Legal Definitions - economic-loss rule

The economic-loss rule is a legal principle that generally prevents a party from suing in tort law (such as for negligence) to recover damages for losses that are purely financial in nature. This means that if the only harm suffered is monetary, without any accompanying physical injury to a person or damage to property other than the defective product or service itself, a lawsuit for that financial loss typically cannot be brought under tort law.

Instead, claims for purely economic losses are often better suited for contract law or warranty claims, which deal with agreements, promises, and the expectations of performance between parties. The rule helps maintain a distinction between the types of harms addressed by tort law (which focuses on duties owed to the public generally) and contract law (which focuses on duties arising from specific agreements).

However, many states recognize exceptions to this rule. For instance, if the financial loss was caused by intentional fraud, negligent misrepresentation, or if there was a special professional relationship between the parties (like an attorney and client), a tort claim for economic loss might be allowed.

• Example 1: Defective Manufacturing Component

  A car manufacturer purchases a batch of engine control units (ECUs) from a supplier. Due to a manufacturing defect, these ECUs frequently malfunction, causing the cars in which they are installed to operate inefficiently, leading to higher fuel consumption and premature wear on other engine parts. The car manufacturer incurs significant costs recalling and replacing the defective ECUs, and also faces warranty claims from customers for the increased fuel costs and related repairs. No one is physically injured, and no other property (like the car's body or interior) is damaged beyond the engine components themselves.

  How it illustrates the rule: The car manufacturer's losses—the cost of replacing the ECUs, increased warranty expenses, and customer compensation for fuel—are purely economic. Since there was no physical injury to a person or damage to property other than the defective ECUs and the parts they directly affected, the economic-loss rule would likely prevent the car manufacturer from suing the ECU supplier for negligence in tort. Their claim would typically need to be based on their contract with the supplier or a breach of warranty.

• Example 2: Ineffective Business Consulting Service

  A startup company hires a business consulting firm to develop a new marketing strategy, expecting it to significantly boost sales. The consulting firm delivers a strategy that is poorly researched and completely ineffective, resulting in the startup failing to attract new customers and suffering substantial financial losses due to wasted marketing budget and missed revenue targets. The consulting firm's actions did not cause any physical damage to the startup's office or equipment, nor did they cause any physical harm to individuals.

  How it illustrates the rule: The startup's losses are entirely economic—wasted funds and lost profits. The economic-loss rule would generally prevent the startup from suing the consulting firm for negligence in tort for these financial harms. The appropriate legal avenue would typically be a breach of contract claim, arguing that the consulting firm failed to provide the agreed-upon service competently.

• Example 3: Exception for Negligent Misrepresentation in Real Estate

  A real estate developer is considering purchasing a large parcel of land for a new housing development. Before buying, they hire an independent geological survey company to assess the stability of the soil. The geological company negligently performs its survey, incorrectly reporting that the soil is stable and suitable for construction. Relying on this report, the developer purchases the land. During the initial phase of construction, significant soil instability is discovered, requiring extensive and costly remediation efforts, causing substantial delays and financial losses for the developer.

  How it illustrates the rule: The developer's losses are purely economic—the unexpected remediation costs and financial impact of construction delays. While the economic-loss rule might ordinarily apply, this scenario falls under a common exception: negligent misrepresentation. Because the geological survey company provided a faulty report that the developer reasonably relied upon to their financial detriment, the developer would likely be able to bring a tort claim against the survey company despite the purely economic nature of the harm.