Contracts are an integral part of every company’s daily life. Negotiating a contract allows the company to evaluate the transaction and hammer out an accord that allocates risks and rewards in a satisfactory way. Executing and performing the contract permits the company to realize these rewards by exchanging with a counterparty the consideration provided by the agreement. And, if necessary, a suit on the contract calls upon the parties to seek the enforcement of the terms of the agreement so as to protect each party’s interests.
In the eyes of the law, these three practical aspects of a contract are all directed toward the parties’ expectations for their commercial relationship. Inherent in the sanctity of a contract is that these expectations – as recorded in the (ordinarily) written contract – will be reliably followed by the parties and upheld by a court. This predictability is an important component of fostering business relationships, which overall is good economically.
But what happens when the commercial relationship sours and a party thinks it has been injured well beyond what contract law would allow? Do the scales of justice weigh against a party’s true damages, inescapably limiting him or her to the terms of the contract? Or can a court toss out the parties’ negotiated allocation of risk and evaluate the injurious conduct through the lens of tort?
These questions – and ways contracting businesses can protect themselves – in light of the Florida Supreme Court’s recent decision in Tiara Condominium Association, Inc. v. Marsh & McLennan Cos., Inc., are the focus of this post.
History of the Economic Loss Rule in Florida
For more than two decades, the Florida-law answer to the latter of these questions was “No,” with well-settled exceptions. Although at times unwieldy in application, the so-called Economic Loss Rule was rooted in “the assumption that the parties to a contract have allocated the economic risks of nonperformance through the bargaining process.” Declining to enforce that allocation could allow a party “to circumvent the contractual relationship” and “seek to obtain a batter bargain than originally made,” an unjust and inappropriate result.
Over time, two branches of the Rule developed: products liability and contract. The former, which arose first, acts to protect the manufacturer of a defective product that does not injure a person or other property. For example, if an auto manufacturer produces a car with defective brakes, it will only be liable in warranty to the end user, so long as the defect does not harm any person or damage any other property.
The latter variety of the rule, which has also been the more controversial, focuses generally on the independence of the proposed tort from the parties’ contractual relationship. Paralleling various exceptions that developed to the Economic Loss Rule – for professional malpractice and intentional torts, among other things – the inquiry here is whether the tortious conduct was a component of contractual performance. If not, and the tort consisted of some additional conduct that together amounted to an independent tort, then the Rule would not apply. This second circumstance was sometimes measured by whether the fair negotiation and formation of the contract was undermined by a party’s tortious conduct.
By way of example, then, if a first party made misrepresentations that induced a second party to enter into a contract and prevented that second party from fairly negotiating and entering into the contract, the Rule typically would not apply. Conversely, the first party could not be said to have committed an independent tort simply by failing to provide the second party consideration. In other words, the tort would have to consist of more than the second party’s claims that he or she did not receive the benefit of the bargain.
Although relatively simple to understand, without explicit instructions from the Florida Supreme Court, the contract side of the Rule became tedious to apply in the real world. Courts soon expressed their exasperation. After expending much effort untangling Florida precedent, the Southern District of Florida in one decision conveyed its longing for clarification, noting that “much of Economic Loss Rule jurisprudence . . . is mired in controversy.” One Florida Supreme Court justice even described the Rule as a “confusing morass.”
The Tiara Condominium Association Decision
Amidst this chaos, conditions were ripe for the Florida Supreme Court to issue a watershed decision on the Rule. But Tiara was hardly an ideal development for the business community.
Beginning in federal court and growing out of a question certified by the Eleventh Circuit Court of Appeals, Tiara initially concerned whether an insurance broker fell within the professionals exception to the Rule, such that the Rule would not apply and a tort claim could be stated against the broker. The Court broadened this question and spent much of the majority opinion tracing the origins and history of the Rule, at numerous turns lamenting its “unprincipled extension.”
Based on this history, the Court noted that its “experience with the . . . rule over time, which led to the creation of the exceptions to the rule, now demonstrates that expansion of the rule beyond its origins was unwise and unworkable in practice.” Without any further substantive explanation (as the dissent later pointed out), the majority took what it described as its “final step” and “return[ed] the . . . rule to its origin in products liability” by holding that the Rule “applies only in the products liability context.”
In other words, the Court in Tiara abolished the Rule as a bulwark for non-manufacturers, even in instances where the parties have wrapped their commercial relationship in a binding written agreement. Although by concurrence several of the Tiara justices noted that frivolous tort claims can still “be considered and dismissed as appropriate based on basic contractual principles,” the Court’s broad referral to these unspecified “principles” is far from helpful, particularly given the Court’s silence on the fate of the exceptions to the Rule. Indeed, the Court’s extraction of the Rule from Florida jurisprudence will likely lead to even more confusion in courts’ efforts to decide whether a claim belongs in tort or contract.
A Few Best Practices
Despite the breadth of its holding, Tiara does not signify that non-manufacturing businesses must forever gird themselves for endless tort claims. Rather, there are a few steps companies can take to push the focus of their commercial relationships closer to the sphere of contract:
Ensure that all contracts meet the three “C’s” – i.e., they must be clear, concise, and comprehensive – and are in writing. Key to protecting your business and eliminating any confusion down the road is making each side fully aware of its obligations at the time of contract. Insist on your counter-party’s signature to the agreement before providing your consideration to be sure everyone is on the same page.
Instruct your employees to refrain from making any material pre-contractual, oral representations about the services or other intangibles you will provide or that have any bearing on the deal that are not later included in the contract. In the sale of a business unit, for example, your CFO should not describe the unit’s relationship with its largest customer as “excellent” unless you are prepared to reduce the statement to writing or include a corresponding disclaimer in the purchase and sale agreement.
Be careful to document any changes in a written amendment to the contract as the commercial relationship progresses. Parties oftentimes become less formal after the first contract is signed and each grows more familiar with the other. Although trust building is important, it is equally if not more critical that the parties have a clear understanding of each other’s obligations as the relationship develops and circumstances change. A simple contract addendum can go a long way.
By clearly and consistently enshrining your and your counter-party’s rights and duties in a written contract, a Florida court in analyzing a later dispute should be more inclined to recognize that tort law is not the better means of adjudication, Tiara notwithstanding.
(Of course, for manufacturers and other resellers of goods, Tiara has at least one unspoken benefit: its reaffirmation of the Rule in products liability. Thus, absent any independent conduct beyond the malfunction of the product – and assuming the malfunction caused no personal or property damage – plaintiffs should be hard pressed to recast their warranty claims in tort.)