Economic Loss Problem Question

Jessica has decided that she wishes to establish a business manufacturing clothes for sale to high street clothing shops. In order to obtain a bank loan to set up the business, she has to show the bank that she has a list of clients who have placed regular orders. She consults her financial advisor, Derek, from Ashfield Associates, and asks him to find out about the financial position of her largest client, XED Exec Clothing. Derek approaches the bankers of XED Exec, DEF Bank, who inform him that XED Exec has an unblemished financial record. Derek informs Jessica of this.

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In fact, XED Exec has failed to make payment to other suppliers in the past. DEF Bank is aware of this, but, due to work pressure, the banking official who dealt with Derek did not check the bank’s records thoroughly. Armed with a good reference about XED Exec, as well as a list of other reputable clients, Jessica makes her way by train to her bank to obtain the bank loan. She finds a bundle of papers left on her seat, which contain an audit of the accounts for Total Investments Company. The papers were prepared by AHR Auditors for a private client interested in taking over Total Investments.

Jessica decides that Total Investments looks like a good investment to assist her in running her business and buys several shares in it. She successfully obtains a loan from her bank. During the same period, Jessica has earmarked premises from which to run her business. She approaches Creditwise Mortgage Company for a mortgage to buy the premises. Creditwise Mortgage Company appoints Stephen, a valuer, to conduct a survey of the premises. Stephen reports that the premises are in a sound structural condition. On the basis of this report, Creditwise Mortgage Company grants Jessica a mortgage to buy the premises.

A month later, XED Exec Clothing, having received several orders from Jessica, is declared bankrupt and unable to pay its creditors. Having lost its biggest client, Jessica’s business runs into financial difficulties. She decides to realise her shares in Total Investments, and discovers that it has been blacklisted for fraud, is no longer doing business and has had its assets frozen. In addition, the roof of the premises collapses and the clothing is destroyed by rain coming into the premises. In order to survive, Jessica undertakes some sewing work for a clothing factory, Fast Clothing.

She is to be paid for each batch of clothing that she completes, and is required to work at the factory premises. Due to the negligence of one of the employees of Southern Water Company, a pipe on the premises leaks, flooding the factory. Jessica is unable to do any sewing for several weeks, and consequently receives no money from Fast Clothing. Advise Jessica. You must refer fully to the relevant case law in support of your answer. The area of law that this question is concerned with is economic loss caused by negligent acts, and the reliance on negligent words.

The loss that Jessica suffers is known as pure economic loss, as it does not stem directly from personal injury or physical damage to her property[1]. The judiciary are reluctant to allow damages to be recovered for pure economic loss, as it could be considered to be too ‘indirect’[2] or too ‘remote’[3], and for fear of opening the ‘floodgates of litigation’[4], causing a ‘ripple effect[5]’, which is not present in physical damage claims. Jessica has suffered pure economic loss caused by relying on the negligent misstatement[6] made by DEF Bank.

The legal issue here is whether DEF Bank owed a duty of care to Jessica in the making of the statement. It would therefore be necessary to apply the principle set out in Hedley Byrne v Heller [7], regarding the reliance of negligent misstatements, leading to pure economic loss. Here, the appellants asked their bankers to enquire into the financial stability of a company for whom they planned to place orders. The respondents gave favourable responses in relation to the company’s financial status, ‘without responsibility[8]’. It is also important to note that no consideration (payment) was given for the statement made.

The majority of the House of Lords held that, in principle, and in the absence of such a disclaimer, a duty could be implied upon those who make negligent, but honest misstatements. According to Lord Hodson in Hedley Byrne, there would still be a duty of care even in the absence of a contractual or fiduciary relationship, meaning that the fact that Jessica did not pay for the statement made by the bank is irrelevant. However, he also held that it would be unreasonable to impose a duty of care upon a banker, only a duty to be honest, meaning that under this approach, Jessica’s claim would not succeed.

In application of Lord Reid’s approach, the first step to take would be to establish whether there was a special relationship between Jessica and DEF Bank. Such a relationship exists where: ‘It is plain that the party seeking information or advice was trusting the other to exercise such a degree of care as the circumstances required, where it was reasonable for him to do that, and where the other gave information or advice when he knew or ought to have known that the inquirer was relying on him’

It is clear that in this scenario, it was plain that Jessica trusted DEF Bank to exercise such a degree of care, as her financial adviser acted as an intermediary, asking them to find out the financial situation of her biggest client. This also suggests that it would be reasonable for Jessica to rely on DEF Bank’s statement, as with XED Clothing being her biggest client, the financial statement produced by the bank would be crucial to her decision in providing orders to them.

Lord Reid held that the reasonable man could have refused to give a statement, given a statement without responsibility, or given a statement without qualification, and in doing the latter, he accepted responsibility to exercise due care[9]. Therefore, it could be argued that by supplying a statement, without a disclaimer, DEF Bank accepted responsibility to take care in the making of the statement. The second approach to take would be that of Lord Morris, who suggested that if someone had a ‘special skill’[10], and undertook to use that skill, in order to help someone who relied on that skill, a duty of care arises[11].

It is also important to note that he stated that damage caused by reliance on an act is no different to damage caused by reliance on words. However, he also held that if a bank only gave a brief reference on creditworthiness, there might only be a duty to be honest[12] – which he found unnecessary to decide in Hedley Byrne, as the bank gave an express disclaimer. In which case, it is difficult to determine whether the courts would find that DEF Bank, on this basis, owed a duty of care, or merely a duty to be honest.