Offices of Clinton D. Hubbard
Lesson: Do not submit false certificates of
specification compliance to your buyer (even if you think your product is just
as good) or you may get hit with punitive damages. In fact, do not even suggest
that you are giving the buyer the exactly specified product if you are not in
fact doing so.
In a stunning ruling on December
23, 2004, the California Supreme Court gave businesses a new incentive to be
honest by holding that they could incur punitive damages for fraudulently
breaching contracts. Normally there are
only economic damages recoverable for breach.
The 6-1 decision affirms in principle a
Plaintiff Robinson Helicopter Co. manufactured helicopters that used
sprag clutches manufactured by defendant Dana Corp.
Part way through the contract the clutch supplier changed certain
aspects of the assembly but did not disclose this change to Robinson Helicopter,
and in fact continued to provide a routine certificate saying that each delivery
exactly conformed to the original contract (and federal) specification. This change later produced a much higher
defect rate and after a delay Dana finally came clean, told Robinson what it
had done, and identified the non-conforming units. However, there was no evidence that Dana
tried to or did save money by this change or that it knew the change would
adversely affect quality. It cost
Robinson $1.5 million to replace the already-installed non-conforming parts.
and fraud claims were based on defendant's provision of false certificates of
conformance. The jury found that defendant had made false misrepresentations of
fact and had knowingly misrepresented or concealed material facts with the
intent to defraud. The Supreme Court held that the traditional “economic loss
rule” did not bar plaintiff's fraud and intentional misrepresentation claims
because they were independent of
defendant's breach of contract. The court stated that but for defendant's affirmative misrepresentations by supplying the
false certificates of conformance, plaintiff would not have accepted delivery
and used the nonconforming clutches over the course of several years, nor would
it have incurred the cost of investigating the cause of the faulty clutches.
Accordingly, defendant's tortious conduct was separate from the breach itself,
which involved defendant's provision of the nonconforming clutches.
The single dissenting Justice complained
that this decision greatly enhances the ease with which every breach of
contract claim can include a tort/punitive damages claim as well. There is a general rule that that punitive
damages in a primarily contract case between businesses weren't permissible
under the state's “economic loss rule”, which prohibits tort damages in
contractual disputes unless some person or property is physically injured/damaged.
Here, none of the helicopters with
faulty parts crashed.
However, the 6-1 majority held
that the economic loss rule doesn't bar fraud claims if they are independent of
the underlying breach. "Allowing
Robinson's claim for Dana's affirmative misrepresentation discourages such
practices in the future while encouraging a business climate free of fraud and
deceptive practices," Justice Brown wrote.
The Court attempts to limit the
scope of this ruling: “Nor do we believe
that our decision will open the floodgates to future litigation. Our holding
today is narrow in scope and limited to a defendant's affirmative misrepresentations
on which a plaintiff relies and which expose a plaintiff to liability for
personal damages independent of the plaintiff's economic loss.”
As a practical matter most
litigators will probably choose to add a fraud/tort cause of action (with
punitive damages) to the basic ‘breach of contract’ case, where the supplier
may have misrepresented the quality of the product or service actually
delivered, or made some other false representation at the outset of the
contract, which could potentially have caused property damage or personal
injury to a re-sale customer or the end user.
punitive damages are available in a contract case –
To review the main instances under
California law where tort damages are permitted in contract cases: 1- where a breach of duty directly causes physical injury; 2- for breach of the covenant of good faith and
fair dealing in insurance contracts ;
3- for wrongful employment discharge
in violation of fundamental public policy; 4- or where the contract was fraudulently induced. In each of these cases, the duty that gives
rise to tort liability is either completely independent of the contract or
arises from conduct which is both intentional and intended to harm.
Helicopter Co. expands these opportunities for punitive damages: Generally, when one party commits a fraud
during the contract formation or performance, the injured party may recover in
contract and tort. Specifically, a
tortious breach of contract may be found when either (a) the breach is accompanied
by a traditional common law tort, such as fraud or conversion; or (b) the means used to breach the contract
are tortious, involving deceit or undue coercion; or (c) one party intentionally breaches the contract intending or
knowing that such a breach will cause severe, unmitigable harm in the form of
mental anguish, personal hardship, or substantial consequential damages.
summary, if you deceive the buyer into thinking you are giving it exactly what
the specification requires you may be liable for fraud damages. It is not yet clear whether you avoid exposure to fraud liability if the breach has no potential
to make the buyer liable for personal/property damages to its customer or
other users. In either case you would still be liable for ordinary breach of contract economic damages.