Jul 13, 2020
Economic loss and allegedly flawed financial product
The Lawyer's Daily
Ordinarily, if a person or corporation suffers pure economic harm, the remedy is a claim for breach of contract. This places the wronged party in the same financial position as if the contract had been performed. But if there is no contract between the parties and a plaintiff suffers only economic harm, without injury to their person or property, what is the remedy?
For years, Canadian courts have sought to limit when a party may rely on tort law to claim pure economic loss. Adopting a "rights-based" approach to tort, the courts have embraced the principle that tort law compensates rights like damage to personal security or property, not harm to pure economic interests.
A recent decision of the Ontario Court of Appeal, Wright v. Horizons ETFS Management (Canada) Inc. 2020 ONCA 337, however, may have expanded the scope of recovery for economic loss under negligence law. Wright introduces a potentially novel claim for financial harm arising from the "negligent performance of a service."
Economic loss and allegedly flawed financial product
Wright involved a proposed class action resulting from the failure of the defendant's proprietary derivatives-based, exchange-traded fund (the Fund). The defendant Fund manager warned in the prospectus that the Fund was "highly speculative" and "involv[ed] a high degree of risk."
The proposed class were unit owners of the Fund who suffered dramatic financial losses when the Fund lost almost 90 per cent of its value on Feb. 5, 2018. The Fund never recovered and was ultimately closed by the defendant. The representative plaintiff, Wright, sought to certify an action in negligence and for prospectus misrepresentation under the Securities Act, R.S.O. 1990, c.S.5. The action alleged that the Fund manager was negligent in designing, developing, offering and promoting a financial product that was not adequately tested before launching. According to the plaintiffs, the Fund was doomed to fail.
On the motion to certify the class action, the motion judge refused certification on the basis that the plaintiffs' claim disclosed no cause of action under the Securities Act and in negligence.
The Court of Appeal reversed, in part. It held, amongst other things, that it was not plain and obvious that the claim for pure economic loss based on the defendant's negligent performance of a service did not give rise to a reasonable cause of action.
Why recovery for economic loss is limited in tort
The Court of Appeal's analysis began with a summary of the Supreme Court of Canada's decision, Deloitte & Touche v. Livent Inc. 2017 sec 63. In Livent, the court established five types of cases for recovery in negligence for economic loss that is not "causally connected" to physical or property damage:
- The independent liability of statutory public authorities;
- Negligent misrepresentation;
- Negligent performance of a service;
- Negligent supply of shoddy goods or structures; and
- Relational economic loss.
While the list from Livent is not exhaustive, it is limited. Canadian courts restrict tort recovery for pure economic loss where is no physical harm or damage to property for a number of policy reasons. These include the fact that a rights-based approach to tort law recognizes a person's right to personal security and property rights, but not a "primary right related to purely economic interest" (see A. Linden, Canadian Tort Law, 11th ed. (Toronto: LexisNexis, 2018) at 408).
Other policy considerations identified in Wright include: " ... the possibility of indeterminate liability, the difference between social loss (such as physical harm) and the transfer of wealth from one person or group to another, the relevance of existing and potential contractual allocation of loss, and the fact that negligently-caused purely financial injury does not constitute a violation of a recognized legal right."
With these policy rationales in mind, the court in Wright assessed the merits of the plaintiffs' claim that the defendant manager's design and promotion of the Fund amounted to the "negligent supply of shoddy goods" and the "negligent performance of a service."
Novel claim for negligent performance of a service?
The court upheld the motion judge's dismissal of Wright's claim for pure economic loss resulting from the defendant's negligent supply of shoddy goods. The court noted that absent a "dangerous physical defect," a claim for economic loss from the supply of shoddy goods was bound to fail.
However, the court was prepared the recognize that the plaintiffs had a reasonable prospect of showing that the defendant's conduct met the threshold of the second category of economic loss, the "negligent performance of a service."
There was sufficient proximity between the defendant and the plaintiffs. The defendant "undertook to create and sell a Fund that was suitable for some investors and, on the pleading as drafted, it was not." According to the claim, investors were not given sufficient information about the nature and extent of the risks. The risk of injury from "producing a product doomed to fail was reasonably foreseeable."
Even if, however, Wright's claim did not fall within a recognized category for economic loss, the court nevertheless allowed it to proceed as a "novel claim for economic loss resulting from the negligent performance of a service."
The court noted that there was a proximate relationship resulting from the defendant's undertaking that invited the plaintiff's reasonable reliance in this case. In the court's view, the defendant may have had a duty to the plaintiff investors based on its duty act in good faith: " ... as the Fund manager, [the defendant] undertook to its investors to act honestly, in good faith and in the best interests of the investment fund .... "
The failure to provide full disclosure of the risks and/or the fact that the product was doomed to fail and the Fund manager's failure to develop a viable strategy for the Fund might constitute a breach of a prima facie duty of care and/or breach of the fund's managers' statutory duties.
According to the court, there was no good reason at the pleadings stage not to allow Wright's novel claim to proceed: "The risk of loss cannot be addressed by contract because this was not a vendor-purchaser relationship. Nor, on the claim as pleaded, can it be addressed by insurance, or due diligence by Class members ... it does not seem apparent that imposing a duty [of care in this case] would create liability toward an indeterminate number of persons."
The effect of Wright
On a rights-based theory of tort, Wright arguably lies on the "expansive" end of the spectrum. It recognizes the possibility of pure economic claims for the "negligent performance" of the design and promotion of an allegedly defective financial product. There was no personal or physical damage to the plaintiffs, but the court was clearly guided by: (i) the allegation that the defendant allegedly failed to meet its undertaking to the plaintiffs; and (ii) the risk of economic injury to the plaintiffs as a result of the defendant's purported conduct was foreseeable.
On the facts, these were wrongs that could not be addressed by contract.
This article was originally published by The Lawyer’s Daily, part of LexisNexis Canada Inc.