Predicting the Outcome of Negligence Claims for Relational or Secondary Economic Loss

By Dr Norman Katter 

The oft cited dictum of Lord Macmillan in Donoghue v Stevenson that ‘the categories of negligence are never closed [1] resonates in the varied circumstances in which pure economic loss can result at one or more removes from the direct effect or detriment of negligent acts or omissions. This relational or secondary economic loss is no less damaging to a party simply because it was not caused directly, but indirectly by the defendant’s negligence.

Both the number of those incurring relational or secondary economic loss (hereinafter referred to as relational loss) and the quantum of that loss can be vast. Negligent damage to public utilities [2] such as power lines, water or gas or infrastructure such as bridges [3] can generate widespread financial losses to commerce and industry. The negligent spillage of toxic substances such as oil into the ocean can cause extensive financial loss for example to the fishing industry with a ripple effect on businesses in the area. [4]

Negligently caused damage to cargo ships or wharves can cause significant financial loss to the cargo owner or in the case of damaged wharves loss to the shipowner or charterer who cannot unload. [5]

Negligent acts or omissions can cause interference with collateral commercial arrangements thereby generating relational economic loss. For instance, where a company has contracted to supply medical services under a life-care contract with X, that contract becoming more onerous and costly as a result of the defendant injuring X; [6] or a defendant negligently causing the escape of water into the premises of a manufacturer who consequently could not supply under an existing contract, goods to a third party retailer with resultant economic loss to the retailer. [7]

The “disappointed legatee” cases [8] involving professional negligence by solicitors under their solicitor/ client contract with resulting financial loss to a third party beneficiary whose legacy fails, highlights the varied circumstances that produce relational economic loss. The High Court of Australia as recently as 2016 has revisited the “disappointed legatee” situation. [9] As well, the High Court of Australia in Barclay v Penberthy [10] was presented with a situation involving relational loss to a company whose key employees were either killed or seriously injured in a negligently caused plane crash.

This is not to suggest that the above categories of relational economic loss are exhaustive. No doubt new and differing factual situations involving relational loss to third parties will come before the courts.

The fundamental tension for courts in cases of relational economic loss is between doing justice to a claimant whose economic loss has been caused through a wrong (delict) of the defendant, and the exposure of a defendant tortfeasor to claims far outweighing the wrong done. As earlier stated, the potential for purely economic loss to occur at one or more removes from the direct effect of a negligent act or omission (the ripple effect) raises ‘floodgate’ concerns of indeterminate liability.

One response to this tension is an approach which provides certainty such as an exclusionary rule denying any recovery for purely economic loss. Another response is to seek a middle course, by not denying recovery altogether, but to examine a range of policy issues or ‘salient features’ in discrete categories that restrict those who can recover their purely economic loss. This latter response is highlighted in cases before the courts of Canada, [11] New Zealand, [12] Australia [13] and the United States. [14]

This latter middle course relies on deductive reasoning from precedents and while not providing certainty, does provide to legal advisers a degree of predictability as to the outcome of relational loss claims.

This article suggests that case law on relational loss claims fall within discrete categories and within those categories there are limited circumstances in which the courts will allow recovery for relational loss. Those circumstances involve policy choices and facilitate recovery of loss by a limited range of parties having a special relationship to the person or thing directly affected by the defendant’s negligence. These policy issues and the special relationship just mentioned are discussed below.

It is suggested that by categorising a potential relational loss claim into a discrete category and then analysing case law within that category, legal advisers can predict a likely outcome.

Policy Issues in Relational Economic Loss Claims

Indeterminate Liability

In those cases in the United States, [15] Canada, [16] Australia [17] and New Zealand [18] where relational economic loss has been recovered, the defendant knew or ought to have known in each instance, of a specific individual or limited class of individuals who would likely suffer relational economic loss as a result of the negligence.

The corollary of this is that in those instances where the defendant could not reasonably have foreseen relational economic loss to any specific individual or limited class but only to an unascertained or indeterminate number of persons and the plaintiff was a member of that unascertained class, then the claim has been rejected.

