Claims for pure economic loss - General rule against recovery

Learning Outcomes

This article outlines the general rule in the tort of negligence regarding claims for pure economic loss. After studying this material, you should understand the definition of pure economic loss, how it differs from consequential economic loss, the rationale behind the general prohibition on recovery, and the limits this places on the duty of care. This knowledge will assist you in identifying and analysing scenarios involving economic loss in SQE1 assessments.

SQE1 Syllabus

For SQE1, you are required to understand the principles governing claims for pure economic loss within the broader context of negligence. This includes the ability to distinguish pure economic loss from other types of damage and appreciate the policy reasons limiting recovery. You will need to apply these principles to factual scenarios presented in single best answer multiple-choice questions.

As you work through this article, ensure you can:

• Define pure economic loss and differentiate it from consequential economic loss.
• Explain the general rule that pure economic loss is not recoverable in negligence.
• Identify the key policy reasons supporting this general rule.
• Understand how the general rule affects the scope of the duty of care in relevant situations.

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. Which of the following best defines pure economic loss in tort?
   1. Financial loss resulting directly from physical damage to the claimant's property.
   2. Financial loss suffered independently of any physical injury or property damage to the claimant.
   3. Compensation awarded for pain and suffering.
   4. The cost of replacing a defective product.
2. What is the general rule regarding recovery for pure economic loss in negligence?
   1. It is always recoverable if caused by a negligent act.
   2. It is recoverable only if caused by a negligent statement.
   3. It is generally not recoverable.
   4. It is recoverable if the loss is substantial.
3. Which policy reason is often cited for the general rule against recovering pure economic loss?
   1. The difficulty in proving the defendant was negligent.
   2. The need to encourage claimants to take out insurance.
   3. The desire to avoid imposing potentially indeterminate liability ('floodgates').
   4. The fact that financial loss is less serious than physical injury.

Introduction

In the tort of negligence, a claimant must demonstrate that the defendant breached a duty of care, causing actionable damage. Damage typically involves personal injury or physical damage to property. However, claimants sometimes suffer financial loss that is not directly linked to such physical harm. This type of loss is termed pure economic loss. The general rule established through case law is that pure economic loss is not recoverable in negligence. This principle significantly limits the scope of a defendant's duty of care. Understanding this rule and its rationale is essential for analysing negligence claims.

Distinguishing Pure Economic Loss from Consequential Economic Loss

It is essential to distinguish between pure economic loss and consequential economic loss, as the rules governing recovery differ significantly.

Key Term: Consequential Economic Loss
Financial loss that is suffered as a direct consequence of physical injury to the claimant or physical damage to the claimant's property.

Consequential economic loss is generally recoverable in negligence because it flows directly from damage for which a duty of care is already owed (ie, physical injury or property damage).

Worked Example 1.1

Ahmed, a self-employed taxi driver, is involved in a road traffic accident caused entirely by Ben's negligent driving. Ahmed suffers a broken arm and his taxi is damaged. Due to his injury, Ahmed cannot work for two months, losing £4,000 in earnings. The repairs to his taxi cost £1,500. Are Ahmed's lost earnings and repair costs recoverable?

Answer: Yes. Both the lost earnings (£4,000) and the repair costs (£1,500) are consequential economic loss. The lost earnings result directly from Ahmed's personal injury (the broken arm), and the repair costs result directly from the physical damage to his property (the taxi). Ben owed Ahmed an established duty of care as a fellow road user not to cause physical injury or property damage, and this duty extends to the consequent financial losses.

Now consider the definition of pure economic loss.

Key Term: Pure Economic Loss
Financial loss suffered by a claimant which does not flow directly from physical injury to their person or physical damage to their property.

This type of loss stands alone, independent of any physical harm suffered by the claimant.

Worked Example 1.2

Beta Ltd operates a factory relying on a continuous electricity supply provided via a cable owned by the electricity company. Gamma Ltd, carrying out roadworks nearby, negligently damages this cable, causing a power cut to Beta Ltd's factory for eight hours. Beta Ltd suffers no physical damage but loses £10,000 in profits due to the interruption of production. Can Beta Ltd recover this loss from Gamma Ltd?

Answer: No. Beta Ltd's loss of profit (£10,000) is pure economic loss. It does not result from any physical damage to Beta Ltd's own property (the cable belonged to the electricity company). Under the general rule, pure economic loss is not recoverable in negligence. Gamma Ltd did not owe Beta Ltd a duty of care in respect of this type of loss. (Based on Spartan Steel & Alloys Ltd v Martin & Co (Contractors) Ltd [1973])

The General Rule Against Recovery

The fundamental principle is that no duty of care is owed in respect of pure economic loss. Therefore, such loss is generally irrecoverable in negligence. This rule applies whether the loss is caused by a negligent act or a negligent statement, although specific exceptions exist, particularly for negligent statements (which will be considered in a separate article).

The rationale for this restrictive approach is primarily based on policy considerations.

Policy Reasons for the Rule

1. The Floodgates Argument: Courts fear that allowing recovery for pure economic loss could lead to an unmanageable number of claims ('opening the floodgates'). A single negligent act could cause financial ripples affecting a large and indeterminate number of people. For instance, the damaged power cable in Worked Example 1.2 might affect numerous businesses, leading to potentially overwhelming liability for the defendant.
2. Indeterminate Liability: Closely linked to the floodgates argument is the concern about imposing liability 'in an indeterminate amount for an indeterminate time to an indeterminate class' (Ultramares Corp v Touche (1931) - US case, principle influential in UK). Allowing recovery for pure economic loss could make the extent of a defendant's potential liability unpredictable and potentially infinite.
3. Contract/Tort Distinction: Tort law traditionally focuses on compensating for physical harm and interference with property rights. Contract law is generally seen as the appropriate mechanism for protecting financial expectations and allocating economic risk through negotiation and agreement. Allowing recovery for pure economic loss in tort could undermine this distinction and interfere with contractual allocation of risks.
4. Insurance: Parties are generally expected to protect themselves against purely financial risks through their own contractual arrangements or insurance, rather than relying on tort law for recovery.

Effect on Duty of Care

The general rule against recovery for pure economic loss operates as a significant control mechanism, limiting the scope of the duty of care in negligence. It means that even if harm is foreseeable and there is some connection (proximity) between the parties, a court may find it is not 'fair, just and reasonable' (Caparo Industries plc v Dickman [1990]) to impose a duty of care where the only loss suffered is purely economic.

Key Point Checklist

This article has covered the following key knowledge points:

• Pure economic loss is financial loss that is not consequent upon physical injury to the claimant or physical damage to their property.
• Consequential economic loss flows directly from physical injury or property damage and is generally recoverable.
• The general rule in negligence is that no duty of care is owed in respect of pure economic loss, making it irrecoverable.
• This rule is based on policy reasons, primarily the 'floodgates' argument, the need to avoid indeterminate liability, and maintaining the distinction between contract and tort.
• The general rule significantly limits the scope of the duty of care in negligence claims involving only financial loss.

Key Terms and Concepts

• Pure economic loss
• Consequential economic loss