United States: Robinson Helicopter Co. v. Dana Corp.: Potential Tort Exposure for Contracting Party’s Misrepresentations of Due Performance

A new California Supreme Court decision holds that tort recoveries, including punitive damages, are available in some circumstances for intentional misrepresentations made by a contracting party in a certificate of due performance required by the contract. Many commercial agreements involve statements or certificates about performance given by one party to the other. This decision greatly increases the stakes for and the exposure of the party making the representations.

On December 23, 2004, in Robinson Helicopter Co. v. Dana Corp., the California Supreme Court concluded that the economic loss rule does not bar tort recovery (including punitive damages) for intentional misrepresentation or fraud in the performance of a contract, where there are affirmative misrepresentations that are relied upon by the plaintiff and that "expose a plaintiff to personal damages independent of the plaintiff’s economic loss."¹

Generally, liability for breach of contract does not include exposure to recovery in tort, including liability for punitive damages. In part, this outcome is the consequence of the "economic loss rule" in tort law. In a nutshell, this rule prohibits negligence or strict liability recovery based on supplying a defective product unless there is personal injury or property damage other than to the product itself.² If the only damage is to the product itself, then the purchaser’s remedy is in contract only. The Robinson decision recognizes an exception to this rule.

In 1984, Robinson contracted to purchase from Dana parts for the helicopters Robinson manufactures. Dana initially delivered parts that complied with the contract specifications. Between July 1996 and October 1997, without notifying Robinson or obtaining the approval required by the FAA, Dana temporarily changed the process of manufacturing the parts. During this period, Dana provided contractually required written certificates with each delivery of parts that the parts had been manufactured "in conformance with Robinson’s written specifications,"³ even though Dana knew that as a result of the change in the manufacturing process the parts did not conform to the specifications.

The nonconforming parts suffered a much higher failure rate than did conforming parts. Dana did not disclose that it had changed its manufacturing process until three months after Robinson had notified Dana of the higher failure rate. Dana later disputed whether the deviation from specification was the cause of the increased failure rate.

Though in theory failure of a nonconforming part might have caused physical injury or property damage, there were no accidents or other incidents of injury or property damage caused by the failure of the nonconforming parts supplied by Dana. In fact, the failure of the nonconforming parts did not cause any damage to other parts of the helicopters.

Robinson was required by the FAA, and its British equivalent, to recall and replace the nonconforming parts. Robinson sued Dana, and after trial, the jury returned a verdict in favor of Robinson for $1.5 million in compensatory damages, plus $6 million in punitive damages based on the jury’s finding that Dana had "knowingly misrepresented or concealed material facts with the intent to defraud."⁴

Dana appealed the verdict. The Court of Appeal affirmed the award of compensatory damages but reversed the judgment with respect to the misrepresentation claim and punitive damage verdict, holding that because Robinson suffered only economic loss it could not recover in tort. By a 6-1 decision, the Supreme Court reversed the Court of Appeal’s decision and remanded the case for proceedings consistent with its own opinion.

Writing for the majority, Justice Janice Rogers Brown relied heavily on Erlich v. Menezes, 21 Cal.4th 543 (1999), in which the Court stated that conduct amounting to a breach of contract becomes tortious only when it also violates a duty independent of the contract arising from the principles of tort law. ⁵ Erlich described several circumstances in which tort damages were permitted in contract cases, noting that in each "the duty that gives rise to the tort liability is either completely independent of the contract or arises from conduct which is both intentional and intended to harm."

The Robinson majority reiterated that outside of the insurance context, "a tortious breach of contract may be found when (1) the breach is accompanied by a traditional common law tort, such as fraud or conversion; (2) the means used to breach the contract are tortious, involving deceit or undue coercion; or (3) one party intentionally breaches the contract intending or knowing that the breach will cause severe unmitigable harm in the form of mental anguish, personal hardship, or substantial consequential damages."⁶ In the present case, the majority concluded that the economic loss rule did not apply to the misrepresentation claims made by Robinson because the claims "were independent of Dana’s breach of contract; Dana’s knowing false certifications amounted to fraud.