As Buckley LJ stated in SCM (United Kingdom) v Whittall & Son Ltd with respect to negligently damaged public utilities causing relational economic loss:

‘It may be that if for example, an electric generating station or main cable or a principal water main serving a large number of consumers over a wide area were put out of action by the negligent act of someone who enjoyed no statutory immunity, the court might, on the facts of that case, properly reach the conclusion that no claimant for damages could successfully assert that the offender ought to have had him in contemplation as a person to whom he owed a duty of care. On the other hand, and by way of contrast, where, the damaged cable supplied only one establishment, I see no reason for excluding a duty of care merely because, what has caused the damage has been an interference with an electrical supply’ [19]

Tipping J in Mainguard Packaging Ltd v Hilton Haulage Ltd [20] went even further with respect to negligently damaged public utilities, stating that it was sufficient for recovery of relational loss if the defendant ought to have appreciated from the geography of the area, the location of the cable and the plaintiff’s physical proximity to the cable, that the plaintiff was one of a class of persons in the general vicinity of the power cable who might well be directly affected if the defendant damaged the cable

The plaintiff’s obvious (obvious to the defendant) close relationship to the property or the person damaged or injured by the defendant’s negligence has underpinned those cases in which the plaintiff has recovered the relational loss. This close relationship between plaintiff and third party whose person or property has been damaged by the defendant’s negligence, has been labelled under phrases such as “common or joint adventure”, [21] “known plaintiff”, [22] “limited class of individuals” [23] and “closeness of causal relationship”. [24]

In the instance of a breach of the professional/ client contract by a negligent act or omission of a solicitor causing a will to fail with resultant economic loss to the disappointed beneficiary, the latter has been referred to as the “designated beneficiary” [25] or “identified third party”. [26]

The joint adventure of cargo owner and shipowner, the known use of a damaged bridge by a plaintiff train company under a licence agreement, the specific individual (known plaintiff) whose oil terminal is connected to the damaged pipe through which its oil flows, and where a limited number of individuals in the geographic vicinity of a damaged electric cable would obviously be affected, are all examples of a close and obvious relationship between plaintiff and the third party or the third party property damaged by the defendant’s negligence.

The High Court of Australia in Barclay v Penberthy [27] found for a plaintiff company claiming recovery of its relational economic loss resulting from injury to key employees caused in a plane crash. The defendants (pilot and owners of the plane) had specific knowledge that the passengers were key employees of the plaintiff company and that the company had chartered the aircraft for a specific commercial purpose.

A plaintiff whose collateral contract with a third party is made less advantageous or more onerous due to negligently caused harm to the third party or its property, cannot recover against the tortfeasor unless that tortfeasor had specific knowledge or ought to have known of the collateral contract. The mere possibility that a third party may have collateral engagements that are affected by the tortfeasor’s negligence will not be sufficient for recovery of the contractual relational loss. [28]

In those jurisdictions where relational economic loss claims have succeeded there has been an absence in these cases of any ‘floodgate’ fear of exposing the defendant to indeterminate liability.

Vulnerability

An issue for courts in the recovery of purely economic loss is the vulnerability of the claimant. The law’s protection of purely economic interests, in contrast to its protection from physical harm to person or property, is more circumspect.

If a claimant had the opportunity to protect itself under contract from the economic loss sustained through the defendant’s negligence, this factor may weigh against the plaintiff’s recovery in tort. However, in Barclay v Penberthy [29] the High Court of Australia, in a majority joint judgment of five justices, dealt with the issue of the plaintiff’s vulnerability and potential to protect itself under contract. The majority stated that “it was not incumbent upon [the plaintiff company] to establish that it could not have bargained with the [defendant] for a particular contractual provision. The presence or absence of a claim in contract would not be determinative of a claim in tort”. [30] This view of the majority may be contrasted with that of Heydon J, who found that the failure of the plaintiff employer to establish that it could not have negotiated a contractual warranty of protection from economic loss from injury to its employees was fatal to its claim. [31]

