing a duty here is fair, just, and reasonable. Unlike the Caparo auditors scenario (where accounts were for shareholders generally), this advice was prepared knowing it would be used for a specific transaction with a specific party (the bank). The risk of indeterminate liability is lower. Conclusion: A duty of care is likely owed by the accountant to the bank.

Reliance and causation still need to be proved: the bank must show it actually relied and that reliance caused the loss. If, for instance, the bank would have granted the overdraft regardless of the accounts, causation fails.

Exam Warning

Do not assume that reasonable foreseeability of economic loss alone is enough to establish a duty of care for negligent misstatement. The requirements for proximity (often demonstrated by a special relationship involving assumption of responsibility and reasonable reliance) and the 'fair, just, and reasonable' considerations are key hurdles that must also be overcome.

Revision Tip

When analysing problem questions involving negligent misstatements, focus heavily on the relationship between the parties. Look for evidence that the defendant specifically knew the claimant (or a very limited group including the claimant) would rely on their statement for a particular known purpose. This is key to establishing proximity.

Worked Example 1.4

A property surveyor is commissioned by a mortgage lender (Bank A) to value a house that Mr Jones wishes to purchase. The surveyor negligently overvalues the property. Mr Jones receives a copy of the valuation report from Bank A. Relying on the valuation, Mr Jones purchases the house. He later discovers the true, lower value and suffers a financial loss.

Does the surveyor owe a duty of care to Mr Jones?

Answer:
Applying Caparo:

• Foreseeability: Loss to the purchaser (Mr Jones) from an overvaluation is reasonably foreseeable.
• Proximity: This is likely satisfied. Although the contract was between the surveyor and Bank A, surveyors typically know (or ought reasonably to know) that the valuation report will be shown to and relied upon by the prospective purchaser (Mr Jones) when deciding whether to buy the property at the agreed price. This establishes sufficient proximity and an assumption of responsibility towards the purchaser. See Smith v Eric S Bush [1990] 1 AC 831 (HL).
• Fair, Just, and Reasonable: Imposing a duty is generally considered fair, just, and reasonable in this context, especially for standard residential property purchases, as the purchaser often relies heavily on the lender's valuation and may not commission their own separate survey. Conclusion: A duty of care is likely owed by the surveyor to Mr Jones.

Note: In consumer contexts, broad disclaimers purporting to exclude responsibility for the report may be ineffective under UCTA 1977 if they fail the reasonableness test, reinforcing the duty owed.

Worked Example 1.5

An investor buys shares in PLC after reading its audited annual accounts prepared by the company’s auditors. The accounts, compliant with statutory reporting requirements, significantly overstate profits. The investor sues the auditors for the loss.

Is a duty owed?

Answer:
Under Caparo v Dickman, no duty is owed to members of the investing public who rely on audited accounts for investment decisions. Even if loss was foreseeable, proximity is lacking: the accounts were prepared for a statutory purpose (reporting to existing shareholders as a class) and not to guide investment decisions of unknown investors. Imposing a duty would not be fair, just, and reasonable because it risks indeterminate liability to a wide, undefined group.

Worked Example 1.6

A bank issues a credit reference to a supplier about one of the bank’s customers at the supplier’s request. The bank’s reference states it is given “without responsibility”. The supplier relies on it and later suffers loss when the customer defaults.

Does the bank owe a duty of care to the supplier?

Answer:
Hedley Byrne established that a duty may arise for negligent references where a special relationship exists. However, an effective disclaimer stating the information is provided “without responsibility” can prevent any assumption of responsibility and thus prevent a duty from arising. The result is no duty in tort. In other contexts, statutory controls (for example, UCTA/CRA) can render disclaimers ineffective, but a properly framed non-reliance disclaimer will often negate proximity in business-to-business references.

Key Point Checklist

This article has covered the following key knowledge points:

• Pure economic loss (PEL) is financial loss not consequent on physical damage to person or property.
• Recovery for PEL in tort is generally restricted due to policy reasons, primarily to avoid indeterminate liability.
• Negligent misstatement causing PEL is a recognised exception where a duty of care may arise.
• The existence of this duty is determined by the Caparo three-stage test: foreseeability, proximity, and whether it is fair, just, and reasonable to impose the duty.
• Proximity in negligent misstatement cases often requires a 'special relationship' involving an assumption of responsibility by the defendant towards the claimant and reasonable reliance by the claimant on the statement (stemming from the Hedley Byrne principle).
• Assumption-of-responsibility duties extend to services (for example, professionals advising or performing tasks), not just statements.
• Disclaimers can negate assumption of responsibility and duty, but are controlled by UCTA/CRA in consumer and certain business contexts.
• Audited accounts and widely distributed information typically do not found a duty to investors because of lack of proximity and policy concerns about indeterminate liability.
• Reliance and causation must be proved: even with duty and breach, claims fail if the loss would have occurred regardless of the statement.
• It is important to distinguish PEL from consequential economic loss, for which recovery rules are less strict and follow general negligence principles.

Key Terms and Concepts

• Pure economic loss
• Consequential economic loss
• Special relationship
• Negligent misstatement
• Assumption of responsibility
• Reasonable reliance
• Disclaimers