Torkin Manes LegalWatch
Jun 10, 2020

When do Courts Allow Recovery for Pure Economic Harm?

By Marco P. Falco

Where a person or corporation suffers a pure financial loss, contract law ordinarily comes to the rescue. It places the wronged party in the same position as if the agreement had been performed, and awards damages for that breach.  

But what happens when there is no contract and a plaintiff only suffers economic harm, without any other injury to their person or property?

For years, Canadian Courts have made a concerted effort to limit when a party can rely on tort law to claim pure economic loss. Adopting a “rights-based” approach, the Courts have embraced the principle that tort law compensates actual rights like damage to personal security or property, not harm to their pure economic interests.

A recent decision of the Ontario Court of Appeal, Wright v. Horizons ETFS Management (Canada) Inc., 2020 ONCA 337, however, has arguably expanded the scope of recovery for economic loss under negligence law. Wright opens the door to novel claims for financial harm caused by the “negligent performance of a service”.

Allegedly Defective Financial Products

Wright involved a proposed class action resulting from the failure of the defendant’s proprietary derivatives-based, exchange-traded fund (the “Fund”). 

In the Fund’s prospectus, the defendant Fund manager warned that the Fund was “highly speculative” and “involv[ed] a high degree of risk”.

The proposed class of plaintiffs were owners of units of the Fund who suffered dramatic financial losses when the Fund lost almost 90% of its value on February 5, 2018.   

The Fund never regained its value. 

It was closed by the defendant on the basis that it “no longer offer[ed] an acceptable risk/reward trade-off for investors”.

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. In other words, 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. 

With respect to the negligence claim, the judge held that the case did not fall within one of the recognized categories for recovery of pure financial harm.

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 reference to the Supreme Court of Canada’s leading decision, Deloitte & Touche v. Livent Inc., 2017 SCC 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:

  1. The independent liability of statutory public authorities;
  2. Negligent misrepresentation;
  3. Negligent performance of a service;
  4. Negligent supply of shoddy goods or structures; and
  5. Relational economic loss.

While the list from Livent is not exhaustive, it is necessarily 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 right-based theorists of tort law recognize 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. When looking at a claim for pure economic loss, it is therefore important to consider whether the plaintiff had an opportunity to protect itself by contract from the risk of economic loss and declined to do so…

With these factors in mind, the Court in Wright considered 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”.

A Novel Claim for the Negligent Performance of a Service

First, the Court of Appeal 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 a “relationship of 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 tortious 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 could have 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…

Assuming the allegations in the pleading are proven, [the defendant] created a Fund that was not suitable for any investors because the design flaw rendered it doomed to fail…

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…

From a policy perspective, 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. Allowing the claim might cause fund managers…to exercise caution and control in designing investment products and ensure that all material facts are provided to investors…

The Implications of Wright

The extent to which Wright has expanded claims for pure economic loss absent physical or proprietary harm is, as of now, uncertain.

On a rights-based theory of tort, Wright is expansive. 

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 were and could not be addressed by contract. 

Whether a negligence claim is the appropriate way to redress them remains to be seen.