Justice Brown distinguished the Court’s earlier decision in Aas v. Superior Court, 24 Cal.4th 627 (2000), in which the Court held that no recovery in negligence was available for construction defects that have not yet caused other property damage. Robinson’s claims were based on Dana’s intentional and affirmative misrepresentation that "risked physical harm to persons," the majority noted, whereas the claims in Aas were based on ordinary negligence: "[t]he economic loss rule is designed to limit liability in commercial activities that negligently or inadvertently go awry; not to reward malefactors who affirmatively misrepresent and put people at risk."⁷ Thus, the Court held that tort liability may be found where the plaintiff is simply exposed to (but does not incur) liability for personal damages independent of economic loss.

Justice Kathryn Mickle Werdegar was the lone dissenter. She noted that the rationale of Aas was to negate tort liability for breaches accompanied only by economic loss. It is interesting to note that in that case, the majority expressly rejected a rule (proposed by Chief Justice Ronald George in a concurring and dissenting opinion) that would have recognized tort exposure based on the "potential seriousness of possible property damage, rather than the existence of actual damage."⁸ After a series of recent Court decisions virtually eliminating a tort cause of action for denying the existence of, or liability under, a contract, she noted, the majority was introducing tort liability for the highly similar action of misrepresenting due performance under a contract.⁹

As Justice Werdegar stated in her dissent, "rare is the commercial contract that does not involve ongoing statements by the parties relating to their performance. In all such cases, under the majority’s rule, it is now possible to plead a fraud claim."¹⁰ Such performance-related statements as may be contained in a routine application for payment, notice to proceed or certificate of completion may now in some circumstances be used as the basis for a tort claim for punitive damages—in what would otherwise have been considered a breach of contract claim only for compensatory relief.

It is likely that we will see an increase in the number of breach of contract claims accompanied by tort claims alleging misrepresentations, where a risk of personal damages can also be alleged. It is easy to see how a plaintiff would be able to plead a risk of potential "personal damages" in myriad circumstances. The additional tort claims will likely increase liability exposure with respect to such actions, and also increase the cost and complexity of defending against them.

As with many important decisions, Robinson leaves several unresolved questions:

• The case involved findings of fact that placed Dana in a bad light; even Justice Werdegar acknowledged that "what Dana did was not admirable." But the holding in Robinson does not appear to be limited to misrepresentations in written certificates required by contract, to a change in manufacture in mid-performance, or to supply of a part whose specifications are subject to regulatory approval. Its rationale is capable of being extended to cover other representations made in connection with a contract.

• Robinson involved the sale of industrial goods. It remains to be seen whether it will be applied to leases of personal or real property or to the supply of other goods, services or software.

• The majority expressly declined to decide whether omissions—what it termed "intentional concealment of material facts," as distinguished from intentional misrepresentations—could provide a basis for tort liability.

• The decision does not address misrepresentations made in the contract itself, for example, as part of the representations and warranties set forth in the text of the contract.

• The decision does not define the "personal damages" to which the majority requires the plaintiff be exposed as a condition of tort recoveries. It is not clear whether the Court simply intended this apparently novel term to include both personal injury and property damage, or was ascribing to it some other meaning that has yet to be articulated.

• The decision does not address the effect of contractual provisions purporting to define exclusive remedies or to exclude liability in tort.¹¹

From a contract planning and negotiation standpoint, additional consideration should be paid to the making and drafting of representations and warranties—both those made in the agreement itself and those that may be contained in certificates of due performance on an ongoing basis. Such representations and certificates may now be made "to the actual knowledge" of the individual executing them, or state that they do not affect or expand the party’s liability under the base contract. Another area in which we are likely to see the consequences of Robinson is in the drafting and negotiation of contract provisions that attempt to define exclusive remedies and limit liability for other remedies and damages, including tort law exposures and consequential and punitive damages.

Justice Werdegar may well be right that "[a]llowing a tort claim to be pleaded in every case where a breach is accompanied by representations about performance forces all parties, not just those engaged in malfeasance, to bargain in the shadow of potential tort liability. That cannot be a good thing." California contract parties, and their counselors and litigators, must now draft contracts and resolve disputes in that shadow.