In California, fraud is fraud—whatever that means

Rattagan v. Uber Technologies, Inc. is about the economic loss rule—a confusing doctrine about when a plaintiff can recover in tort for economic losses.  The question in Rattagan is whether tort recovery is available in cases of fraudulent concealment (rather than an affirmative lie). 

According to the California Supreme Court, tort recovery is allowed in this situation, so long as the nondisclosure was not contemplated by the parties’ contract.  That conclusion is straightforward when a party is fraudulently induced to enter a contract, but far less clear when the fraudulent concealment happens during performance of the contract. 

Factual Background

Plaintiff Rattagan is an Argentine lawyer who was contacted when Uber was attempting to launch its app in Argentina.  He agreed to be Uber’s registered legal representative in Argentina, but only after warning Uber about the personal exposure he might face if Uber violated Argentine law.  Nevertheless, he alleges that Uber decided to secretly launch its ridesharing platform without complying with all legal requirements and without informing him about its intent to do so.  This led to a wave of backlash in Buenos Aires, including the plaintiff’s office being surrounded by protesters for hours.  Eventually, the plaintiff was criminally charged and banned from traveling abroad.

Plaintiff filed suit in federal court, asserting (among other things) a claim for fraudulent concealment.  The case made its way to the Ninth Circuit, where the court certified a question to the California Supreme Court about the scope of the economic loss rule under California law. 

Legal Background

The economic loss rule is simple to state, but confusing in practice: tort law does not allow recovery for pure economic losses resulting from negligence (i.e., financial harm that is not connected to physical or property harm).  In cases of pure economic loss, parties are stuck with contract claims.    

Although this may seem unfair, it serves a valuable purpose.  Parties are allowed to structure their contracts in the way they decide best, including the allocation of benefits and risks.  If a party could easily resort to tort law when they become unsatisfied with the contract, then the value of all contracts is diminished.

To get around the economic loss rule in cases of negligence, there are two conditions that must be met.  First, the conduct that caused the injury must have violated some duty independent of the contractual duties.  Second, the injury must be to some person or property that was not reasonably contemplated by the parties when the contract was formed.  (Op. 13.)

But what about cases of intentional torts, like when a party makes a fraudulent misrepresentation?  The economic loss rule doesn’t apply, because fraud undermines the very purpose of the rule—i.e., to allow parties to structure a contract as they would like.  When one party defrauds another, then the parties cannot properly allocate the benefits and risks because one of the parties is operating on faulty information caused by the fraud of another.  Parties should not be expected to anticipate fraud in every transaction, and permitting such fraud would hinder rather than promote commerce.  (Op. 34.)

In light of this, the Ninth Circuit asked the California Supreme Court whether the economic loss rule only exempts affirmative fraud (actively telling someone a lie), or whether it also exempts fraudulent concealment (failure to disclose the facts). 

The Opinion

The court’s opinion can be summed up in three words: fraud is fraud.  For the same reasons that an affirmative misrepresentation is exempt from the economic loss rule, fraudulent concealment must be exempt as well.

This is easy enough to apply in the typical case of fraudulent concealment, which arises in precontract negotiation where one party fraudulently induces another party to enter into a contract due to some nondisclosure.  In such situations, the economic loss rule exemption is straightforward, because parties have always been able to affirm the contract and sue for the fraud.  This is relatively straightforward, because the contract is tainted by the fraud from the outset, so there’s no need to consider whether disclosure was contemplated by the contract.

What’s tougher, though, are cases where the fraudulent concealment happens after the contract is already in existence.  Parties may not enter contracts assuming that the other party will affirmatively lie to them, but they probably do anticipate that the other party will withhold information.  (Op. 49.)  As such, if the nondisclosure was reasonably contemplated by the parties, then the economic loss rule still applies, because the parties agreed to operate in the “mini-universe” of the contract (which is a great phrase, by the way).  (Id.)  This means that a lot of cases of nondisclosure during the contract will still implicate the economic loss rule.  The plaintiff may sue in tort only when when an independent duty to disclose arises because the nondisclosure was not reasonably contemplated when the parties entered into the contract.

What might this look like?  The court gives an example of a seller who delivers a product under warranty without being aware of a latent defect.  If the seller later learns of the defect that went beyond the parties’ contractual expectations, and knows that the defect is not reasonably discoverable by the buyer, then failure to disclose or active concealment could give rise to a tort claim.

Ultimately, the court was not tasked with applying this ruling to the facts at-hand, because this was a certified question from the Ninth Circuit.  So, it will be up to the Ninth Circuit to determine whether the plaintiff adequately pled a claim for fraudulent concealment that arises independently of the parties’ contract.

Takeaways

1. The court gives just one example of an on-contract fraudulent concealment case: the seller who delivers the product with a latent defect.  The key question in this circumstance will be whether the defect fell outside the parties’ reasonable expectations.  But how is the seller supposed to evaluate this question?  How will the seller know which defects the buyer could reasonably expect?  There are probably some clear answers to this, but I can’t think of many.  For example, if the seller delivers some piece of technology and later learns that the product will inexplicably stop functioning after one year, then presumably the buyer would not have reasonably anticipated such a severe flaw.  So, maybe failure to reach out and disclose this flaw could possibly lead to a tort claim.  But situations like this seem uncommon.  In most cases, it will be unclear what disclosures are contemplated by the contract.  I worry that this opinion does not provide enough guidance to parties on this issue.

2. Relatedly, the court’s test for nondisclosure on-contract seems to mirror the test in negligence cases—where the duty must be independent and the injury must be to some person/property outside the reasonable contemplation of the contract.  This is a bit odd, though, because the fraud exemption to the economic loss rule supposedly stems from the fact that the tort is intentional, so the negligence test wouldn’t be applicable.  This appears to be an implicit recognition that cases of nondisclosure may turn out to be far more like negligence cases than intentional tort cases, even if the fraud is labeled an “intentional” tort.