Liability for Pure Financial Loss: Revisiting the Economic Foundations of a Legal Doctrine

Abstract

The economic loss rule states that a plaintiff cannot recover damages for a pure financial loss. The comparative study of the pure economic loss rule reveals that in different jurisdictions, the legal definitions of the rule frequently lump together diverse situations. The actual significance of the notion of economic loss varies considerably across Western legal systems. Legal doctrines provide little insight as to why liability should, or should not, be denied. On the other hand, economic models of liability provide some valuable guidance for classifying different categories of economic loss, and identifying cases in which denial of recovery for economic loss would lead to inefficient outcomes. A law and economics analysis shows that a key factor in determining the optimal scope of the economic loss rule is in the relationship between pure economic loss and social loss. Economic loss should be compensable in torts only to the extent that it corresponds to socially relevant loss. After identifying several factual categories, this paper characterizes the optimal level of liability with reference to the relevant economic and social loss components and the resulting optimal incentives to reduce risk. In a few situations, the application of the optimal liability rule finds obstacles in entrenched principles of civil liability. Generally, however, the legal applications of the economic loss rule are consistent with the ideal liability rule identified by the economic model.