United States: Federal Court Narrows Impact Of New Jersey Limitation On Economic Loss Rule And Integrated Product Doctrine For Component Part Manufacturers

Previously published in the Bloomberg BNA Product Safety & Liability Reporter

The United States District Court for the District of New Jersey has signaled that, on a case-by-case basis, component part manufacturers may be protected from tort claims by the combined effect of the economic loss rule and integrated product doctrine under New Jersey law, despite a New Jersey Supreme Court ruling that left product manufacturers vulnerable to increased exposure in litigation over pure economic loss to a product as a whole.

In Adams Extract & Spice, LLC v. Van De Vries Spice Corp., Civ. No. 11-720, 2011 U.S. Dist. Lexis 147851 (D.N.J. Dec. 23, 2011), the court defined the narrow scope of the New Jersey Supreme Court ruling and thereby reestablished the viability of the integrated product doctrine, as an extension of the economic loss rule, in barring tort-based recovery when an allegedly defective product is incorporated into another product that the incorporated product then allegedly damages.

Understanding the Legal Principles

While these legal arguments are not frequently employed by defense counsel, they are by no means a new legal creation. The seminal U.S. Supreme Court decision, East River S.S. Corp. v. Transamerica Delaval Inc., 476 U.S. 858 (1986), held that the economic loss rule barred a claim by the corporate plaintiff against the manufacturer of a ship's engine turbines, a part of which had allegedly failed causing damage only to the turbines themselves. The Court explained that the public policy behind the rule is that contract law, and the law of warranty in particular, is better suited than tort law to set and regulate the responsibilities of a manufacturer if a product fails to perform the function for which it was intended. In keeping with this principle, under the economic loss rule a manufacturer has ''no duty under either a negligence or strict productsliability theory to prevent a product from injuring itself,'' because if the product itself is defective, the purchaser is limited to a contract claim for breach of warranty. East River, 476 U.S. at 871.

The economic loss rule evolved following East River, and lower courts throughout the country began applying the rule to consumer plaintiffs as well. New Jersey's economic loss rule, codified in the New Jersey Product Liability Act, only permits a plaintiff to recover for ''harm'' which it defines as personal injury and ''physical damage to property, other than the product itself.'' N.J.S.A. 2A:58C-1(b)(2).

The New Jersey Supreme Court, in Alloway v. General Marine Industries, L.P., 695 A.2d 264 (1997), found that, pursuant to the economic loss rule and the integrated product doctrine, a luxury boat owner's insurance company was barred from any recovery against the manufacturer of an allegedly defective seam in the boat that caused the boat to sink. In determining the proper allocation of the risk of loss as between a manufacturer and a purchaser (or his insurance company), the New Jersey Supreme Court adopted and expanded upon the reasoning in East River by applying the rule to an individual consumer: ''a purchaser may be better situated to absorb the risk of economic loss caused by the purchase of a defective product. . . . Additionally, [when one has] prudently protected himself against the risk of loss by obtaining an insurance policy that distributed the risk to his insurer, . . . the question becomes whether [the insurance company] . . . which is in the business of insuring against the risk of harm caused by defective products, can better bear the risk of loss from damage . . . . [to which the Court answered: yes.]'' Alloway, 695 A.2d at 268 (internal quotations omitted). The court also explained that:

[I]njury to a product itself neither implicates the safety concerns of tort law, nor justifies '[t]he increased cost to the public that would result from holding the manufacturer liable in tort.' Allowing recovery for all foreseeable damages in claims seeking purely economic loss, could subject a manufacturer to liability for vast sums arising from the expectations of parties downstream in the chain of distribution.

Id. at 270 (quoting East River, 476 U.S. at 872).

Applying the principles of East River to consumers, the vast majority of courts in recent years have ruled in favor of economic loss/integrated product defense arguments when component parts of a product allegedly caused damage to the product as a whole. Part of the reasoning behind applying the economic loss rule to damage to an integrated product allegedly caused by a defective component is that the unreasonable risk of subjecting a manufacturer to such massive tort liability is even more unjust when the manufacturer only provides one component of a much larger final product that is ultimately sold to the consumer. As the U.S. Supreme Court explained, ''[s]ince all but the very simplest of machines have component parts, a contrary holding would require a finding of property damage in virtually every case where a product damages itself. Such a holding would eliminate the distinction between warranty and strict products liability.'' East River, 476 U.S. at 867 (internal quotations omitted).

Component Part Maker Defense Weakened by New Jersey Decision

These manufacturer protections were called into question, however, by the New Jersey Supreme Court's decision in Dean v. Barrett Homes, Inc., 8 A.3d 766 (2010). There, the manufacturer of an allegedly defective Exterior Insulation and Finishing System (''EIFS'') argued that the economic loss rule and integrated product doctrine shielded it from liability for toxic mold damage that the EIFS allegedly caused to plaintiffs' home because it was an integrated part of the home. The trial court awarded summary judgment to the EIFS manufacturer and the Appellate Division affirmed.

The New Jersey Supreme Court reversed, holding that the EIFS was not ''sufficiently integrated into the home to become a part of the structure for purposes of broadly applying the economic loss rule.'' 8 A.3d at 775- 76. The decision was a noted departure from New Jersey and federal case law, including the Appellate Division's ruling one year earlier in Marrone v. Greer & Pollman Construction Inc., 964 A.2d 330, 336 (N.J. Super. App. Div. 2009), that the integrated product doctrine shielded a manufacturer of EIFS from liability for damage to the plaintiff's home because ''the house is the 'product,' and it cannot be subdivided into component parts for purposes of supporting a [Product Liability Act] cause of action.''

