Commercial Parties, Transactional Lawyers and Litigators Beware: California Law Has Changed

California law has changed. The change now makes it easier for California litigants to sue their opponents for fraudulently breaching a contract. Lawyers who negotiate and draft agreements subject to California law should immediately become familiar with this change. More important, they should understand the way the California Supreme Court instructs how this risk, at least in case of fraudulent concealment claims, can potentially be avoided.

On Aug. 22, 2024, in Rattagan v. Uber Technologies, Inc. (Aug. 22, 2024, No. S272113) ___Cal.5th___ [2024 Cal. LEXIS 4639, at *14 (Rattagan), California's High Court redefined the "often elusive boundary line between tort and contract law." Rattagan holds under certain circumstances parties can be sued for committing fraudulent concealment during the course of an ongoing contractual relationship.

In so doing, Rattagan expands what many commentators previously called the "narrow in scope" exception to California's economic loss rule (ELR) approved in Robinson Helicopter v. Dana Corp. (2004) 34 Cal.4th 979 [22 Cal. Rptr. 3d 352, 102 P.3d 268] (Robinson). Indeed, the Court decided Rattagan at the request of the U.S. Court of Appeals for the Ninth Circuit to clear up "uncertainty" created by Robinson.

California's Economic Loss Rule

"[T]he economic loss rule was developed to ensure that the law of contract would not 'drown in a sea of tort.' The rule itself is deceptively easy to state: In general, there is no recovery in tort for negligently inflicted 'purely economic losses,' meaning financial harm unaccompanied by physical or property damage." Or, as Robinson phrased the rule: "[t]he economic loss rule requires a [contractual party] to recover in contract for purely economic loss due to disappointed expectations, unless [the party] can demonstrate harm above and beyond a broken contractual promise." Rattagan¸ 2024 Cal. LEXIS 4639, at *17 (italics in original, internal citations omitted). The reason for this is "'[u]sing contract law to govern commercial transactions lets parties and their lawyers know where they stand and what they can expect to follow legally from the words they have written. But if a disappointed buyer has the option of abandoning the contract and suing in tort, the significance of the contract is diminished and the doctrines that protect the integrity of the contractual process are reduced in importance. Parties wrangle over integration clauses to make clear that their obligations are the ones stated in the contract and nothing else; the point of bothering about such matters becomes unclear if a disappointed party can later invoke an outside set of obligations that are imposed on the promisor and defined by the law of tort.'" Rattagan 2024 Cal. LEXIS 4639, at *35 (internal citations omitted).

Robinson

Notwithstanding the ELR, Robinson permitted a company that manufactured and sold "sprag clutches" to a helicopter manufacturer to be sued for breaching a written agreement to sell clutches that were required to come with certificates of conformance issued by the Federal Aviation Administration and fraud. In so doing, the Court issued what it then called a "narrow in scope" exception to the ELR "limited to a defendant's affirmative misrepresentations on which a plaintiff relies and which expose a plaintiff to liability for personal damages independent of the plaintiff's economic loss." Robinson, 34 Cal.4th at 993. In other words, after Robinson, it was generally understood that to sue for a fraudulent breach of contract in California, one had to plead and prove 1) an affirmative misrepresentation of fact (as opposed to concealment or a negligent misrepresentation) and 2) resulting personal injury (as opposed to lost money or other economic harm).

Rattagan

In response to the Ninth Circuit's question whether "[u]nder California law … claims for fraudulent concealment [as opposed to affirmative deception are] exempted from the economic loss rule?," Rattagan holds "tort recovery for breach of a contract duty is generally barred … unless two conditions are satisfied. A plaintiff must first demonstrate the defendant's injury-causing conduct violated a duty that is independent of the duties and rights assumed by the parties when they entered the contract. Second, the defendant's conduct must have caused injury to persons or property that was not reasonably contemplated by the parties when the contract was formed ." 2024 Cal. LEXIS 4639, at *17.

