The Bernard Madoff scandal is probably the most visible example of the fact that from spectacular financial frauds to ordinary business transactions, bad things can happen, particularly in times of economic distress. An investment is lost, a transaction collapses, or a deal disappoints. The law of economic negligence is an excellent, if under-used, device by which plaintiff attorneys can obtain recovery.

When a client’s loss is due to fraud, the principal wrongdoer may be unavailable as a target because he or she is gone or insolvent. When there is no fraud and no principal wrongdoer, but only an act of carelessness that caused the loss, the carelessness may not be that of a direct participant in the transaction. In both cases, third-party economic negligence provides a means of shifting the loss to someone else.

Two parties have a contract that affects a third person. The breach or negligent performance of the contract by one party—often a professional such as an accountant or a lawyer—injures the economic interests of the third person, who then is able to sue in tort or as a third-party beneficiary of the contract. Using this approach, those who suffer economic harm can successfully sue an accountant who performed an audit, an attorney who issued an opinion, and others involved in financial failures.

There are two related keys to successfully pursuing an economic negligence case. First, frame the case broadly, looking beyond the parties’ contracts to the relations in the situation that should give rise to liability. Second, by framing the case broadly, look to the range of doctrines that are available to address economic loss issues and how they can be applied expansively.

Defendants will often try to narrow the scope of the case by focusing on the contracts the parties entered into that created the transaction and arguing that liability should be imposed only when the narrow standards of third-party beneficiary law are met. From this perspective, the parties allocate the costs, benefits, and risks of their interaction through this contracting process, sometimes explicitly and sometimes implicitly. The law’s role in this process is to support the parties’ private ordering by using contract law, including third-party beneficiary law. Tort law is better suited to the redress of accidental physical harm than to the regulation of consensual economic relationships. When the courts impose liability beyond the contract, it upsets the parties’ own allocation of rights and duties and it raises the threat of vast liability to an indeterminate number of plaintiffs for an indeterminate amount of harm.

In most cases plaintiff attorneys need to take a broader approach that builds on extracontractual elements of the parties’ relationships and stresses the responsibility that arises from causing harm to another. From this expanded perspective, the law’s role is not limited to enforcement of the express terms of the parties’ contracts but also serves values in addition to effectuating the parties’ explicit planning, particularly the values expressed in tort policies. Accordingly, tort liability is an appropriate supplement to liability on the contract, and the available tort doctrines—negligence and negligent misrepresentation—should be applied broadly to redress harm. At the same time, by focusing on the likelihood of harm to the plaintiff, the plaintiff attorney can demonstrate that the fear of indeterminate liability is exaggerated.

Because every economic negligence case arises out of a fact situation in which two parties have a contract, the breach of which injures a third-party, a third-party beneficiary action is possible. Most courts look to Restatement (Second) of Contracts § 302 or an analogous doctrine. To establish liability, these doctrines generally require that “recognition of a right to performance in the beneficiary is appropriate to effectuate the intention of the parties.”

In many jurisdictions, however, courts apply this doctrine restrictively, requiring, for example, that the contract expressly manifest the intention to benefit the third party.¹ Therefore, third-party beneficiary actions are only available in a limited class of economic negligence cases. When they are available, however, they provide a firm basis of liability.

Defendants may argue that the economic loss rule precludes recovery under any doctrine other than third-party beneficiary. The most general statement of the economic loss rule is that someone who suffers only pecuniary loss through the failure of another person to exercise reasonable care has no tort cause of action against that person. But courts routinely impose liability for economic negligence by focusing on the injustice of allowing wrongfully imposed economic harm to go unredressed.

Typically, the wrong in an economic negligence case takes the form of a negligent performance. Every case, therefore, can be addressed as a negligence case. Negligence provides one of the most expansive bases of liability in these cases. Most jurisdictions use foreseeability as the test for negligence, imposing liability where both the victim of the harm and the way in which harm is suffered are reasonably foreseeable to the defendant.² 

In third-party cases, the defendant’s performance typically has a communicative element, so the case can be treated as a misrepresentation case as well. Most jurisdictions have adopted Restatement (Second) of Torts § 552 as the standard for misrepresentation. Section 552 has a double foreseeability requirement: The victim must be a member of a foreseeable group and the transaction in which the victim relies on the misrepresentation must be foreseeable. Misrepresentation is a common middle ground between the limits of third-party beneficiary actions and the expansive possibilities of negligence.

Here are a few examples of the way in which a relational approach to economic negligence can be used to establish liability.

