Robinson Helicopter Co., Inc. v. Dana Corp.

WERDEGAR, J., Dissenting.

To reach an outcome that allows a party engaged in wrongdoing to be punished is undeniably appealing, but sometimes sound reasons exist for resisting the urge. This is such a case. In structuring its holding to allow the punishment of this defendant, the majority has embarked on a path previously wisely rejected. In the guise of permitting punitive damages for torts independent of a contract breach, the majority breathes new life into the heretofore moribund doctrine of bad faith denial of breach of contract. I respectfully dissent.

I

Dana Corporation (Dana) entered into a commercial contract with Robinson Helicopter Company, Inc. (Robinson) to supply helicopter parts. It warranted that the parts would be manufactured in conformance with particular specifications. It later changed its manufacturing process and began delivering parts that no longer conformed to the contract specifications, accompanied by contractually required certificates of compliance that represented the parts were still being manufactured according to those specifications. Robinson discovered the manufacturing change and was forced to replace the nonconforming parts. Was this a contract breach? Absolutely. The contract called for a particular performance, and the breaching party, Dana, failed to deliver that performance.

Was this conduct also a basis for tort damages? As the majority notes, Robinson makes no claim that Dana had any fraudulent intent when it changed its manufacturing process. (Maj. opn., ante, at p. 986, fn. 3.) Thus, Robinson’s misrepresentation claim rests in its entirety on a series of form certificates of compliance typically providing; “This is to certify that . . . pieces of part number . . . related to your purchase order . . . have been processed, fabricated and received final inspection in accordance with the applicable blueprint specifications and the purchase order requirements, with pertinent date relative thereto, maintained and on file.” By providing these certificates, Dana represented that its parts satisfied the contract. In effect, it refused to admit that it was breaching the contract while in fact it was doing so. If Dana misrepresented its compliance intentionally, with knowledge that *995 its parts did not satisfy the contract, then its conduct might be described variously as a bad faith breach of contract, a breach of contract by fraudulent means, or a bad faith denial of breach.

Until today, we have rejected the notion that such conduct could give rise to punitive damages. As a matter of both statute and common law, a breach of a commercial contract cannot be the basis for punitive damages. (Civ. Code, § 3294, subd. (a); Applied Equipment Corp. v. Litton Saudi Arabia Ltd. (1994) 7 Cal.4th 503, 516 [ 28 Cal.Rptr.2d 475 , 869 P.2d 454 ] (Applied Equipment); Foley v. Interactive Data Corp. (1988) 47 Cal.3d 654, 698 [ 254 Cal.Rptr. 211 , 765 P.2d 373 ] (Foley).) The law eschews inquiry into a breaching party’s motives; whether acting in good faith or bad faith, a party that breaches a commercial contract must pay only contract damages. (Applied Equipment, at p. 516; Foley , at p. 699; see Harris v. Atlantic Richfield Co. (1993) 14 Cal.App.4th 70, 82 [ 17 Cal.Rptr.2d 649 ] [“The imposition of tort remedies for ‘bad’ breaches of commercial contracts is a substantial deviation from the traditional approach which was blind to the motive for the breach”].) This rule applies even when the breach is accomplished in a fraudulent manner. (See Hunter v. Up-Right, Inc. (1993) 6 Cal.4th 1174 [ 26 Cal.Rptr.2d 8 , 864 P.2d 88 ] (Hunter) [wrongful termination accomplished through fraudulent misrepresentation is not independently tortious].)

For a limited time in the 1980’s and 1990’s, this court recognized the tort of bad faith denial of the existence of a contract (see Seaman’s Direct Buying Service, Inc. v. Standard Oil Co. (1984) 36 Cal.3d 752 [ 206 Cal.Rptr. 354 , 686 P.2d 1158 ], overruled by Freeman & Mills, Inc. v. Belcher Oil Co. (1995) 11 Cal.4th 85 [ 44 Cal.Rptr.2d 420 , 900 P.2d 669 ] (Freeman & Mills)), but even then, we declined to extend tort liability to the bad faith denial of liability under a contract. Indeed, one of the problems with Seaman’s was that it required courts to do the “impossible[,] to draw a principled distinction between a tortious denial of a contract’s existence and a permissible denial of liability under the terms of the contract.” (Oki America, Inc. v. Microtech Int’l, Inc. (1988) 872 F.2d 312, 315 (conc. opn. of Kozinski, J.); see Freeman & Mills, at pp. 101-102 [critiques of Seaman’s “emphasize the extreme difficulty courts experience in distinguishing between tortious denial of a contract’s existence and permissible denial of liability under the terms of the contract”].) The rule precluding tort liability for the denial of a breach of contract has remained unchanged. “Our decisions in Foley, Hunter, and Applied Equipment each contain[] language that strongly suggests courts should limit tort recovery in contract breach situations to the insurance area, at least in the absence of violation of an independent duty arising from principles of tort law other than denial of the existence of, or liability under, the breached contract.” (Freeman & Mills, at p. 95, italics added.)

