Vol. 78, No. 11, November
More litigation to come:
Exceptions to the economic loss doctrine
In three cases decided in July 2005, the Wisconsin Supreme Court
revisited the economic loss doctrine, carving out exceptions to its
application on three discrete issues. The authors say that, even with
these three new cases, there remains no more clarity for consumers and
their lawyers than before, which leaves the door open to still more
by R. Thomas Cane & Sheila Sullivan
n an earlier article in this journal, we
suggested that the resolution of three then-pending cases -
Kaloti, Grams, and Cascade Stone - would
reveal whether the Wisconsin Supreme Court was ready to articulate "an
economic loss doctrine rule with a well-defined and logical
reach."1 This doctrine, barring commercial
purchasers of goods from bringing tort claims against the manufacturers
of those goods for solely economic losses, was originally intended to
limit the products liability torts of negligence and strict
liability.2 Over the last decade, however,
the doctrine's application has been radically expanded, narrowing and in
some cases effectively eliminating a variety of common-law tort causes
of action.3 Given the uncertainty this
expansion has created, we speculated that the court's recent concern
with the economic loss doctrine might signal a desire to rethink the
doctrine's purposes and its defining paradigms.
Kaloti, Grams, and Cascade Stone, decided
on July 8, 2005, do offer some guidance to those interested in the
doctrine's development in Wisconsin.4 Read
together, the opinions in this trio of cases also reveal continuing
divisions within our highest court about the policies in which the
doctrine is rooted and how its reach should be circumscribed. Those
divisions make it unlikely that Kaloti, Grams, and
Cascade Stone represent a final word on the economic loss
doctrine. The cases remain important, however, because they identify
questions of law whose resolution will affect not only business and
contract law practitioners, but also the ordinary citizens whose ability
to protect themselves against negligence increasingly depends on how
courts deploy the judge-made economic loss doctrine. The most important
of these questions is whether clearly formulated exceptions to the
doctrine will ensure the survival of whole classes of common-law torts
or whether those exceptions will be so eroded that the economic loss
doctrine becomes a blanket rule.
Kaloti and the Fraud in the Inducement
Kaloti5 apparently settles the
question of whether Wisconsin will join other states in recognizing a
fraud in the inducement exception to the economic loss doctrine. This
exception holds that the doctrine does not bar tort claims when the
fraud in question is "extraneous to the contract."6 In certain restricted factual situations, a party
alleging it was fraudulently induced to enter a contract can seek tort
remedies for intentional misrepresentation from another party to the
contract. The economic loss doctrine cannot be used as a defense unless
the fraud is "interwoven with" the contract. Kaloti thus adopts
what has become known as a Huron Tool-style exception7 to the rule that commercial purchasers of goods
cannot use tort theories to recover solely economic losses from the
manufacturers of those goods.
Whether to apply a fraud exception to the doctrine has been contested
for almost a decade. In the 1990s, various federal courts predicted that
Wisconsin would not allow an intentional misrepresentation claim when a
plaintiff sought to recover only economic damages; that Wisconsin would
adopt a broad, general fraud in the inducement exception; and that
Wisconsin would choose a narrow Huron Tool exception.8 In 1999, in Douglas-Hanson Co. v. BF Goodrich
Co.,9 the Wisconsin Court of Appeals
concluded that public policy and common-law tradition favored a general
fraud in the inducement exception to the economic loss doctrine.10 On review, the Wisconsin Supreme Court formally
affirmed Douglas-Hanson in a 3-3 decision.11
The supreme court returned to the problem of fraud in the inducement
again, however, in 2003 and 2004. Of the five justices who participated
in Digicorp Inc. v. Ameritech Corp.,12 two agreed on a Huron Tool exception,
two argued for a general Douglas-Hanson exception, and the
fifth, Justice Sykes, insisted there should be no exception to the
economic loss doctrine for fraud. The next year, the majority in
Tietsworth v. Harley-Davidson Inc.13 concluded that Digicorp overruled
Douglas-Hanson with respect to recognizing a general exception
to the economic loss doctrine for all fraud in the inducement, but they
did not determine whether any narrower exception existed.
