Ky. SC clarifies economic loss rule

By Jessica M. Karmasek | Jun 30, 2011


FRANKFORT, Ky. (Legal Newsline) - The Kentucky Supreme Court, in a ruling earlier this month, held that the "economic loss rule" applies to claims arising from a defective product sold in a commercial transaction.

By definition, the rule prevents the commercial purchaser of a product from suing in tort to recover for economic losses arising from the malfunction of the product itself, recognizing that such damages must be recovered, if at all, pursuant to contract law.

The Court, in its June 16 opinion, said the rule applies regardless of whether the product fails over a period of time or destroys itself in a "calamitous event," and the rule's application is not limited to negligence and strict liability claims but also encompasses negligent misrepresentation claims.

Appellee Ingersoll Rand purchased from appellant Giddings & Lewis Inc. a Diffuser Cell System for use in its Mayfield, Ky., plant. The cell system, which consisted of a vertical turning lathe, two vertical machining centers and a material handling system, was used to cut and shape metal parts through a series of steps.

Ingersoll Rand's engineers provided Giddings & Lewis with extensive specifications for the cell system, including the requirement that the vertical turning lathe operate at a maximum of 690 revolutions per minute, a speed that was considerably faster than the 400 RPM customary on Giddings & Lewis machines.

Giddings & Lewis apparently redesigned the bearings, transmission and the pallet material to accommodate Ingersoll Rand's specifications, and then manufactured the cell system generally to the specifications provided by Ingersoll Rand in an eight-page document. The parties' written contract included an express warranty that provided that the goods furnished were "the best quality of their respective kinds and... free of defects in design, workmanship or material."

After seven years of virtually continuous operation -- by which time the express warranty had expired -- an incident occurred in which the clamp, the pallet and a large chunk of spinning metal flew off the vertical turning lathe and "catapulted around" the workspace in Ingersoll Rand's plant.

The clamp weighed 3,400 pounds, the pallet 1,500 pounds and the chunk of metal about 300 pounds. No one was injured and damage to property beyond the cell system itself, if any, appears to have been minimal.

Ingersoll Rand engaged Giddings & Lewis to rebuild the system and filed a claim with its insurers, which paid $2,798,742 for repairs to the damaged machinery, overtime payments to employees and related expenses.

The insurers -- now the appellees and collectively referred to as Industrial Risk Insurers -- then sued Giddings & Lewis to recover the amount paid, claiming breach of implied warranty, breach of contract, negligence, strict liability, negligent misrepresentation and fraud by omission.

Giddings & Lewis moved for summary judgment, which was initially denied by the Graves County Circuit Court but granted upon reconsideration.

The trial court agreed Industrial Risk Insurers' implied warranty claim was barred by the statute of limitations and held that the economic loss rule barred the tort claims, including those for fraud and negligent misrepresentation. The court considered but declined to adopt the "calamitous event" exception to the economic loss rule.

The trial court held that the vertical turning lathe, the two vertical machining centers and the material handling system constituted the product, effectively preventing Industrial Risk Insurers from recovering for damage to any part of the cell system.

An appeals court affirmed the trial court's explicit adoption and application of the economic loss rule and agreed the calamitous event exception should be rejected. However, the court found the economic loss rule did not bar Industrial Risk Insurers' negligent misrepresentation and fraud claims because they arise in tort, independent of any contractual duty.

The appeals court also reversed with respect to whether the components of the cell system constituted one product or several individual products, finding this a question of fact for the jury.

The state's high court granted Giddings & Lewis' motion for discretionary review as well as Industrial Risk Insurers' cross-motion.

Justice Lisabeth Hughes Abramson authored the Court's 37-page unanimous opinion.

In it, she notes that the "relevant product" is the entire item bargained for by the parties and placed in the stream of commerce by the manufacturer.

"The trial court properly determined as a matter of law that the product at issue in this case is the Diffuser Cell System bargained for by Ingersoll Rand and that the losses claimed are purely economic losses," the Court wrote.

"The economic loss rule precludes an action to recover those losses in tort, based on negligence, strict liability or negligent misrepresentation and, consequently, the trial court properly dismissed those claims."

It continued, "The fraud by omission claim was also properly dismissed because as a matter of law there was no duty to disclose and, in any event, no undisclosed past or present material fact."

The Court, affirming and reversing in part the appeals court's opinion, rendered final the trial court's grant of summary judgment in favor of Giddings & Lewis.

As for the impact of the rule on fraud claims, the Court said that issue awaits another case.

"The plaintiffs in this case pled fraud by omission, a claim that is unsustainable on the record before us, irrespective of the economic loss rule," it wrote.

From Legal Newsline: Reach Jessica Karmasek by e-mail at jessica@legalnewsline.com.

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