Claims for pure economic loss - Distinction between pure economic loss and consequential loss

Learning Outcomes

This article explains the difference between pure economic loss and consequential economic loss within the tort of negligence. It outlines the general principle that pure economic loss is not recoverable and explores the exceptions, particularly concerning negligent misstatements. After reading this article, you should be able to identify the different types of economic loss and understand the principles governing the recovery of such losses in negligence claims, which is essential for applying the law to SQE1 assessment questions.

SQE1 Syllabus

For SQE1, you are required to understand the rules governing recovery for different types of loss in negligence, specifically the distinction between pure economic loss and consequential economic loss. This includes appreciating the policy reasons behind the general exclusion of recovery for pure economic loss and the specific requirements for establishing a duty of care where exceptions apply. Your revision should focus on:

• defining pure economic loss and consequential economic loss
• understanding the general rule that pure economic loss is irrecoverable in negligence
• identifying the key exceptions to the general rule, particularly in cases of negligent misstatement
• applying the principles from key case law, such as Hedley Byrne & Co Ltd v Heller & Partners Ltd, to factual scenarios
• recognising the policy reasons limiting recovery for pure 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.

1. True or False? Pure economic loss is financial loss that results directly from physical injury to the claimant or damage to their property.
2. What is the general rule in negligence regarding the recovery of pure economic loss?
3. Which landmark case established that a duty of care could arise for pure economic loss caused by negligent misstatement?
4. What are the key elements required to establish a special relationship for the purpose of recovering pure economic loss caused by a negligent statement?

Introduction

In the tort of negligence, establishing that the defendant owed the claimant a duty of care is the first essential element. The type of damage suffered by the claimant significantly influences whether such a duty exists. While the law readily imposes a duty of care regarding physical injury or damage to property, it adopts a much more restrictive approach when the loss is purely financial. This article focuses on the key distinction between two types of financial loss: consequential economic loss, which flows from physical damage, and pure economic loss, which does not. Understanding this distinction is essential for determining the recoverability of financial losses in negligence claims.

Defining Economic Loss in Negligence

Financial loss suffered as a result of negligence can broadly be categorised into two types. It is important to distinguish between them because the rules governing recovery differ significantly.

Consequential Economic Loss

This is financial loss that is a direct consequence of physical damage to the claimant's person or property caused by the defendant's negligence.

Key Term: Consequential Economic Loss Financial loss that results directly from physical injury to the claimant or damage to the claimant’s property.

Because consequential economic loss stems directly from physical harm, it is generally recoverable in negligence, provided the standard requirements of duty, breach, causation, and remoteness are met. The physical damage provides the necessary link or proximity between the defendant's negligence and the claimant's financial loss.

Worked Example 1.1

A negligent driver crashes into a taxi, causing significant damage to the vehicle and injuring the taxi driver. The taxi driver incurs repair costs for the vehicle, medical expenses for their injuries, and loses earnings while unable to work during recovery and while the taxi is being repaired. Are these financial losses recoverable?

Answer: Yes. The repair costs, medical expenses, and lost earnings are all consequential economic losses. They flow directly from the physical damage to the taxi (property) and the personal injury suffered by the driver. The driver can claim these losses as part of their negligence action against the negligent driver.

Pure Economic Loss

This type of loss is financial damage that is not directly linked to any physical injury suffered by the claimant or physical damage to the claimant's property.

Key Term: Pure Economic Loss Financial loss suffered by a claimant that does not arise directly from physical injury to themselves or physical damage to their own property.

Examples include loss of profit due to a power cut caused by damage to a third party's cable, acquiring a defective product that is merely faulty (but hasn't caused other damage), or losses incurred due to reliance on negligent advice.

The General Rule: Irrecoverability of Pure Economic Loss

The fundamental principle in the tort of negligence is that pure economic loss is generally not recoverable. Courts are reluctant to impose a duty of care for this type of loss primarily due to policy reasons.

Policy Reasons for the Exclusionary Rule

The primary policy reason for restricting recovery for pure economic loss is the fear of indeterminate liability, often referred to as the 'floodgates' argument. Allowing claims for pure economic loss could potentially expose defendants to liability to an undefined number of claimants for an unquantifiable amount, extending far beyond the immediate physical consequences of their actions.

Exam Warning

Do not assume financial loss is automatically recoverable in negligence. Always identify whether the loss is consequential (flowing from physical damage/injury) or pure economic loss. The general rule is that pure economic loss is irrecoverable, subject to specific exceptions. Misidentifying the type of loss can lead to incorrect conclusions about liability.

Consider the scenario where a defendant negligently damages a bridge, causing it to close for repairs. Businesses in the area might suffer significant loss of profit due to reduced customer traffic. Allowing all these businesses to claim would impose potentially crushing liability on the defendant for losses far removed from the initial physical damage to the bridge.

