Legal Definitions - risk-stops-here rule

The "risk-stops-here rule" is a legal principle, often referred to as the Doctrine of Superior Equities, that helps courts determine which of two innocent parties should bear a loss when a dispute arises. It essentially states that when a loss must fall upon one of two parties who are both blameless, the loss should be borne by the party whose actions or inaction created the opportunity for the loss to occur, or who was in the best position to prevent it. This rule aims to assign responsibility to the party who had the greater ability to foresee or mitigate the risk.

• Example 1: Fraudulent Property Sale

  Imagine a property owner (Party A) gives their real estate agent (Party B) a signed, but otherwise blank, deed with specific instructions to complete a future sale. The agent, acting fraudulently, fills in their own name on the deed and then sells the property to an unsuspecting third party (Party C) for personal gain. Both Party A and Party C are innocent of the fraud.

  In this scenario, the "risk-stops-here rule" would likely place the loss of the property on Party A. By providing a signed blank deed, Party A created the opportunity for the agent's fraud to occur. Party A was in the best position to prevent this risk by not providing a blank document or by carefully supervising the agent's actions. Therefore, Party A's action enabled the fraudulent transaction, and the risk "stops" with them.

• Example 2: Stolen Company Check

  Consider a business (Party A) that issues a check payable to a specific supplier (Party B). The check is stolen from Party A's mailroom before it can be sent. The thief then forges Party B's endorsement and successfully cashes the check at a bank (Party C). Both Party A and Party C (the bank) are innocent parties in the sense that neither directly participated in the theft or forgery.

  Under the "risk-stops-here rule," the loss would typically fall on Party A. Party A was responsible for the security of the check until it was properly delivered. The theft occurred from Party A's premises, indicating a failure in their internal security or mailing procedures. Party A was in the best position to prevent the check from being stolen and subsequently forged. Thus, the risk "stops" with the business that failed to secure its negotiable instrument.

• Example 3: Unauthorized Use of a Corporate Credit Card

  A company (Party A) issues a corporate credit card to an employee (Party B) for legitimate business expenses, with clear policies outlining its use. The employee, however, abuses this privilege by making numerous unauthorized personal purchases, exceeding their authority. The credit card company (Party C) processes these transactions in good faith, unaware of the employee's misuse.

  Here, both the company (Party A) and the credit card company (Party C) are innocent of direct wrongdoing. However, Party A was responsible for monitoring its employee's use of the corporate card and enforcing its own internal policies. Party A was in the best position to prevent the unauthorized use through internal controls, regular audits, or by setting appropriate spending limits. The "risk-stops-here rule" would likely assign the financial loss from the unauthorized personal purchases to Party A, as their oversight (or lack thereof) enabled the employee's misuse of the card.