The Kaloti Facts. Against this backdrop of
uncertainty, Kaloti provided the court with an opportunity to
determine the precise scope of a critical exception to the economic loss
doctrine. Kaloti, a Wisconsin food wholesaler, had worked for several
years with Geraci & Associates, a Kellogg agent.14 Geraci initiated contact with Kaloti and
negotiated the elements of every transaction.15 After Geraci and Kaloti reached an agreement,
Kellogg shipped its products directly to Kaloti, which resold them to
large market stores.16 Sometime after
Kaloti, Kellogg, and Geraci established this pattern of business,
Kellogg decided to market certain products directly to those
stores.17 Despite knowing that Kellogg
would be shifting to direct sales, Geraci solicited another order from
Kaloti.18 That order was delivered, and
customers began notifying Kaloti they would be buying their products
directly from Kellogg from that time on.19
Geraci told Kaloti it had kept silent about the marketing change because
it was bound by a confidentiality agreement.20 When Kaloti attempted to return the products,
Kellogg refused them, and Kaloti was left without a market for the goods
it had purchased.21 Kaloti sued, alleging
that Geraci's intentional misrepresentation resulted in a $100,000
According to the Kaloti majority, a narrow fraud in the
inducement exception exists when, "as here," a plaintiff can show that
intentional misrepresentation occurred, the misrepresentation took place
before the contract was formed, and the misrepresentation was extraneous
to that contract.23 The first two elements
were easily established. The majority then determined that Kaloti had
alleged the occurrence of misrepresentation extraneous to the contract
because the facts Geraci omitted did not "concern Kellogg and Geraci's
performance of the contract ... and ... [did] not regard the
quality or character of the ... products that Kellogg sold
Kaloti."24 The majority characterized the
alleged misrepresentation as "a matter whose risk was never contemplated
to be a part of the contract."25Such an
application of the economic loss doctrine was appropriate because, "in
these limited circumstances," the purchaser should not be "expected to
assume, allocate or insure against the risk of the seller's intentional
lie or material omission."26
Concurring in the result, Chief Justice Abrahamson strongly
criticized the rule adopted by the court. A Huron Tool-style
exception is, she wrote, "deficient as a matter of principle" and
"inherently defective because it cannot be applied in a principled
way."27 In the chief justice's analysis, a
narrow fraud in the inducement exception is deficient as a matter of
principle because it does not recognize the public interest in
discouraging intentional misrepresentation and instead embraces a vision
of the world in which risk allocation reflects purely private choices
and has only individual consequences.28
Even if one finds that vision compelling, however, there are reasons
to be disturbed by Kaloti.
Kaloti suggests the line between tort law and contract law
can best be maintained by distinguishing between fraud "extraneous to" a
contract and fraud "interwoven" with it.29
At first glance, that distinction appears to be clear, but the test or
standard for determining whether a misrepresentation belongs in one
category or another is not clear - in part because Kaloti
provides several versions of that test. The first version of the
Huron Tool/Kaloti test is that fraud is interwoven
with a contract if the misrepresentation concerns "the quality or
character of the goods sold." 30 This
version is rooted simply in the terms of the contract. But the test is
also formulated this way: "[or] stated another way, the fraud concerns
matters whose risk and responsibility did not relate to the quality or
the characteristics of the goods for which the parties
contracted."31 This formulation applies
both to misrepresentations explicitly dealt with in the contract and to
the unwritten "expectations of the parties to the risk of loss in the
event the goods purchased did not meet the purchaser's
expectations."32 In a third variant of the
test, fraud is interwoven with a contract if the misrepresentation
relates to the performance of the contract.33 Based on the facts in Kaloti, the
majority appears to have combined the first and second articulations of
the test. However, the third version undoubtedly sometimes will be cited
as the holding in Kaloti, begging the question of what
kind of misrepresentation would not somehow relate to contract
The questions raised by Kaloti are brought into sharp focus
by a recent decision of the Seventh Circuit Court of Appeals. On June
13, 2005, the court used a prediction that Wisconsin would elect a
Huron Tool-style fraud in the inducement exception to settle a
dispute between Cerabio LLC, a research and development company, and
Wright Medical Technology Inc., a designer and manufacturer of bone
replacement products.34 Cerabio developed a
bone replacement made from tricalcium phosphate (TCP), the FDA approved
the product, and Cerabio patented the production process and
materials.35 Wright and Cerabio eventually
negotiated a deal in which Wright bought all of Cerabio's assets. Before
entering into the agreement, Cerabio told Wright it had established a
repeatable process for producing the filler and that all the raw
materials necessary were commercially available.36 After Wright made an initial payment, Wright
found it could not repeat the process because the old TCP powder was no
longer available.37 Wright refused to pay a
second installment, notifying Cerabio that Cerabio was in breach. After
Wright began producing a replacement product, which, it claimed, was
different from the one Cerabio sold it, Cerabio sued.38 Wright counter-sued, alleging it was
fraudulently induced to enter the contract because Cerabio knew the TCP
powder was unavailable before the contract was signed.39
The Seventh Circuit concluded that Wright's claims were barred by the
economic loss doctrine. The court focused first on evidence that the
parties had negotiated the risks of repeatability.40 The contract was explicitly contingent on a
successful run of three test lots, an end which could not have been
achieved if "the starting materials were not available."41 The court found that the repeatability
contingency clause thus reflected a consideration of exactly the kind of
problem that actually occurred. The other evidence that the availability
of starting materials was addressed came in a nondisclosure agreement
(or nonreliance clause) in which Cerabio specified it provided all
information on an "as is basis."42 Based on
these terms, the court reasoned that Cerabio's alleged fraud was
interwoven with the contract although the availability of TCP powder was
never explicitly mentioned in the contract.
The Hon. R. Thomas Cane,
Marquette 1964, LL.M.,Virginia 1986, is chief judge for the Wisconsin
|Sheila Sullivan, U.W. 2004 magna
cum laude, Order of the Coif, is a former law clerk for Judge Cane.
