The Contract Controls: TN Supreme Court Rules That Economic Loss Doctrine Bars Fraudulent Inducement Claim

 In Blog, Litigation and Dispute Resolution

The economic losses that arise from a breach of contract can be varied and extensive, including disruptions to a business’s operations, lost profits, and other damages. But regardless of the extent of such losses, a party to a contract in Tennessee is generally bound by any limitations to the remedies and damages described within the four corners of the contract.

That is the essence of Tennessee’s “economic loss” doctrine, distinguishing between claims for breach of contract and tort claims, such as fraud. A recent ruling by the Tennessee Supreme Court clarified that distinction. It held that sophisticated parties to a contract for the sale of goods are limited to the remedies contained in their agreement even in a case of fraudulent inducement when “the only misrepresentation[s] by the dishonest party concern[s] the quality or character of the goods sold.”

“A Careful Balance Between Freedom of Contract and Abhorrence of Fraud”

The Court’s unanimous decision in Milan Supply Chain Solutions, Inc. f/k/a Milan Express, Inc. v. Navistar, Inc., et al. was an attempt, in its own words, to strike “a careful balance of two concepts crucial to Tennessee law—freedom of contract and abhorrence of fraud.”

Freedom of contract includes the right and ability of parties to define the terms of their relationship, including their respective rights and obligations if things go wrong. If a party suffers economic losses due to a breach of that contract, and the agreement bars a party from recovering such damages, they are not recoverable.

But what happens when a party was fraudulently induced into entering the contract in the first place? Does the economic loss doctrine apply in such a case? That was the question before the Milan court.

Sophisticated Parties, Specific Remedies

The case involved Milan’s $30 million purchase of trucks manufactured by Navistar. The purchase contract contained a standard limited warranty according to which Navistar agreed to “repair or replace covered truck components that proved defective in material and/or workmanship in normal use and service.” The warranty also explicitly excluded coverage for “[l]oss of time or use of the vehicle, loss of profits, inconvenience, or other consequential or incidental damages or expenses.”

After the purchase, Milan had significant problems with some of the vehicles. According to the warranty, Navistar made the necessary repairs and returned the trucks to Milan. But the problems continued, and Milan concluded that the defendants had made several misrepresentations about the trucks’ quality, reliability, and other characteristics before the signing of the agreement.

But for sophisticated businesses with a chance to negotiate contractual damages, Milan serves as a reminder that they need to pay particularly close attention to the warranty, limitations of damages, indemnification, and other provisions of their contract that define the scope of available remedies.

Accordingly, Milan sued Navistar and the company that sold the trucks, making several claims, including fraudulent inducement. A jury found in Milan’s favor on its fraud claim and its claim under the Tennessee Consumer Protection Act (TPCA) and awarded Milan over $30 million in damages, including punitive damages and Milan’s lost profits when trucks could not operate.

The Court of Appeals reversed the judgment, holding that because Milan’s fraud claim was based solely on economic loss and only concerned the quality of the trucks, the economic loss doctrine under Tennessee law barred such a claim.

The Tennessee Supreme Court agreed. After a lengthy discussion of the economic loss doctrine generally, the Court considered whether the “fraud exception” to the rule applied in this case. It concluded that whatever the extent of the fraud exception may be, it did not apply to the specific facts of this case:

“When the alleged fraud concerns pre-contractual misrepresentations and nondisclosures about the quality, reliability, and character of the goods that are the subject of a contract between sophisticated business entities, Tennessee’s interest in freedom of contract prevails, and the economic loss doctrine applies.”

Not Definitive on the Scope of the “Fraud Exception” in Tennessee

Notably, the Court emphasized that while it found the economic loss doctrine barred Milan’s fraudulent inducement claims, it did not say, for all time, that there could never be a “fraud exception” to the doctrine on different facts:

“…we expressly stop short ‘of resolving the broad question of whether there may ever be a fraudulent inducement exception to the economic loss rule’ in Tennessee and defer ‘that question to a future case in which the facts may warrant it.'”

For example, a fraud claim might survive if the plaintiff was less sophisticated or had a limited opportunity to negotiate contractual remedies.  These are open issues after Milan.  But for sophisticated businesses with a chance to negotiate contractual damages, Milan serves as a reminder that they need to pay particularly close attention to the warranty, limitations of damages, indemnification, and other provisions of their contract that define the scope of available remedies.  You never know when problems may arise, and you may be stuck with those remedies.

Milan Also Made News For The Court’s Ruling on The Tennessee Consumer Protection Act

Not only did the Court address the economic loss doctrine in Milan, but it also rejected Milan’s claims under the Tennessee Consumer Protection Act (TCPA). The Court held that businesses were not covered “consumers” under the TCPA, nor were the trucks at issue “goods” as defined in the act. Our next post will discuss the significant implications of this aspect of the decision.

[jiawangkun]/Adobe

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