Again Heydon J’s view of the importance of vulnerability and the potential of a plaintiff to protect itself from economic loss under a contract can be contrasted with the view of McLachlin J (as she then was) in the Supreme Court of Canada in Canadian National Railways Co v Norsk Pacific Steamship Company. [32] McLachlin J stated “that a ‘contractual allocation of risk’ rested on a questionable assumption that all persons or business entities organise their affairs in accordance with the laws of economic efficiency assigning liability to the ‘least cost risk avoider’ and that all parties to a transaction share an equality of bargaining power. It overlooks the historical centrality of personal fault to our concept of negligence …. and the role this may have in curbing negligent conduct”. McLachlin J concluded that “it is far from clear that the courts should deny recovery of pure economic loss on the basis of arguments based on allocation of risk”. [33]

The obvious vulnerability of a designated beneficiary under a will to the solicitor’s negligence under the contract with the testator in the ‘disappointed legatee’ cases, is a factor weighing in favour of the beneficiary. The beneficiary is a passive sufferer and has no ability to protect itself under the solicitor/client contract to which it is not a party.

The current law on the relevance of vulnerability is, that the fact a claimant seeking recovery of relational economic loss in a tort action could have protected itself under contract is not fatal to its claim.

Economic Efficiency

Where only economic interests are sought to be protected it is argued that it is better to spread the loss through the hands of the victims of negligently caused relational loss rather than place the economic burden on the shoulders of one tortfeasor. This is particularly so having regard to the availability of cheaper loss insurance for the victims, rather than expensive liability insurance.

Bishop however has correctly noted that the loss spreading rationale cannot justify the numerous cases where there is only one victim. [34] Furthermore Bishop states that relieving the tortfeasor of liability based on efficient risk distribution will result in more accidents and increase the cost of loss insurance. [35]

Arguments based on economic efficiency and risk distribution did not sway the majority in the landmark decision of the Supreme Court of Canada in Canadian National Railway Co v Norsk Pacific Steamship Co. [36] The majority preferred to rest their decision on the obvious close relationship or ‘joint adventure’ between the plaintiff railway company and the bridge owner whose bridge was damaged by the defendant’s ship.

Unwarranted Interference in Legitimate Commercial Activity

Will the imposition of a tort remedy for relational economic loss stifle and fetter the otherwise legitimate pursuit of economic gain? This question has been raised and advanced in cases of relational loss but has generally been rejected since the defendant’s conduct was not otherwise lawful [37] or the defendant was already under an existing duty to take care. Allowing recovery by the plaintiff for negligently caused relational loss would therefore not add an additional burden or fetter upon the conduct and enterprise of the defendant.

Certainty

A rejection of the exclusionary rule in relational economic loss claims removes the element of certainty. A significant justification in the cases for application of a rule which denies recovery for purely economic loss, not consequential on any injury to person or property of the claimant, has been the certainty it provides to legal advisers. [38]

But has the rejection of the exclusionary rule in favour of allowing recovery of relational economic loss in limited circumstances, resulted in uncertainty and an inability of legal advisers to predict a likely outcome? This question is discussed in the final section of this article (see Predictability below).

Deterrence

‘Floodgate’ and justice concerns of liability far outweighing the wrong done, economic efficiency, alternate means of protection to the claimant, and certainty in the law, are weighed against the policy of deterring negligence which may cause vast economic loss.

Relieving defendants of liability for negligence causing relational losses ignores the historical base of fault or delict in tort and will facilitate more accidents and more unprofessional conduct. [39] The effect on the community is to raise the cost of insurance and lower professional standards.

An analysis of the case law where claims are made for relational economic loss indicate that, absent any concern of indeterminate liability, policy issues of economic efficiency, availability of alternate means of protection to the victim, unwarranted interference in commercial activity, have not prevented recovery of relational loss.

Predictability

To what extent can legal advisers predict the likely outcome of relational economic loss claims and has the removal of the exclusionary rule preventing any recovery for purely economic losses, opened a vast unchartered area of uncertain claims?