Cerabio thus indicates that misrepresentation is not
interwoven with a contract unless there is at least vestigial evidence
in the contract's terms that the parties actually allocated the risks of
fraud. But does Kaloti stand for the same proposition? Would
the Kaloti majority have followed the Seventh Circuit's
analytic model and decided that the doctrine of economic loss barred
Kaloti's claims if the contract had included a nonreliance clause?
Depending on the answer to that question, Kaloti could
transform a broadly drafted nonreliance clause into a
get-out-of-tort-free card. But it might just as easily make unnecessary
the type of analysis engaged in in Cerabio. Under the broad
third formulation of the Kaloti test, for example, Cerabio's
silence about the fact that a third party was no longer producing TCP
would be misrepresentation related to the performance of the contract,
whatever the contract said, and thus the misrepresentation would be
interwoven with the contract.
Comparing Cerabio with Kalotiidentifies another
area of potential concern. Cerabio repeatedly stresses the
parties' sophistication and the thoughtfulness of the negotiations
between them.43 As business entities,
Kaloti, Geraci, and Kellogg also are presumably sophisticated parties.
Yet Kaloti nowhere explicitly limits its holding to that class
of actors. Rather it speaks broadly of parties who are "expected to
negotiate ... and will be held to their agreements" and of
commercial purchasers, buyers, and sellers.44
Where does Kalotileave business and contract law
practitioners? If the parties to a transaction are commercial entities,
it may be best to attempt to allocate the risk of misrepresentation
directly. Drafting nonreliance clauses and agreements with contingency
terms might also help protect parties that are determined to avoid tort
liability for economic losses arising from misinformation. How such
negotiations will affect the relations among commercial parties is
difficult to predict, but judicial limitations on access to tort
remedies will necessarily produce greater attention to fraud in contract
Kaloti's effect on ordinary consumers is more uncertain. The
holdings in Huron Tool and Kalotiare premised on the
assumption that negotiation is not just possible but also that it is a
fundamental responsibility of contracting parties. Two recent supreme
court decisions, Cease Electric and Swimwest,45 suggest a majority of the court recognizes that
ordinary consumers often cannot realistically negotiate contract terms.
Whether that recognition will inform the court's view of fraud in the
inducement claims made in the consumer context, however, remains an open
Cascade Stone and Home Buyers and Construction
Linden v. Cascade Stone is likely to have a more immediately
visible impact than Kaloti because Cascade Stone deals
with such a common type of transaction. The Lindens contracted with
Groveland to build a new home.46 Groveland
hired subcontractors, including Cascade, which applied exterior stucco,
and Fern, which shingled the roof.47
Construction was delayed by water infiltration, and the Lindens
eventually sued Groveland, Cascade, Fern and others, alleging breach of
contract, breach of warranty, and negligence.48 After Groveland settled,49 the circuit court granted summary judgment to
the remaining defendants on the ground that the economic loss doctrine
barred the Lindens' tort claims against Fern and Cascade. The supreme
court agreed to review the case to decide three issues: what controls
the analysis of whether a contract is for goods or services; whether an
objective test should be used to determine a contract's predominant
purpose; and whether "the integrated system" limitation to the "other
property" exception to the economic loss doctrine bars a negligence
claim against a subcontractor who provided services.50
The contract questions were inextricably intertwined with the
economic loss doctrine question in Cascade Stone because of the
court's recent ruling that the doctrine does not apply to service
contracts.51 The contracts between
Groveland and its subcontractors were predominately for services.52 Thus, the Lindens argued as a threshold issue
that those contracts were controlling and that the economic loss
doctrine should not bar them from asserting tort claims against Cascade
and Fern. Cascade and Fern countered that the general contract with
Groveland controlled. Because that contract was for a product, the
finished house, the economic loss doctrine should be available to them
as a defense.
The majority agreed with Fern and Cascade, citing the general
policies furthered by the economic loss doctrine.53 The majority concluded that focusing on the
service contracts would allow the Lindens to make an "end run" around
their contract with Groveland - even though Groveland was no longer a
party to the lawsuit.54 The Lindens had,
the majority reasoned, the best opportunity to bargain for coverage of
the risk of faulty workmanship. The majority also agreed with the court
of appeals that, "at its core, the Lindens' complaint is that the house
they received is not the house for which they contracted."55 Allowing the Lindens to maintain a tort claim
against the subcontractors would thus undermine the terms of the general
agreement they had made.56
Having determined that the general contract controlled,57 the majority addressed the nature of the
contract. The parties agreed the general contract was for both goods and
services. They also agreed that the applicability of the economic loss
doctrine depended on the contract's predominant purpose. But they did
not agree on how to resolve what was the contract's predominant purpose.