*996 These decisions reflect a circumspect approach to attaching tort liability to conduct occurring in the course of contract performance. As we have frequently explained, the reason for this justifiable circumspection is the value commercial parties place on predictable potential costs and the chilling effect tort exposure in routine breach cases would have on commercial enterprise. (Erlich v. Menezes, (1999) 21 Cal.4th 543, 553 [ 87 Cal.Rptr.2d 886 , 981 P.2d 978 ] (Erlich); Freeman & Mills, supra, 11 Cal.4th at pp. 97, 102-103; Applied Equipment, supra, 7 Cal.4th at p. 520 ; Hunter, supra, 6 Cal.4th at pp. 1193-1194; Foley, supra, 47 Cal.3d at pp. 683, 696-699; White v. Western Title Ins. Co. (1985) 40 Cal.3d 870 , 900-901 & fn. 2 [ 221 Cal.Rptr. 509 , 710 P.2d 309 ], (conc. & dis. opn. of Kaus, J.); see also Harris v. Atlantic Richfield Co., supra, 14 Cal.App.4th at p. 77 ; DuBarry Internat., Inc. v. Southwest Forest Industries, Inc. (1991) 231 Cal.App.3d 552, 569 [ 282 Cal.Rptr. 181 ].) As we have said in the context of rejecting tort liability for interference with one’s own contract, if every breach creates a potentially triable tort claim, “the potential consequences of any breach of contract—efficient or inefficient, socially desirable or undesirable—become uncertain and unpredictable. Tort liability may or may not follow, depending on a myriad of imponderable factors. As a result, a business fearful of unfathomable tort exposure might lose the ability to respond flexibly to changing economic conditions or hesitate to enter into contracts at all in fast-moving aspects of commercial enterprise.” (Applied Equipment, at p. 520.) Restricting parties to contract damages in the wide run of cases “promote[s] contract formation by limiting liability to the value of the promise.” (Harris v. Atlantic Richfield Co., at p. 77.)

The challenged conduct in this case is a breach of contract accompanied by false contractually required representations that the party was not in breach. This, the majority holds, is enough to allow a jury to inquire into whether the breaching party knew it was breaching the contract at the time and, if so, whether such a knowing misrepresentation might appropriately give rise to punitive damages. Of course, rare is the commercial contract that does not involve ongoing statements by the parties relating to their performance. In all such cases, under the majority’s rule, it is now possible to plead a fraud claim. This raises the specter that every alleged breach will yield satellite litigation over whether contemporaneous remarks by one side or the other amounted to intentional misrepresentations about the existence of a breach, thus subjecting the breaching party to the possibility of punitive damages for such conduct. The implications of such a result for commercial predictability and certainty are considerable.

I do not disagree with the majority’s desire to sanction deceit in commercial relationships. Commercial parties should be entitled to rely on the representations their contractual partners make. Indeed, the stability of commercial relationships depends on such trust, and the legal rules governing

*997 those relationships should foster it. The problem is not with the principle but the practice. (Cf. White v. Western Title Ins. Co., supra, 40 Cal.3d at p. 900, fn. 2 [“The problem is not so much the theory of the bad faith cases, as its application”].) Allowing a tort claim to be pleaded in every case where a breach is accompanied by representations about performance forces all parties, not just those engaged in malfeasance, to bargain in the shadow of potential tort liability. That cannot be a good thing.

n

How, then, to sanction deceitful representations about one’s performance without chilling commercial relationships? As it happens, a solution to this problem exists: the economic loss rule.

We first developed and applied the economic loss rule in the context of product liability claims. A manufacturer “can appropriately be held liable for physical injuries caused by defects by requiring his goods to match a standard of safety defined in terms of conditions that create unreasonable risks of harm. He cannot be held for the level of performance of his products in the consumer’s business unless he agrees that the product was designed to meet the consumer’s demands. A consumer should not be charged at the will of the manufacturer with bearing the risk of physical injury when he buys a product on the market. He can, however, be fairly charged with the risk that the product will not match his economic expectations unless the manufacturer agrees that it will. Even in actions for negligence, a manufacturer’s liability is limited to damages for physical injuries and there is no recovery for economic loss alone.” (Seely v. White Motor Co. (1965) 63 Cal.2d 9, 18 [ 45 Cal.Rptr. 17 , 403 P.2d 145 ] (Seely); see also Jimenez v. Superior Court (2002) 29 Cal.4th 473, 482-483 [ 127 Cal.Rptr.2d 614 , 58 P.3d 450 ]; Aas v. Superior Court (2000) 24 Cal.4th 627, 639-640 [ 101 Cal.Rptr.2d 718 , 12 P.3d 1125 ].) The function of the economic loss rule is to prevent tort law from shifting back to sellers a specific risk that better rests with buyers—the risk that a product will not perform to a particular level beyond that warranted by the seller. If a buyer desires protection against this risk, she can and should negotiate for a higher warranty or seek it out from other sellers in the marketplace. (See Seely , at pp. 18, 19.)