Spartan Steel & Alloys Ltd v Martin & Co (Contractors) Ltd [1973] QB 27

This case provides a clear illustration of the distinction. The defendants negligently damaged a power cable (owned by the electricity board, not the claimant) supplying the claimant's factory. This caused a power cut, resulting in:

1. Physical damage to metal that was being processed in a furnace at the time (due to solidification).
2. Loss of profit on that specific batch of metal.
3. Loss of profit on further batches that could not be processed during the power cut.

The court held that the physical damage to the metal (1) and the loss of profit directly resulting from that damage (2) were recoverable as consequential economic loss. However, the loss of profit on the further batches (3) was deemed pure economic loss because it did not stem from damage to the claimant's property but from the damage to the third-party cable. This loss was irrecoverable.

Exceptions to the General Rule

Despite the general exclusionary rule, there are limited circumstances where a duty of care can be owed in respect of pure economic loss. The most significant exception arises from negligent misstatements causing financial loss.

Negligent Misstatement: The Hedley Byrne Principle

The basis for this exception was laid down in Hedley Byrne & Co Ltd v Heller & Partners Ltd [1964] AC 465.

Key Term: Negligent Misstatement An inaccurate statement made carelessly (negligently) by one party to another, which the recipient relies upon to their financial detriment.

Key Term: Assumption of Responsibility Where one party (usually possessing special skill or knowledge) assumes responsibility for the accuracy of advice or information given to another party, knowing that the other party will rely on it. In Hedley Byrne, the House of Lords established that a duty of care could arise for pure economic loss caused by a negligent misstatement if there was a 'special relationship' between the party making the statement and the party relying on it. This special relationship typically involves an assumption of responsibility by the defendant and reasonable reliance by the claimant.

Requirements for Establishing a Duty of Care for Negligent Misstatement

Following Hedley Byrne and subsequent cases like Caparo Industries plc v Dickman [1990] 2 AC 605, specific criteria must generally be met to establish the necessary special relationship and assumption of responsibility:

1. Reasonable Reliance: The claimant must have actually relied on the defendant's statement, and it must have been reasonable for them to do so.
2. Knowledge of Reliance: The defendant must have known, or reasonably ought to have known, that the claimant (or a class of persons to which the claimant belongs) would rely on the statement.
3. Knowledge of Purpose: The defendant must have known, or reasonably ought to have known, the purpose for which the claimant would use the statement.
4. Assumption of Responsibility: The defendant must have voluntarily assumed responsibility for the statement's accuracy towards the claimant. This is often inferred where advice is given in a business context.

Worked Example 1.2

A surveyor prepares a mortgage valuation report for a bank. The report negligently fails to identify significant structural defects in the property. The buyer, who is shown the report by the bank, relies on it and purchases the property. Later, the defects become apparent, significantly reducing the property's value. Can the buyer recover their financial loss from the surveyor?

Answer: Potentially yes. Although the primary contract was between the surveyor and the bank, the surveyor likely knew the buyer would rely on the valuation (Smith v Eric S Bush). If the surveyor assumed responsibility towards the buyer (or ought to have known the buyer would rely on the report without independent inquiry), and the reliance was reasonable, a duty of care for the pure economic loss may be established based on negligent misstatement.

Revision Tip

Remember that the Hedley Byrne exception primarily applies to negligent statements or advice, not usually to negligent acts causing pure economic loss (like in Spartan Steel). Always identify the source of the economic loss – was it an action or a statement?

Summary

Distinguishing between consequential economic loss and pure economic loss is fundamental in negligence.

Table 1: Consequential vs Pure Economic Loss

Policy reasons, particularly the fear of indeterminate liability ('floodgates'), underpin the general rule against recovering pure economic loss. The primary exception allows recovery for pure economic loss caused by negligent misstatements where a 'special relationship' based on assumption of responsibility and reasonable reliance exists between the parties.

Key Point Checklist

This article has covered the following key knowledge points:

• Economic loss in negligence is categorised as either consequential or pure.
• Consequential economic loss flows directly from physical damage or injury and is generally recoverable.
• Pure economic loss is financial loss not linked to physical damage/injury to the claimant or their property.
• The general rule is that pure economic loss is irrecoverable in negligence due to policy concerns (indeterminate liability).
• Spartan Steel illustrates the distinction, allowing recovery for losses consequential to physical damage but not for unrelated lost profits.
• An exception exists for pure economic loss caused by negligent misstatements under the Hedley Byrne principle.
• Establishing this exception requires demonstrating a 'special relationship' involving an assumption of responsibility and reasonable reliance.
• Key case law like Hedley Byrne and Caparo outlines the criteria for establishing this special relationship.

Key Terms and Concepts

• Consequential Economic Loss
• Pure Economic Loss
• Negligent Misstatement
• Assumption of Responsibility