The Lindens argued that predominant purpose should be determined by a
quantifiably objective test. The court should, they suggested, calculate
the costs of materials and labor and compare the two totals. The
majority admitted that relying on quantifiably objective factors would
"make courts' applications of the predominant purpose test
predictable."58 But they did not accept
that such a test would make "applications more consistent, or ...
more fair or accurate."59 The majority
concluded that the Bonebrake predominant purpose test, which
considers both quantitative and subjective factors, was preferable
because "considering the totality of the circumstances will give the
most complete picture of the transaction at issue."60
Cascade Stone's analysis of the costs of materials and
services is brief. Its discussion of the contract's language is equally
brief. Though the majority found evidence of mixed purpose in both the
cost information and the contract language, it concluded that the
Lindens contracted with Groveland for a product.61 Dismissing the issue of how much money was spent
on goods versus services, the court focused on how the project's cost
was billed. Like many home buyers, the Lindens signed a fixed price
contract - the cost was dependent on project specifications.62 This structure demonstrated, the majority
observed, that the parties bargained based on the nature of the product,
not on the work put into it.63
As applied in Cascade Stone, the predominant purpose test
looks less like a cumulative test than a general feel test, reflecting a
judicial decision about the essential nature of the underlying
transaction. The less the test depends on construing specific provisions
of a text, of course, the more difficult it is to predict what, if any,
changes in terms could prevent an agreement between a home buyer and a
general contractor from being characterized as a contract for goods. The
majority's conclusion rests primarily on the contract's basic form, a
fixed price linked to product specifications.64 Would the predominant purpose of that contract
be different if the contract had set out a formula for specification
changes demonstrating the relation between those costs and the cost of
labor expended to make the changes? Based on the majority's analysis, it
might. However, it is equally possible that, under Cascade
Stone, a court might still decide the contract was for a
Nothing in the majority opinion limits Cascade Stone's
holding. The language is expansive. General contracts will control
whether an economic loss doctrine defense is available to
subcontractors. The totality of the circumstances will determine the
predominant purpose of those contracts. And, most intriguingly, "the
integrated system limitation of the other property exception to the
economic loss doctrine is applicable where the subcontractor mainly
provided services that have no independent value or use apart from their
function as components of the project into which they were
incorporated."66 Identifying subcontractor
services as part of an integrated system - a component of the completed
product - raises the question of whether Cease applies to
service contracts associated with the construction of a new home.
In 1325 North Van Buren LLC v. T-3 Group Ltd., decided a few
months before Cascade, the court of appeals concluded that
Cease governed a commercial contract for the renovation and
management of a warehouse.67 The core of
the opinion was an analysis of the contract's purpose. Without
mentioning "predominant purpose" or Bonebrake, the court
observed that the contract involved providing "construction and
administrative services," that there was no record that T-3 constructed
anything itself, and that it had no design authority.68 While only $176,000 of the $6 million contract
went to pay T-3 for its services, the court concluded that T-3 was
merely the conduit through which the majority of the money flowed, and
controlling that flow was part of the service it provided.69
How T-3 and Cascade Stone are reconciled may
determine whether the precise wording of commercial agreements with a
general contractor will remain significant in determining the
predominant purpose of those agreements.70
T-3 indicates that a totality of the circumstances analysis
requires assessing particular facts and specific contract language. But
it is also possible to read T-3as reflecting the court's
judgment that, at bottom, renovating an existing structure is different
than constructing a new one. If predominant purpose analyses finally
rest on the generic nature of a transaction, it will probably make no
difference how an agreement describes what is being purchased.
The Cascade Stone majority reiterated its approval of the
rationale, adopted by Bay Breeze,71 that home buyers buy an integrated product when
they contract for a house, in large part because they are uninterested
in how the components of the product are obtained.72 In that context, it makes sense to assert that,
like bad concrete in condominiums or defective windows installed after a
house is completed, stucco siding and roof shingling "have no
independent value or use apart from their function as components of the
Justice Roggansack dismissed the idea that Cascade Stone
diminishes Wisconsin homeowners' right to bring suit for negligent
work.74 Homeowners retain contractual
remedies against general contractors who have their own remedies against
subcontractors.75 She also suggested that
homeowners might be able to bring third-party beneficiary actions
against negligent subcontractors.76 The
dissent admitted that, in theory, homeowners could protect themselves by
obtaining warranties directly from individual subcontractors.77 In practice, however, as Justice Bradley noted,
such protections would be difficult to secure because subcontractors
often are not identified until after general contracts are
Knowledgeable consumers - or their lawyers - will thus now have to
consider whether general contracts can be revised to reflect the service
aspects of the parties' agreement, whether consumers can convince
general contractors to provide assurances that subcontractor-related
losses will be fully compensated for, and whether consumers can obtain
protection by direct agreement with individual subcontractors. None of
those options seem likely to achieve greater protection for the home
buyer, however. Home buyers from small or rural areas will be
particularly handicapped because they ordinarily have only a few general
contractors to choose among and an equally limited choice of experienced
and competent subcontractors. In such virtually captive markets,
contractors and subcontractors have little incentive to agree to
increase their potential liability and thus little reason to bargain
For people interested less in its precise holding than in the
policies served by the economic loss doctrine, Cascade Stone
highlights inconsistencies that make the doctrine's continued expansion
problematic. Negligent subcontractors now may be protected from tort
liability for failures that, under state law, they once might have been
accountable for. The principle that justifies this limitation on
traditional common-law tort causes of action reflects the policy choice
that the buyer is best suited to allocate the risk of economic loss
through negotiation.79 Yet the hook that
brings the losses that plaintiffs like the Lindens suffer into the reach
of the doctrine is the integrated systems limitation to the other
property exception. And that limitation is premised on the assumption
that home buyers are unaware of, and thus logically incapable of
assessing, the risks associated with the complex network of services,
suppliers, and products that are the component parts of the home they
Grams and the "Other Property"
The economic loss doctrine has never precluded tort claims when a
product causes personal injury nor does it bar claims for damage to
property other than the property itself.80
However, as Justice Prosser's majority opinion in Grams
candidly recognizes, the parameters of the other property exception to
the doctrine have "proved elusive."81
Unfortunately, Grams does little to solidify those elusive
The plaintiffs in Grams raised calves for resale.82 During the first weeks of the calves' lives, the
Grams fed their charges a milk replacer, manufactured by Milk Products
Inc. and bought from Cargill.83 Initially,
the Gramses fed the calves a medicated milk replacer.84 The medicated replacer was expensive, however,
and the Gramses approached Cargill about finding a less costly version.