The answer lies in an analysis of the body of precedent of claims for relational loss. By a process of analogical and deductive reasoning from precedents a likely outcome can be predicted. This process requires firstly a categorisation of the direct or primary effect of the defendant’s negligence. Has that negligence, in the first instance, injured or damaged (a) a third party or (b) property of the third party (c) public property or the environment, or (d) breached a contract between the third party and the defendant tortfeasor, such that there has resulted from (a) (b) (c) or (d) relational or secondary economic loss to the plaintiff (claimant).

This categorisation assists in isolating relevant cases and assessing by analogy and deductive reasoning, a likely outcome.

(a) Defendant’s Negligence has caused Injury to a Third Party with Relational Loss to the Plaintiff

Where the direct injury is to a third party with relational economic loss to the claimant, and leaving aside statutory claims by dependants under Lord Campbell’s Act legislation or an action per quod servitium amisit by a master (employer) for injury and breach of a duty of care owed to a servant (employee), the cases that have found for the claimant are situations where the defendant tortfeasor knew or ought to have known of the specific relationship or contract between claimant and injured third party. (See, for instance, the specific knowledge of the defendants in Barclay v Penberthy [40] ). Mere knowledge by the defendant of the possibility that there may be collateral or contractual commercial arrangements affected by injury to a third party is not sufficient to ground a successful claim for relational loss. [41]

(b) Defendant’s Negligence has caused Damage to the Property of a Third Party with Relational Loss to the Plaintiff

Where the defendant’s negligence has caused damage to the property of a third party with resultant economic loss to the plaintiff, it is the closeness of relationship of the plaintiff to the damaged property which will determine the outcome of the claim for such economic loss. If the plaintiff’s special relationship to the property damaged is obvious, or ought to have been obvious to the defendant tortfeasor, then the plaintiff is likely to succeed. This close relationship may be in the nature of a ‘common or joint adventure’ whereby the property of the plaintiff and the damaged property are exposed to the same risks (eg plaintiff’s cargo on a ship owned by the third party, where the ship is damaged by the defendant’s negligence; [42] or the third party’s pipeline, damaged by the defendant, was connected to the plaintiff’s oil terminal. [43] )

The mere fact that negligently caused damage to the property of a third party has resulted in relational financial loss to indeterminate persons not having any special or obvious relationship to that property, will not be sufficient for recovery.

(c)  Defendant’s Negligence has damaged Public Utilities or the Environment with Relational Loss to the Plaintiff

Similarly, where the defendant has damaged public property (eg interrupting the supply of water, electricity or gas) or the environment (ie toxic torts) with resultant relational loss, then again, unless there is some special and obvious relationship of the claimant going beyond the general relationship which the mass of the public have, to the property or thing affected, then recovery of relational loss will be denied. The relationship of the fishing industry to the waters affected by an oil spill is a special and obvious relationship to the thing damaged [44] . Whereas the general decline in commercial activity in the area of an oil spill would not result in those businesses having successful claims for their economic loss, since there is no special or obvious relationship between the businesses and the thing affected (ocean). [45]

In the instance of damage to public utilities such as water, gas or electricity causing financial loss to business through interruption of supply, that relational loss has only been recoverable where the defendant knew or ought to have appreciated that a specific individual or limited class of individuals would be affected and the plaintiff was one of these individuals. [46] If the plaintiff was merely one of an indeterminate class of persons affected by the interruption to supply any claim for relational loss would fail. [47]

(d) Defendant’s Negligence has breached a Contract with a Third Party with resultant Relational Loss to the Plaintiff

This category of relational loss has been highlighted in the ‘disappointed legatee’ cases where the negligence of the solicitor has breached the solicitor/client contract thereby causing a will to fail with resultant economic loss to a designated beneficiary. The ‘disappointed legatee’ cases have not raised any ‘floodgate’ fears of indeterminate liability since the loss has been caused to a limited and predetermined number of individuals, namely designated beneficiaries. Nor have any policy reasons been sufficient to override the claim of the disappointed beneficiary.