Attorneys
Although an attorney’s primary duty is to his or her client, in nearly every jurisdiction an attorney also owes a duty to nonclients in some settings. Nonclients reasonably rely on attorneys in some settings and that reliance needs to be protected. The reliance may be on a statement, whether a formal legal opinion or a less formal representation; misrepresentation is the best cause of action in those cases. The reliance may also be on a promise to act, in which case negligence is the appropriate cause of action.

The Restatement (Third) of the Law Governing Lawyers § 51 codifies this approach, imposing liability when the attorney or client invites reliance on the attorney’s opinion or actions, when one of the “primary objectives” of the representation is to benefit the nonclient and a duty is necessary to enforce the attorney’s obligations, and when the attorney’s client is a fiduciary who is breaching his duties to the third party by extending liability in several situations. It is important to recognize that the Restatement imposes limits on liability of remoteness and causation that are narrower than those often used by the courts.

So, for example, when an attorney issues an opinion letter or otherwise makes representations in the course of a business transaction where he or she knows or should know that someone is likely to rely on the representation, the attorney owes a duty of reasonable care enforceable by the injured relying party.³ An attorney for one party to a business transaction can be liable to the other party for negligently misrepresenting some aspect of the transaction.⁴ And an attorney who volunteers to take some action that affects the interest of a nonclient—perfecting a security interest, for example⁵ —may be liable to the nonclient whose interests are injured by the failure.

Accountants
There is a strong majority rule on the liability of an accountant for negligently preparing an audit. Courts generally read § 552 or related doctrines to impose on an accountant a duty to people for whom the accountant intends to supply the audit or knows know will rely on the audit.⁶

They vary, however, on what it means to “intend” or “know.” Some courts interpret the section broadly, often using an approach that renders the accountant liable to foreseeable third parties.⁷ Others read it more narrowly, particularly jurisdictions that have adopted “tort reform” statutes that use a near privity rule; these require specific conduct linking the accountant to the relying third party.⁸ 

Accountants also may be liable for harm caused in nonaudit engagements, such as the preparation of nonaudit or review reports⁹ and consulting and tax planning that affects third parties.¹⁰

Evaluative Business Services
Cases involving attorney opinions and accountant audits are instances of a larger class of cases known as evaluative business services. One party engages the defendant to provide a professional or expert evaluation of condition, quality, or value; although the plaintiff did not contract with the defendant for the evaluation, the plaintiff relies on it and suffers a loss because the evaluation turns out to be incorrect. For example, a surveyor negligently surveys a piece of real property,¹¹ an appraiser negligently conducts an appraisal,¹² or an engineer or other expert inadequately inspects a building or property.¹³

Courts commonly hold that the defendant expert owes a duty to the plaintiff third party in most instances of the paradigm evaluative business service case. The defendant is brought into the underlying transaction specifically because of its role as an expert, in order to provide a specialized evaluation of the condition, quality, or value of some aspect of the transaction upon which the identified third party will rely. All of the participants understand that the expert’s task is to provide an objective evaluation according to professional standards, for the purpose of providing information that will be relied on by its client and by the third party. The parties’ planning of the transaction assigns this clear role to the expert, and an important element of the transaction is the third party’s ability to trust the expert’s evaluation. From the expert’s point of view, providing the evaluation for use by its client, the third party, or both, is what it is being paid for. The expert can anticipate the risk of loss to the third party in case of error, and it is the risk of that loss that it is being paid to prevent.

This result can be easily justified in doctrinal terms. From the third-party beneficiary perspective, the intent of the contract between the defendant providing the evaluation and the second party is to benefit the plaintiff by providing the assurance of a positive evaluation in the ultimate transaction. From the misrepresentation perspective, the defendant’s report is known or intended to induce reliance by a specifically identified third party or a member of an identifiable group, in a particular type of transaction, and the third party is injured when the report contains a negligent misstatement. From the negligence perspective, the harm to the third party is a foreseeable consequence of the defendant’s negligence.

In some cases the expert may have some information that suggests that its report will be relied on by a third party, but it will not know specifically the person who will rely or the transaction in which the reliance will occur. In a practical sense, a defendant such as an abstracter provides a service for the transaction, not only for the party who hires it. The defendant is compensated for this service, and it matters little whether the compensation comes directly from the user of the service or indirectly as one of the transaction costs that must be allocated among the parties. Courts often hold even in these cases that the party providing the evaluative business service is liable.