Cargill told them they could buy the same replacer without medication
more cheaply. Soon after the Gramses began using the cheaper product,
they noticed their calves were not gaining weight. The mortality rate of
the calves tripled, rising from an average of 8 percent to a high of 34
percent.85 As a result of these problems,
the Gramses sued Cargill and Milk Products, alleging breach of implied
warranty, strict liability tort, negligence, intentional
misrepresentation, and strict responsibility misrepresentation. The
circuit court granted summary judgment to both defendants on all tort
claims,86 finding they were barred by the
economic loss doctrine.87 The Gramses
appealed, and the supreme court agreed to review the economic loss
The Grams majority first set out the policies that underlie
the economic loss doctrine, stressing its roots in Uniform Commercial
Code (U.C.C.) policy and the distinction between economic losses, for
which risk-sharing is encouraged, and other losses, such as personal
injury losses, for which such sharing is undesirable.88 The majority also noted that the most developed
test for distinguishing between damage to the product itself and damage
to other property, the integrated systems concept,89 does not "translate well to all situations
involving property damage to which the economic loss doctrine logically
applies." For that reason, some courts, like the Michigan Supreme Court,
have adopted a disappointed expectations concept - or test - to govern a
situation in which commercial products cause damage that was either
within the "scope of the bargaining" or in which "the occurrence of such
damage could have been the subject of negotiations between
parties."90 In such a test, the
determination of whether particular damage qualifies as damage to other
property depends on what the parties expect of the bargained-for
A Wisconsin court employed the disappointed expectations concept to
bar tort claims against the manufacturer of a defective silo when the
feed damaged by the defect reduced milk production and killed
cattle.92 The plaintiffs expected the silo
to enrich the feed, and thus all their losses flowed from that
disappointed expectation. The court of appeals similarly applied the
concept to another transaction that did not appear to involve component
parts of the purchased product, in Selzer v. Brunsell Bros.
Ltd.93 There the plaintiff bought
windows that were warranted to protect permanently against decay and
rot.94 Years later, defects in the windows
spread rot to the siding and other parts of the house. The court of
appeals concluded that the losses involved stemmed "at bottom" from
disappointed expectations.95 Such damages,
the court felt, could and should have been expected.
Based on these cases, the Grams majority incorporated both
"disappointed expectations" and "integrated systems" methodologies into
its analysis of the facts before it, concluding that "the economic loss
doctrine will apply when `prevention of the subject risk was one of the
contractual expectations motivating the purchase of the defective
product.'"96 Rejecting as overly
formalistic the Gramses' claim that "other property" should include
damage to everything beyond the physical dimensions of the purchased
property, the majority analogized all products to products that are
components of an integrated system.97 "If a
product is expected and intended to interact with other products and
property, it naturally follows that the product could adversely affect
and even damage that property."98 Such a
test will not necessarily be simple, requiring "interpretation of the
purpose of a transaction and the expected uses of a product," but it
will help strike the appropriate balance between tort and contract
Chief Justice Abrahamson's dissent focused on the effects of using
the "disappointed expectations" test to distinguish between property and
other property. She raises the possibility that consistent application
of the test "might completely eliminate the [other property] exception
to the economic loss doctrine."99 She asked
whether, for example, it would bar claims for economic losses if a
defective car lurched backward, out of park, destroying a garage
door.100 Cars are, in the chief justice's
hypothetical, expected to interact with other property, including
garages; damage to a garage would be an injury flowing from
disappointment with the car's performance.
Whether one believes expansion of the doctrine is a good or a bad
thing, it seems unarguable that the parameters of "other property,"
already blurred considerably by the "integrated systems" concept, are
further softened by the addition of a malleable "disappointed
expectations" test. It is easy to see how a composite "integrated
systems" and "disappointed expectations" test could, as the U.S. Supreme
Court observed in an earlier other-property case, erode a fundamental
principle of defective product tort law: that manufacturers will make
safer products if they are liable both for injuries to people and for
damages to property other than the product purchased.101
Considered in this context, Grams presents a challenge not
only for practitioners but also for the courts that must determine when
to apply the "integrated systems test," when to consider the facts in
terms of "disappointed expectations," and when to combine both
frameworks. Perhaps more important, judges will need a principled way to
constrain "disappointed expectations" analyses. As a matter of common
sense, any product we buy that damages something we own disappoints us.