Rejecting the application of the integrated product doctrine on the facts before it, in contrast to most of the existing case law, the Dean court stated that ''[p]articularly in the case of houses, a product that is merely attached to or included as part of the structure is not necessarily considered to be an integrated part thereof.'' 8 A.3d at 775. The court relied upon asbestos cases in which courts have taken the position that contamination constitutes harm to the building as other property, and two cases from the California Supreme Court holding that the integrated product doctrine did not bar recovery for structural damages to houses caused by defective windows and a faulty foundation. Id. at 775-76. The court concluded that plaintiffs could recover for damages to the house's structure or to its environs. Id. at 776. Justice Rivera-Soto wrote a vehement dissent, stating that the majority's conclusion that the integrated product doctrine did not apply to the facts before the court ''defies basic common sense'' and ''runs contrary to stark reality.'' 8 A.3d at 778-79.

Justice Rivera-Soto emphasized that EIFS siding is permanently attached to homes and can only be removed by extensive demolition work, much like roofing shingles, and he concluded that to find that ''any system so designed and installed is anything other than permanently integrated into the structure to which it is applied simply makes no sense.'' Id. at 779.

The court opened a wide door for plaintiffs to pursue tort-based economic claims against component part manufacturers without providing adequate guidance for determining when a product is integrated with its component part.

Federal Court Decision Narrows Impact of New Jersey Ruling

Now the U.S. District Court for the District of New Jersey has provided guidance on the scope of the Dean decision. In Adams, the court addressed the tort liability of the third-party defendant, a U.S. agent for an Indian manufacturer of red pepper spice, A.A. Sayia & Co. (''Sayia''), to the defendant/third-party plaintiff supplier Van de Vries Spice Corporation (''VDV''), in litigation over damages incurred by plaintiff Adams Extract & Spice, LLC (''Adams'') in recalling some of its spice blend products after it learned that a shipment of red pepper spice supplied by VDV tested positive for salmonella. 2011 U.S. Dist. Lexis 147851 at *1-*2. The court held that despite the Dean decision, ''the law as applied to this case weighs heavily in favor of considering the spice blends integrated products,'' and dismissed the negligence and product liability claims on Sayia's motion to dismiss. Id. at *10-*11, *15. The court concluded that the facts and reasoning of Dean, which address an allegedly defective product that was added to the basic structure of a house, were clearly distinguishable from the case of an allegedly defective component of a blended spice product, noting that the Dean opinion itself states that houses are particularly unique. Id. at *12. The court also reasoned that the rationale underpinning the economic loss rule, that damages occurring ''at the core of a commercial transaction'' are compensable only in contract, weighed in favor of applying the economic loss rule in this case, where contract remedies included incidental and consequential damages. Id. at *12-*13.

The Litigation Plan

Following the lead of Adams, other courts in New Jersey addressing dispositive motions based on the economic loss rule and integrated product doctrine should consider whether the case-specific facts are similar or distinguishable from Dean. Counsel for component part manufacturers must carefully time and frame the argument. Once defense counsel learns that no personal injury or other property damage occurred, then the question is the ideal time to raise the shield of the economic loss doctrine. The timing issue is best discussed with clients as soon as counsel determines that the economic loss rule and integrated product doctrine may apply. Raising the argument early on may be appealing to the client who is not eager to pay litigation costs for a year or more of fact discovery. Advising a plaintiff of the defense early in a case or even pre-litigation could result in an early and inexpensive victory for a component part manufacturer.

However, raising the defense too early in a case gives the plaintiff the opportunity to amend the pleadings to allege facts that may defeat the defense. Note that a simultaneous motion for a stay early in the case is infrequently granted. Many plaintiffs will oppose a stay and many judges may agree with the plaintiff and allow full discovery to play out—raising defense costs. Alternatively, skilled defense counsel may choose to make use of early fact discovery to lock in plaintiff's story, propound interrogatories on damages claimed and document requests for all insurance documents, product manuals, express warranties, etc., issue any document subpoenas to non-parties with information, and then take the deposition of the plaintiff (if needed). Once the plaintiff's story is locked-in—and ideally after the time for the plaintiff to amend the complaint has long passed—the component part manufacturer may safely move for summary judgment pursuant to the economic loss rule and integrated product doctrine.

Finally, the last reasonable time to raise the defense is at the close of discovery and no later than the deadline for dispositive motions. While plaintiff cannot object to the timing of a summary judgment motion at this stage, the component part manufacturer has now expended significant funds in defending a case (although notably far less than if the case was to proceed to trial). Of course, if the defense is rejected by the court at summary judgment, then trial is right around the corner and defense counsel better be prepared with additional defenses for trial, or be prepared to settle or try the case. One thing that cannot be overemphasized: the importance of defense counsel and the client engaging in an early discussion analyzing the economic loss rule and integrated product doctrine defense and the timing of a litigation plan, so as to fully explore the pros and cons of when to move to dismiss.

Anticipating the Future

After Dean and Adams, the central question remains whether or not a component part will be viewed as an integrated part of a product, and the answer to this question will make the difference between a case that is dismissed under the economic loss rule and one where the component part manufacturer may be liable for substantial damages.

Adams tells us that Dean's holding and reasoning may be significantly narrowed and may be limited to cases involving defective products added to the structure of a home, and thus the broad protections of the economic loss rule and integrated product doctrine remain a viable defense for a wide range of component part manufacturers in New Jersey.

www.schnader.com

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