Where a defendant’s negligence towards a third party is a breach of contract with that third party and the negligence results in relational loss to the plaintiff, the plaintiff will not recover unless the defendant knew or ought to have known of the likely specific loss to the plaintiff. In the case of the disappointed beneficiary, the loss to the beneficiary is obvious to the defendant solicitor. Mere knowledge by the defendant that its negligence and breach of contract with a third party, possibly might cause secondary loss to indeterminate individuals, without knowledge of any specific person affected would not be sufficient for recovery.

Conclusion

In those cases where relational loss has been recovered there has been no threat of exposing the defendant to indeterminate liability.

The case law indicates discrete categories where recovery of relational loss has succeeded by a limited number of individuals having a special and obvious close relationship to the person or thing directly affected by the negligence. While not providing certainty, these discrete categories and the cases in that category where claims have succeeded, provide a basis for legal analysis of a potential claim. By a process of deductive reasoning from similar claims in a particular category legal advisers are able to predict a likely outcome. [48]

Dr Norman Katter

Footnotes

[1] [1932] AC 562, 619.

[2] Spartan Steel & Alloys Ltd v Martin & Co (Contractors) Ltd [1973] QB27; Electrochrome Ltd v Welsh Plastics

Ltd [1968] 2 All ER 205; SCM (United Kingdom) Ltd v WJ Whittall & Son Ltd [1971] 1QB 337; SeawayHotels

Ltd v Cragg (Canada) Ltd (1959) 21 DLR (2d) 264; Dynamco Ltd v Holland and Hannen & Cubitts (Scotland)

Ltd [1971] SC 257; Byrd v English (1903) 117 Ga 191; Mainguard Packaging Ltd v Hilton Haulage [1990] 1NZLR 360; New Zealand Forest Products Ltd v Attorney – General [1986] 1 NZLR 14.

[3] Canadian National Railway Co v Norsk Pacific Steamship Co Ltd [1992] 1 SCR 1021; Gypsum Carriers Inc v

The Queen (1977) 78 DLR (3d) 175; Bethlehem Steel Corp v St Lawrence Seaway Authority (1977) 79 DLR

(3d) 522; Star Village Tavern v Nield (1976) 71 DLR (3d) 439; Rickards v Sun Oil Co (1945) 41 A (2d) 267, 23

NJ Misc 89.

[4] Union Oil Company v Oppen (1974) 501 F 2d 558.

[5] Candlewood Navigation Corporation Ltd v Mitsui OSK Lines Ltd (1985) 3 NSWLR 159; [1986] AC 1; La

Societe Anonyme de Remorquage a Helice v Bennetts [1911] 1 KB 243; Elliott Steam Tug Company Ltd v Shipping Controller [1922] 1 KB 127; Robins Dry Dock & Repair Co v Flint (1927) 275 US 303; [1910] SC772; The Federal Number Two (1927) 21 F (2d) 313; Christopher v Motor Vessel “Fiji Gas” (1993) Aust Torts Reports 81-202.

[6] Fifield Manor (A Corporation) v Finston (1960) 354 P 2d 1073.

[7] French Knit Sales Pty Ltd v N Gold & Sons Pty Ltd [1972] 2 NSWLR 132.

[8] Hill v Van Erp (1997) 188 CLR 159; White v Jones [1995] 1 All E R 691; Gartside v Sheffield, Young & Ellis

[1983] NZLR 37; Seale v Perry [1982] VR 193; Ross v Caunters [1980] 1 Ch 297.

[9] Badenach v Calvert [2016] HCA 18.

[10] [2012] HCA 40

[11] Canadian National Railway Co v Norsk Pacific Steamship Company [1992] 1 SCR 1021; Gypsum Carrier Inc v The Queen (1977) 78 DLR (3d) 175.