As a legal standard, "disappointed expectations" must mean something
more than that. Is disappointment confined to the specific functions for
which a product is designed or the specific use for which it is
purchased? For example, would a dishwasher that cleaned dishes perfectly
well but emitted fumes that discolored walls and destroyed paint cause
damages that were the product of "disappointed expectations"? Arguably
not, because the dishwasher did what it was supposed to do: it got
dishes clean. However, those damages might be seen as flowing from
disappointed expectations because it is foreseeable that a product that
malfunctions inside a house would damage the house. Damages arising from
the dishwasher's malfunction might, in addition, be considered to be
damages to the integrated system of the kitchen, and thus not part of
the "other property" exception to the economic loss doctrine.
Recognizing the policy interests served by the other property
exception, some courts have moved to articulate standards that protect
the exception. A recent Florida admiralty case distinguished neatly
between integrated systems purchased as integrated systems and products
purchased separately that would become part of an integrated
system.102 In Ice Fern, the
parties contracted for a governor (the part that regulates the speed of
a ship's engine). Although the governor was, after installation, part of
the engine system, the court nonetheless reasoned that "because only the
governor was covered under the terms of the contract ....
[p]laintiffs may recover under a negligence theory."103 A Massachusetts admiralty case similarly
permitted tort recovery for damages to a vessel's engine caused by
defects in a separately purchased engine filter.104 With Grams, Wisconsin appears to have
moved in the opposite direction, crafting a test that invites further
erosion of the other property exception to the economic loss
As we have suggested elsewhere, the supreme court's recent focus on
the economic loss doctrine might have signaled a willingness "to rethink
the recent evolution of the economic loss doctrine."105 Indeed, Cease invited speculation
that the court would attempt to limit the doctrine's expansion by
rerooting it in its original policy ground, the U.C.C. To the extent
they indicate a direction, Kaloti, Cascade Stone, and
Grams reject such revisionism, placing Wisconsin solidly in the
camp of a federal judiciary that is enthusiastically extending the
economic loss doctrine to the majority of situations in which commercial
parties and consumers suffer economic losses caused by malfunctioning
products. The clarity of that signal is undercut, however, by divisions
within the court and by the generalized policies and broad standards
employed in the majority opinions. In the wake of Kaloti, Cascade
Stone, and Grams,the only safe bet to make about the
future of the economic loss doctrine in Wisconsin thus seems to be that
the number of such cases litigated will continue to increase.
1See R. Thomas Cane &
Sheila Sullivan, The Future of the Economic Loss Doctrine in
Wisconsin, 78 Wis. Law. 5, 13 (May 2005) (citing Rich
Prod. Corp. v. Kemutec Inc., 66 F. Supp. 2d 937, 970 (E.D.
Wis. 1999)). The court's first bite at the economic loss doctrine last
term came on Nov. 9, 2004, when it unanimously held that the doctrine
did not apply to service contracts. See Insurance Co. of N. Am. v.
Cease Elec. Inc., 2004 WI 139, ¶52, 276 Wis. 2d 361, 688
2See Cane & Sullivan,
supra note 1, at 13.
3See generally R. Joseph
Barton, Drowning in a Sea of Contract: Application of the Economic
Loss Rule in Fraud and Negligent Misrepresentation Claims, 41 Wm.
& Mary L. Rev. 1789 (May 2000).
4See Kaloti Enters.
Inc. v. Kellogg Sales Co., 2005 WI 111, __ Wis. 2d __, 699 N.W.2d
205; Grams v. Milk Prods. Inc., 2005 WI 112, __ Wis. 2d __, 699
N.W.2d 167; Linden v. Cascade Stone Co., 2005 WI 113, __ Wis.
2d __, 699 N.W.2d 189. With Cease, the court thus heard four
economic loss doctrine cases in a single term.
5Kaloti also holds that a
party to a business transaction has a duty to disclose a fact when: 1)
the fact is material to the transaction; 2) the party who knows the fact
also knows the other party is about to enter into the transaction under
a mistake as to the fact; 3) the fact is peculiarly and exclusively
within the knowledge of one party, and the mistaken party could not
reasonably be expected to discover the fact; and 4) on account of the
objective circumstances, the mistaken party would reasonably expect
disclosure of the fact. Kaloti, 2005 WI 111, ¶ 17.
According to Chief Justice Abrahamson, this formulation extends the duty
to disclose beyond the realm of residential real estate transactions in
which it was first articulated. Id. ¶ 54. See, e.g.,
Ollerman v. O'Rourke Co., 94 Wis. 2d 17, 29-42, 288 N.W.2d 95
(1980). Indeed, she contended, the formulation extends that duty beyond
what is described in the Restatement (Second) of Torts § 551. The
consequences of any expansion of the duty to disclose may be more
illusory than real, however. The kind of fact that would create a duty
to disclose would also generally fall outside the newly announced fraud
in the inducement exception, negating tort liability.
6Kaloti, 2005 WI 111,
¶ 42. Interestingly, any dispute over whether there should be a
fraud in the inducement exception has disappeared. The court only
considered the scope of the exception.
