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. After reading this article, you should understand the principles of foreseeability, proximity (including the 'special relationship' concept from Hedley Byrne), and the 'fair, just and reasonable' criterion as applied to negligent misstatements causing financial harm, enabling you to tackle related SQE1 assessment questions.
SQE1 Syllabus
For SQE1, a solid understanding of the principles governing duty of care in negligence is required, particularly concerning claims for pure economic loss resulting from negligent misstatements. This involves applying specific legal tests and case law principles to practical scenarios. Key areas for your revision include:
- 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.
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.
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Financial loss that arises directly as a consequence of physical damage to the claimant's property is best described as:
- Pure economic loss
- Indirect economic loss
- Consequential economic loss
- Non-pecuniary loss
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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?
- Donoghue v Stevenson
- Hedley Byrne & Co Ltd v Heller & Partners Ltd
- Caparo Industries plc v Dickman
- Spartan Steel & Alloys Ltd v Martin & Co (Contractors) Ltd
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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.
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A 'special relationship', sufficient to establish proximity in a negligent misstatement claim, typically requires:
- A written contract between the parties.
- The defendant making a profit from the advice.
- An assumption of responsibility by the defendant and reasonable reliance by the claimant.
- 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.
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).
Understanding Pure Economic Loss
It is important to distinguish pure economic loss from other types of financial loss that are recoverable in negligence.
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.
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.
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 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?
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.
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.
Essentially, these factors point towards an assumption of responsibility by the defendant towards the claimant regarding the accuracy of the statement.
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.
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 (e.g., in contract).
- The potential impact on the defendant's profession or field of activity.
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.
Worked Example 1.2
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 seems potentially 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.
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 1.3
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.
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).
- The 'fair, just, and reasonable' test allows courts to consider wider policy implications before imposing a duty.
- 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