We have extended the economic loss rule to claims for negligent breach of contract. (Aas v. Superior Court, supra, 24 Cal.4th at pp. 642-643.) In Aas , we explained that the rule preserves “the fundamental difference between, on the one hand, the consumer’s contractual interest in having a product of the expected, bargained-for value and quality, and, on the other hand, the consumer’s tort interest in not suffering property damage or personal injury due to negligence in the manufacturing process.” (Id. at p. 642.) Thus, while *998 we recognized “conduct amounting to a breach of conduct becomes tortious when it also violates a duty independent of the contract arising from principles of tort law” (id. at p. 643, citing Erlich, supra, 21 Cal.4th at p. 551 ), we held that recourse for violation of that duty is “limited by the rule in Seely, supra, 63 Cal.2d 9, 18 , which bars recovery of economic damages representing the lost benefit of a bargain” (Aas v. Superior Court, at p. 643).

These principles should apply here. Robinson had a contractual interest in receiving clutches of a particular quality. It had a tort interest in not suffering liability for damages to persons or property as a result of any negligence, fraud, or defective product manufactured by Dana. Only the first interest was burdened here; Dana failed to deliver clutches of the warranted quality. Robinson’s damages consisted exclusively of the costs associated with identifying and replacing the defective product, costs that fall squarely within the definition of economic loss. (See Jimenez v. Superior Court, supra, 29 Cal.4th at p. 482 .) Because Robinson suffered only economic loss, its recovery should have been limited to contract damages under its breach of contract and breach of warranty claims.

This application of the economic loss rule solves the problem of how to sanction deceit without chilling commercial relationships. It allows tort liability in those instances where a misrepresentation may have led to actual property damage or personal injury and, in doing so, both sanctions and deters opprobrious conduct. But by excluding tort recovery in those cases, like this one, where the only damages are economic, it preserves the valuable distinction between tort and contract remedies and avoids the problems that would arise if every routine breach were susceptible to both tort and contract claims.

in

Where does the majority go wrong? The problem lies in its application of a test—whether a tort is independent of the contract breach (maj. opn., ante, at pp. 989-991)—that supplies only a necessary, not a sufficient, condition for the imposition of tort liability.

The majority relies principally on Erlich, supra, 21 Cal.4th 543 , a decision that barred emotional distress damages for negligent breach of contract. Erlich acknowledged that it was “difficult to categorize” those cases where breach of a contractual promise could also give rise to tort damages. (Id. at p. 552.) However, borrowing from a Justice Mosk concurring and dissenting opinion, it identified three categories of cases where the breach of a contractual promise could also give rise to tort damages. (Id. at pp. 553-554, citing Freeman & Mills, supra, 11 Cal.4th at p. 105 (conc. & dis. opn. of *999 Mosk, J.).) It also reiterated the long-standing rule that “conduct amounting to a breach of contract becomes tortious only when it also violates a duty independent of the contract arising from principles of tort law.” (Erlich, at p. 551.)

The majority holds that Dana committed an independent tort, fraud, and therefore may be hable in tort. (Maj. opn., ante, at p. 991.) But the commission of an independent tort, although a necessary condition for the imposition of tort liability, is not sufficient. Thus, that Robinson has shown an independent tort is only the beginning of the discussion, not the end. 1 As we held in Aas , even when an independent tort has been committed, the economic loss rule may still apply. (Aas v. Superior Court, supra, 24 Cal.4th at p. 643 .) Likewise, the Erlich/Justice Mosk taxonomy of contract cases where tort liability may be found is descriptive, not prescriptive. It offers no specific rationale for the characteristics shared by past cases allowing tort recovery, nor does it purport to say that all cases that fall within one or another category will necessarily give rise to tort liability. It thus does not advance the analysis.