7Id. The Michigan Court of
Appeals first formulated this rule in a case involving defective
software. Huron Tool & Eng'g Co. v. Precision Consulting Servs.
Inc., 532 N.W.2d 541 (Mich. 1995).
8See Cooper Power Sys.
Inc. v. Union Carbide Chems. & Plastics Co., 123 F.3d 675, 682
(7th Cir. 1977); Budgetel Inns Inc. v. Micros Sys.
Inc., 8 F. Supp. 2d 1137, 1149 (E.D. Wis. 1988); Raytheon Co.
v. McGraw-Edison Co., 979 F. Supp. 858, 872 (E.D. Wis. 1977).
9Douglas-Hanson Co. v. BF
Goodrich Co., 229 Wis. 2d 132, 137-38, 598 N.W.2d 262 (Ct. App.
1999), aff'd, 2000 WI 22, 233 Wis. 2d 276, 607 N.W.2d 621.
10Wisconsin has long made
distinctions between negligent and intentional misrepresentation that
could justify using the economic loss doctrine to bar tort claims for
one and not the other. See O'Rourke, 94 Wis. 2d 17. Most
significantly, courts have concluded that limiting liability for
accidental misrepresentation encourages a free flow of information
considered vital to economic health. But, as the Restatement (Second) of
Torts, § 552 comment a (1977) observes, that "limitation applies
... only in the case of information supplied in good faith `for no
interest of society is served by promoting the flow of information not
genuinely believed by its maker to be true.'" The question is whether a
Huron Tool-style exception, which encourages individuals to
insure against the risk that their commercial partners are intentionally
lying, encourages a flow of false information detrimental to the economy
and the public good.
WI 22, ¶¶ 1-2, 233 Wis. 2d 276.
12Digicorp Inc. v. Ameritech
Corp., 2003 WI 54, ¶47, 262 Wis. 2d 32, 662 N.W.2d 652.
Harley-Davidson Inc., 2004 WI 32, ¶32, 270 Wis. 2d 146, 677
14Kaloti, 2005 WI 111,
15Id. ¶ 3.
16Id. ¶ 4.
17Id. ¶ 5.
18Geraci knew it would take
Kaloti some months to resell the products it purchased. Id.
20Id. ¶ 8.
22Id. ¶ 9.
23Id. ¶ 42.
24Id. ¶ 45.
26Id. ¶ 50.
27Id. ¶ 78
(Abrahamson, C.J., concurring).
28See id. ¶¶
75-77 (Abrahamson, C.J., concurring).
30Id. ¶ 43.
31Id. ¶ 42.
34Cerabio LLC v.
Wright Med. Tech. Inc., 410 F. 3d 981 (7th Cir. 2005).
35Id. at 984.
37Id. at 984-85.
38Id. at 985-86.
39Id. at 986.
40Id. at 984.
41Id. at 990.
42Id. at 991.
44Kaloti, 2005 WI 111,
45See Cease, 2004 WI
139, ¶¶ 42-46 (noting that the circumstances surrounding
consumer service contracts - informality, absence of lawyers, and
disparities of information and power - make it unlikely the parties will
negotiate risk allocation); Atkins v. Swimwest Family Fitness
Ctr., 2005 WI 4, ¶ 26, 277 Wis. 2d 303, 691 N.W.2d 334
(finding an exculpatory clause that was part of a standardized agreement
void because the customer had no opportunity to bargain).
46Cascade Stone, 2005 WI
113, ¶ 2.
47Id. ¶ 3.
50Id. ¶ 4.
51Id. ¶ 12. See
Cease, 2004 WI 139, ¶ 2.
52Cascade Stone, 2005 WI
113, ¶ 12.
53Id. ¶ 16
54Id. ¶ 17.
56The conclusion that a contract
to construct a house is a contract for a good is not necessarily
obvious. A recent unpublished decision of the North Carolina Court of
Appeals, Pedan General Contractors Inc. v. Bennett, No.
COAO4-744, 2005 WL 1804298 (N.C. App. Aug. 2, 2005),employs the same
test as Cascade, but decides that such contracts are agreements
to provide services. The Pedancourt characterized general
contractors as suppliers of services without citation to authority,
indicating that the court believes such a characterization is simply
logical. Id. at 33. Comparing Peden and Cascade
Stonemakes it clear that Bonebrake can be used not only as
a method of textual analysis, but also as authority for an
impressionistic reading of the nature of a questioned transaction. If
one focuses on the buyer's bargain, the product at issue is more easily
characterized as a house. If one focuses on the seller's bargain, the
product at issue is more easily characterized as services. In this
context, it is worth remembering that the predominant purpose test was
developed in a case involving both existing goods and services, in
response to the U.C.C.'s definition of goods as things moveable at the
time of identification. See, e.g., Bonebrake v. Cox, 499 F.2d
951, 957-58 (8th Cir. 1974).
57Cascade Stone thus
determines which contract prevails based on economic loss doctrine
principles before it decides whether the doctrine applies to that
58Cascade Stone, 2005 WI
113, ¶ 22.