[12] New Zealand Forest Products Ltd v Attorney- General [1986] 1 NZLR 14; Mainguard Packaging Ltd v Hilton Haulage Ltd [1990] 1 NZLR 360; Gartside v Sheffied, Young & Ellis [1983] NZLR 37

[13] Barclay v Penberthy [2012] HCA 40; Badenach v Calvert [2016] HCA 18; Candlewood Navigation Corporation Ltd v Mitsui OSK Lines Ltd (1985) 3 NSWLR 159; [1986] AC 1; Hill v Van Erp (1997) 188 CLR 159.

[14] Union Oil Company v Oppen (1974) 501 F 2d 558; Biakanja v Irving (1958) Cal 2d 647; 320 P 2d 16.

[15] See eg Union Oil Company v Oppen (1974) 501 F 2d 558.

[16] Canadian National Railway Co v Norsk Pacific Steamship Co [1992] 1 SCR 1021.

[17] Barclay v Penberthy [2012] HCA 40; Caltex Oil (Australia) Pty Ltd v The Dredge “Willemstad” (1976) 136 CLR 529.

[18] See eg Mainguard Packaging Ltd v Hilton Haulage Ltd [1990] 1 NZLR 360.

[19] [1971] 1 QB 337.

[20] [1990] 1 NZLR 360, 372.

[21] Caltex Oil (Australia) Pty Ltd v The Dredge “Willemstad” (1976) 136 CLR 529, 51 per Stephen J; Main v

Leask [1910] SC 772, 779 per Lord Ardwell.

[22] Caltex Oil (Australia) Pty Ltd v The Dredge “Willemstad” (1976) 136 CLR 529, 555-556 per Gibbs J (as he then was).

[23] SCM (United Kingdom) Ltd v WJ Whittall & Son Ltd [1971] 1 QB 337.

[24] Mainguard Packaging Ltd v Hilton Haulage Ltd [1990] 1 NZLR 360, 372.

[25] Gartside v Sheffield, Young & Ellis [1983] NZLR 37, 47.

[26] Ross v Caunters [1980] 1 Ch 297 at 322, 323.

[27] [2012] HCA 40.

[28] Fifield Manor (A Corporation) v Finston (1960) 354 P 2d 1073; French Knit Sales Pty Ltd v N Gold & Sons Pty Ltd [1972] 2 NSWLR 132.

[29] [2012] HCA 40.

[30] Ibid at para. 47.

[31] Ibid at paras. 87,88

[32] [1992] 1 SCR 1021.

[33] Ibid at 1157,1158,1160h.

[34] W Bishop “Economic Loss in Tort” (1982) 2 Oxf J Legal Studies 1, 2

[35] Ibid.

[36] [1992] 1 SCR 1021.

[37] See eg Perre v Apand [1999] HCA 36, paras 101,102,103.

[38] See eg Candlewood Navigation Corporation Ltd v Mitsui OSK Lines Ltd [1986] 1 AC 1, 25.

[39] Canadian National Railway Co v Norsk Pacific Steamship Co [1992] 1 SCR 1021, 1157,1158,1160 per

McLachlin J.

[40] [2012] HCA 40, paras 44,48.

[41] Fifield Manor (A Corporation) v Finston (1960) 354P 2d 1073; French Knit Sales Pty Ltd v N Gold & Sons Pty Ltd [1972] 2 NSWLR 132.

[42] Morrison Steamship Co Ltd v Greystoke Castle (Cargo Owners) [1947] AC 265, 279-280, 296-297

[43] Caltex Oil (Australia) Pty Ltd v The Dredge “Willemstad” (1976) 136 CLR 529.

[44] Union Oil Company v Oppen (1974) 501 F 2d 558, 569,570,571.

[45] Ibid.

[46] New Zealand Forest Products Ltd v Attorney-General [1986] 1 NZLR 14; Mainguard Packaging Ltd v Hilton

Haulage Ltd [1990] 1 NZLR 360.

[47] Spartan Steel & Alloys Ltd v Martin & Co (Contractors) Ltd [1973] 1QB 728; SCM (United Kingdom) Ltd v WJ Whittell & Son Ltd [1971] 1 QB 337.

*LL.B, LL.M, PhD Barrister-at-Law