The majority purports to limit its holding to cases in which a misrepresentation exposes a plaintiff to a risk of liability for personal damage. (Maj. opn., ante, at p. 993.) The problem with this asserted limiting principle is that, unlike the requirement that there actually be noneconomic damage, this requirement is no limit at all. It is safe to say that in a large percentage of denial of breach cases, a plaintiff will be able to plead and perhaps prove that it was exposed to at least the risk of liability for personal damage by virtue of the defendant’s failure to immediately confess its sins. In Aas , we expressly rejected an approach that would have carved out an exception to the economic loss rule whenever a tort created a serious risk of personal injury or property damage. (Aas v. Superior Court, supra, 24 Cal.4th at pp. 649-651.) Nothing has changed in the intervening four years to persuade me that such an approach is any sounder today. Instead, we ought to continue to apply the economic loss rule in the absence of actual injury or property damage, adhering to the principle that “when no safety concerns are implicated *1000 because the damage is limited to the product itself, the [commercial party]’s recourse is in contract law to enforce the benefit of the bargain.” (Jimenez v. Superior Court, supra, 29 Cal.4th at p. 490 (conc. & dis. opn. of Brown, J.).)

IV

One final aspect of the majority’s decision merits comment. Robinson argued for tort liability based on two distinct theories: (1) Dana fraudulently misrepresented that its parts conformed to the contract specifications, and (2) it fraudulently concealed its breach. The jury was given a special verdict form that included the following question as the sole basis for tort liability: “QUESTION NUMBER 4 [][] Did [Dana] knowingly misrepresent or conceal a material fact with an intent to defraud Robinson which caused damage to Robinson?” (Italics added.) The jury answered yes, 11 to 1.

Because the question is phrased in the disjunctive, we cannot determine whether the award of punitive damages rests on a finding that Dana fraudulently misrepresented facts or that it fraudulently concealed facts. If either theory is barred by the economic loss rule and thus legally deficient, the jury verdict cannot stand. (Lundy v. Ford Motor Co. (2001) 87 Cal.App.4th 472, 480 [ 104 Cal.Rptr.2d 545 ]; see People v. Guiton (1993) 4 Cal.4th 1116, 1125 [ 17 Cal.Rptr.2d 365 , 847 P.2d 45 ].) Thus, contrary to the majority’s assertion, Dana’s alleged intentional misrepresentations are not “dispositive fraudulent conduct” (maj. opn., ante, at p. 991); for all we know, the jury rejected punitive damages on this basis and imposed them only because of Dana’s alleged later concealments.

The majority disavows any views on application of the economic loss rule to fraudulent concealment, leaving the issue to the Court of Appeal on remand. (Maj. opn., ante, at p. 994, fn. 9.) On remand, the Court of Appeal will have a choice between applying the economic loss rule to bar recovery,. thereby setting up a distinction between deceit by misrepresentation on the one hand and deceit by nondisclosure on the other, or holding that nondisclosures can also be tortious. The issue ultimately will have to be decided, in this or a future case.

Whenever the issue is settled, today’s decision will leave no easy options. On the one hand, if fraudulent concealment is not tortious, the distinction between tortious misrepresentation and nontortious concealment may prove untenable and virtually impossible to administer. If a party makes statements that are true but incomplete and that may or may not have false implications, is this a tortious misrepresentation or a nontortious nondisclosure? Such line drawing will not be easy for parties seeking to order their affairs, judges obligated to instruct juries, or juries forced to split hairs by such a set of rules.

*1001 On the other hand, if the majority’s decision is taken to its logical conclusion, then deceit by nondisclosure is a tort independent of any breach, just like deceit by misrepresentation. (See Civ. Code, § 1710, subds. (1), (3).) If so, every litigator can be expected to attach such a piggyback tort claim to each breach of contract claim, and every breach case can be expected to focus on when a party learned it was in breach and why it failed to disclose that fact to the other side. The threat of tort damages in every such instance can do no good for parties weighing the likely benefits and risks before entering any commercial contract.

V

Let us be clear: what Dana did was not admirable. A jury awarded Robinson $1.5 million in compensatory damages. Dana’s conduct should be sanctioned, and it has been. But to allow tort recovery for bad faith denial of a breach that led only to economic damages is to prescribe a cure worse than the disease. Today’s decision greatly enhances the ease with which every breach of contract claim can don tort clothes. I fear that in doing so, it opens a Pandora’s box better left sealed. Because I would not do so, I respectfully dissent.

Appellant’s petition for a rehearing was denied March 16, 2005. Brown, 1, did not participate therein.

Moreover, even this preliminary conclusion that Dana’s provision of certificates of compliance constituted an independent tort has anomalous consequences. The certificates of compliance Dana provided were mandated by Robinson’s purchase orders. Had Dana withheld the certificates, it would have committed a second breach of contract, subjecting itself to (at most) contract damages. According to the majority, Dana, by instead choosing to comply with its contractual obligation to provide the certificates and thus breach the contract in only one way, not two, committed an independent tort that could subject it to punitive damages. Such an interpretation of the independent tort requirement creates perverse incentives for parties to either (a) breach existing contractual obligations to provide performance assurances, or (b) henceforth refuse to agree to provide such assurances. Neither outcome is commercially desirable.