60Id. ¶ 9 (citing
Bonebrake, 499 F.2d 951). The test was first used in Wisconsin
several years later. See Van Sistine v. Tollard, 95 Wis. 2d
678, 685, 291 N.W.2d 636 (Ct. App. 1980).
61Cascade Stone, 2005 WI
113, ¶ 25.
63Clearly, fixed price contracts
reflect labor costs as well as material costs; the cost of a change in
specifications is based on projected changes in both kinds of costs.
64Cascade Stone, 2005 WI
113, ¶ 25.
65A buyer who chooses a fixed
price contract can be seen as bargaining to avoid both the risk of
service errors and uncertainty about the purchase price. A general
contract that did not specify price but that did specify how costs would
be calculated might thus have a better chance of not being characterized
as a contract for a good despite the fact that the underlying
transaction is the same.
66Cascade Stone, 2005 WI
113, ¶ 32.
671325 N. Van Buren LLC v.
T-3 Group Ltd., 2005 WI App 121, ¶ 2, 701 N.W.2d 13.
68Id. ¶ 19.
70On Oct. 3, 2005, the supreme
court accepted the T-3 case to consider whether application of
the economic loss doctrine is strictly limited to contracts for the
purchase and sale of goods governed by Article 2 of the UCC.
71See Bay Breeze Condo. Ass'n
v. Norco Windows Inc., 2002 WI App 205, ¶ 25, 257 Wis. 2d 511,
651 N.W.2d 738.
72See Cascade Stone,
2005 WI 113, ¶ 9. Both Bay Breeze and Cascade
Stone depend on the same dicta from a Florida case. See Casa
Clara Condo. Ass'n v. Charley Toppino & Sons, 620 So. 2d 1244,
1247 (Fla. 1993) ("Generally, house buyers have little or no interest in
how or where the individual components of a house are obtained. ...
They bargain for the finished products, not their various
73Cascade Stone, 2005 WI
113, ¶ 22.
74The majority did not otherwise
address the dissent's claim that it has diminished Wisconsin buyers'
protection against negligent performance. Id. ¶ 35.
76Id. ¶ 31.
77Id. ¶ 48
(Bradley, J., dissenting).
78Justice Bradley pointed out the
irony of seeking to maintain the fundamental distinction between tort
and contract law by barring home buyers from seeking tort remedies from
subcontractors with whom they have no contract. Id. ¶ 42
(Bradley, J., dissenting).
79Again, the majority relied on
the logic of Casa Clara Condo. See supra n.72.
80See, e.g., Wausau Tile Inc.
v. County Concrete Corp., 226 Wis. 2d 235, 247, 593 N.W.2d 445
81Grams, 2005 WI 112,
82Id. ¶ 5.
83Id. ¶ 6.
85Id. ¶ 8.
86The court granted summary
judgment to Milk Products on the contract claim because there was no
privity between the Gramses and the producer. Id. ¶
89Id. ¶ 31. The
"integrated system" concept was introduced in Wisconsin in Wausau
Tile, 226 Wis. 2d at 249, and recognized by the U.S.
Supreme Court in Saratoga Fishing Co. v. J.M. Martinac &
Co.,520 U.S. 875, 883 (1997).
90Grams, 2005 WI 112,
¶ 31 (citing Neibarger v. Universal Coops Inc., 486 N.W.2d
612, 620 (Mich. 1992)).
91Id. ¶ 32 (citing
Rich Prods., 66 F. Supp. 2d at 972).
92Id. ¶ 33; see
D'Huyvetter v. A.O. Smith Harvestore Prods., 164 Wis. 2d 306, 317,
475 N.W.2d 587 (Ct. App. 1991).
93Selzer v. Brunsell Bros.
Ltd., 2002 WI App 232, 257 Wis. 2d 809, 652 N.W.2d 806.
94Id. ¶ 5.
95Id. ¶ 36.
96Grams, 2005 WI 112,
¶ 43 (quoting Rich Prods., 66 F. Supp. 2d at 975).
98Id. ¶ 47.
99Id. ¶ 75
(Abrahamson, C.J., dissenting).
100Id. ¶ 76
(Abrahamson, C.J., dissenting).
101See Saratoga Fishing
Co., 520 U.S. at 881.
102Ice Fern Shipping Co. v.
Golten Serv. Co., No. 04-20741, 2005 U.S. Dist. Lexis 12200, 10,
unpublished slip op. (So. Dist. Fla. Mar. 22, 2005).
104See Irish Venture Inc.
v. Fleetguard Inc.,270 F. Supp. 2d 84, 85-86 (D. Mass. 2003).
105See Cane &
Sullivan, supra note 1, at 62-63. Wisconsin first recognized
the doctrine in 1989, some years after federal courts initially
predicted it would, and many years after its first articulation, in
1969. See Sunnyslope Grading Inc. v. Miller, Bradford & Risberg
Inc., 148 Wis. 2d 910, 921, 437 N.W.2d 213 (1989); see also
Seeley v. White Motor Co., 403 P.2d 145 (Cal. 1965). Both
Sunnyslope and Seeley stressed the doctrine's
complementary relation to U.C.C. policies; the judge-made doctrine thus
drew its original authority from a legislatively imposed scheme rather
than from abstract legal principles.