Insurance
It is well-settled law that an insurance agent or broker who undertakes to procure insurance for a client but negligently fails to do so is liable to the client for the damages that result. In a number of cases, this principle has been extended to impose liability in favor of a third party who does not recover from the insured because the agent has failed to procure insurance. When an accident victim cannot recover under an automobile liability policy or an employee cannot recover under a workers’ compensation policy because the tortfeasor or employer’s agent has failed to obtain coverage properly, several jurisdictions allow an action either as a third-party beneficiary or in negligence against the insurance agent.¹⁴ A smaller number of jurisdictions refuse to allow the third-party action.¹⁵

Drug Testing Laboratories
The proliferation of employer drug testing policies has sparked a series of legal claims regarding the accuracy of the test results. Job applicants and employees have challenged the procedures used by laboratories, the information given to employers, the accuracy of the results, and employers’ reliance upon the results. The courts that have considered these cases are split on whether to impose liability against drug testing laboratories.

Some have recognized a duty of reasonable care by applying a standard foreseeability analysis.¹⁶ A laboratory should know that negligent testing will compromise an employee’s job prospects, so it is liable for performing or reporting the test negligently. Others have held that the laboratory has no duty of reasonable care in conducting the test or reporting the results because the magnitude of the burden on the laboratory outweighs the harm to the employee.¹⁷

Other Cases
Although most economic negligence cases fall into familiar categories described above, the law is not limited to those categories. Attorneys should explore the application of economic negligence principles in any case in which someone is injured by the defendant’s breach or negligent performance of a contract with someone else. Courts have found causes of action available against a business that was required to keep adequate records on the servicing of an airplane when the failure to do so caused economic harm to a subsequent purchaser of the airplane,¹⁸ a consultant whose negligently prepared report had an adverse effect on the business of a competitor of the party for whom the report was prepared,¹⁹ and a printer whose negligence in producing fictitious certificates of deposit facilitated the fraud of an investment broker.²⁰

  ¹ E.g., Wheeling Trust & Sav. Bank v. Tremco Inc., 505 N.E.2d 1045, 1048 (Ill. App. Ct. 1987).
  ² E.g. Donnelly Constr. Co. v. Oberg/Hunt/Gilleland, 677 P.2d 1292 (Ariz. 1984).
  ³ Geaslen v. Berkson, Gorov & Levin, Ltd., 581 N.E.2d 138 (Ill. App. Ct. 1991), aff’d in part, rev’d in part, 613 N.E.2d 702 (Ill. 1993).
  ⁴ Petrillo v. Bachenberg, 655 A.2d 1354 (N.J. 1995).
  ⁵ Kremser v. Quarles & Brady, L.L.P., 36 P.3d 761 (Ariz. Ct. App. 2002).
  ⁶ E.g., Vigil v. State Auditor’s Office, 116 P.3d 854 (N.M. Ct. App. 2005).
  ⁷ E.g., Blue Bell, Inc. v. Peat, Marwick, Mitchell & Co., 715 S.W.2d 408 (Tex. Ct. App. 1986).
  ⁸ E.g., KAN. STAT. ANN. § 1-402.
  ⁹ Ryan v. Kanne, 170 N.W.2d 395 (Iowa 1969).
  ¹⁰ Jewish Hospital of St. Louis, Missouri v. Boatmen’s Nat’l Bank of Belleville, 642 N.E.2d 1282 (Ill. App. Ct. 1994).
  ¹¹ Rozny v. Marnul, 250 N.E.2d 656 (Ill. 1969).
  ¹² Private Mortg. Inv. Servs., Inc. v. Hotel and Club Assoc., 296 F.3d 308 (4th Cir. 2002).
  ¹³ Burbach v. Radon Analytical Lab., Inc. 625 N.W.2d 135 (Iowa 2002).
  ¹⁴ E.g., Gothberg v. Nemerovski, 208 N.E.2d 12 (Ill. App. Ct. 1965).
  ¹⁵ E.g., Freeman v. Schmidt Real Estate & Ins., Inc., 755 F.2d 135 (8th Cir. 1985).
  ¹⁶ E.g., Sharpe v. St. Luke’s Hospital, 821 A.2d 1215 (Pa. 2003).
  ¹⁷ E.g., Tricoski v. Lab. Corp. of Am., 216 F. Supp. 2d 444 (E.D. Pa. 2002).
  ¹⁸ Indemnity Ins. Co. of North Am. v. Am. Aviation, Inc., 891 So. 2d 532 (Fla. 2004).
  ¹⁹ South Carolina State Ports Authority v. Booz-Allen & Hamilton, Inc., 346 S.E.2d 324 (S.C. 1986).
  ²⁰ Bohan v. Hogan, 567 N.W.2d 234 (Iowa 1997).

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