In other words, Rattagan – unlike Robinson – allows claims for fraudulent concealment and harm other than personal injuries. To help trial courts apply this new two-part test, Rattagan instructs:

If the alleged breach is based on a failure to perform as the contract provides, and the parties reasonably anticipated and allocated the risks associated with the breach, the cause of action will generally sound only in contract because a breach deprives an injured party of a benefit it bargained for. However, if the contract reveals the consequences were not reasonably contemplated when the contract was entered and the duty to avoid causing such a harm has an independent statutory or public policy basis, exclusive of the contract, tort liability may lie.

2024 Cal. LEXIS 4639, at *30 (fn. omitted.)

In the case of claims for both affirmative and constructive (concealment) fraud, the first part of the test is easily satisfied. This is because, per Rattagan "the independent tort duty to refrain from engaging in fraudulent conduct is well established by statute and common law." 2024 Cal. LEXIS 4639, at *31. Moreover, "California has long viewed fraud as being equally blameworthy whether accomplished through affirmative misrepresentation or concealment." Id. at *32. "'Where failure to disclose a material fact is calculated to induce a false belief, the distinction between concealment and affirmative misrepresentation is tenuous. Both are fraudulent.'" Id. at *57.

The second part is potentially more difficult to navigate. This is because, the Court explains:

When evaluating whether the parties' expectations and risk allocations bar tort recovery, the court must consider the alleged facts. First, applying standard contract principles, it must ascertain the full scope of the parties' contractual agreement, including the rights created or reserved, the obligations assumed or declined, and the provided remedies for breach.

2024 Cal. LEXIS 4639, at *29 (fn. omitted.)

When a potential injury stemming from a nondisclosure is determined to have been within the reasonable contemplation of known risks to the parties before entering into their agreement and the parties accounted for that risk, the resulting action is "'"ex contractu"'" or "'"aris[ing] from a breach of a promise set forth in the contract."'" In such a case, public policy considerations tip away from the objective of encouraging a business climate free of fraud and toward the goal of enforcing the contractual obligations that the parties voluntarily assumed in the "mini-universe" they agree to inhabit. In other words, in such situations, a plaintiff asserting a fraudulent concealment claim in the performance of a contract generally cannot demonstrate that the defendant violated a tort duty independent of the parties' contractual rights and obligations. If, on the other hand, an independent duty to disclose certain material facts arises for a party in the course of a contractual relationship but the party intentionally conceals or suppresses such facts, inducing detrimental reliance and exposing the other party to risks of harm not reasonably contemplated when the contract was formed, the party suffering the injury may assert an "'"ex delicto"'" tort action for fraudulent concealment, one "'"aris[ing] from a breach of duty growing out of the contract."'"

2024 Cal. LEXIS 4639, at *63-64 (italics added, internal citations omitted.)

Takeaways

• If California law applies (such as when a contract's choice of law provision so provides or when other "conflict of laws" principles so dictate), parties will now be able to sue their opponents for both affirmative fraud and concealment, even if the resulting harm is purely economic, as long as the resulting harm was not "within the reasonable contemplation of known risks to the parties before entering into their agreement."
• On the other hand, if the parties (or their lawyers after becoming familiar with Rattagan) include a clause in their contract reciting they intend to limit each others' liability to contractual remedies for all claims related to or arising out of the contract's performance including, but not limited to, those for fraudulent concealment, the ELR likely will bar such concealment and other related tort claims e.g., breach of fiduciary duties.
• In either event, claims for affirmative fraud – e.g., false statements of past or existing facts intended to induce, and that do induce, reasonable reliance that results in harm of any sort – are now likely to be allowed, insofar as Rattagan otherwise flatly instructs: "A case in which the plaintiff sues a contractual party for fraud based on conduct committed during the course of a contractual relationship falls outside the economic loss doctrine." 2024 Cal. LEXIS 4639, at *66.

It is important to note that the foregoing pertains only to California law. Some states do not apply the ELR or have exceptions to it, including: Oklahoma and Tennessee (where the ELR applies only to products liability cases). Texas (where the courts have prohibited the application of the ELR as a defense to various statutory claims) and Colorado (where the courts have ruled the Colorado Legislature has the power to create causes of action that trump the ELR). It is unclear whether, if called upon to do so, a California court would enforce a choice of law provision calling for the application of another state's laws that would serve to defeat an otherwise allowable fraud claim on the grounds that doing so would defeat a "fundamental" California public policy.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.