Colorado District Court Dismisses Data Breach Class Action Against Noodles & Company

by Ballard Spahr LLP

Ballard Spahr LLP

The U.S. District Court for the District of Colorado recently dismissed a proposed class action lawsuit filed by financial institutions relating to a 2016 data breach that involved hundreds of Noodles & Company (Noodles) restaurants. The court's decision addresses two important issues in data breach class actions: choice of law and the economic loss doctrine.

In 2016, Noodles was the victim of a cyberattack that targeted customers' credit and debit card information. Four credit unions that had customer financial data possibly compromised by the data breach filed putative class actions against Noodles that were subsequently consolidated in the District of Colorado. The plaintiffs alleged that as a result of the data breach, they had to cancel and reissue bank cards, close and reopen customer accounts, respond to customer inquiries about the breach, monitor accounts for and investigate any fraudulent activity, and refund unauthorized charges. The plaintiffs asserted causes of action for negligence, negligence per se, and declaratory relief.

In January 2017, Noodles moved to dismiss the class actions for failure to state a claim. They argued that the economic loss doctrine barred the plaintiffs' negligence-based claims and that the corollary declaratory judgment claim could not stand alone. Last week, the Colorado district court agreed.

The court first had to decide which state's tort law to apply. Looking to the plaintiffs' home states (Colorado, Oregon, Ohio, Indiana, and Iowa), they applied Colorado law because each state had adopted the economic loss doctrine and there was no "outcome determinative conflict between the potentially applicable bodies of law."

The court then concluded that the plaintiffs' negligence claims were barred under the economic loss doctrine, which "generally forbids recovery in tort for pure financial losses caused by a defendant's negligence in its performance of a contractual duty." Those claims were barred in this instance, the court held, even though there was no bilateral contract between Noodles and the plaintiffs. Instead, Noodles' contractual duties and the plaintiffs' remedies were contained in the "series of contracts governing plaintiffs' payment-card networks."

When a customer swipes a credit or debit card at Noodles, the payment request is routed through a payment-card network governed by a "bank-card association"—the largest of which are Visa and MasterCard. The transaction is then sent electronically to the customer's "issuing bank," which is the financial institution that issued the credit or debit card to the customer. After the issuing bank authorizes the transaction, Noodles notifies its "acquiring bank," which processes credit and debit payments for Noodles. The acquiring bank forwards funds to Noodles to satisfy the transaction, and it is then reimbursed by the customer's issuing bank.

Bank-card associations have sets of rules that directly regulate issuing and acquiring banks, which are passed on through issuing banks' agreements with cardholders and acquiring banks' agreements with merchants. However, merchants and issuing banks typically do not have any direct bilateral contracts. The bank-card associations' rules require merchants like Noodles to abide by certain procedures in handling cardholders' financial information, including the requirement that Noodles comply with the Payment Card Industry Data Security Standard (PCI DSS). This set of standards includes a list of 12 "best practices" incorporating dozens of specific directions on how to maintain secure payment-card processing systems and protect cardholder data.

The court explained that the duties allegedly breached—namely, the secure handling of cardholders' financial information—were contained in this network of interrelated contracts, including the requirement that Noodles comply with PCI DSS. The court made clear that "[it] makes no difference that Noodles & Company's contractual duties arise from a web of interrelated agreements coordinated by Visa and MasterCard rather than bilateral contracts between the merchant and plaintiffs." The court also noted that the plaintiffs could have voluntarily entered into contracts with Noodles to allocate the risk of payment-card fraud, but did not do so.

The court's opinion emphasizes the importance of thoroughly understanding how agreements with and between vendors and processors address rights and obligations in the event of a data breach. Indeed, companies should fully understand how interrelated agreements may impact their ability to recover losses incurred as a result of a third party's data breach. Companies then should take the necessary steps to insulate themselves from losses, whether through additional indemnity agreements or cyber insurance coverage.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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