Pure Economic Loss — SQE1 FLK1 Tort Law

A contractor digging a trench cuts through an underground cable, and a bakery loses power for two days. Three losses follow. A batch of bread already in the ovens is ruined. The orders for that batch cannot be filled. And for two days the ovens stand idle while undamaged flour sits in the store. Which of the three can the bakery recover? Two.

Not the third. Bread that was never baked, from flour that was never harmed, is pure economic loss, and the law will not pay for it. That single line, between money lost with damage behind it and money lost on its own, runs through everything here. Pure Economic Loss, the fifth topic in Tort Law. Keep the bakery in mind.

Here is the route. What pure economic loss is, and why the courts treat it differently. Then the general rule, and the policy behind it. Then careless acts, and the long retreat over defective buildings. Then the main exception, the careless statement. Then the professionals: surveyors, solicitors, employers. Then disclaimers. And last, how far a duty actually stretches.

Start with the definition, because everything turns on it. Pure economic loss is financial loss that is not accompanied by any physical damage to person or property. Loss that exists only on a balance sheet. A negligent builder puts up a wall and it collapses. Nobody is hurt. No other property is damaged. You have simply lost money.

Now compare. Your car is damaged in a crash and you lose earnings while it is repaired. That loss is recoverable, because it flows from physical damage. Lose money purely because someone else was careless, with no injury and no damage to your property, and the courts are far more reluctant. So the first question in every one of these problems is the same. Was anything physically damaged?

The general rule is blunt. There is no duty of care to prevent pure economic loss. It is a strict exclusion. Even if the defendant was careless, and even if your financial loss was entirely foreseeable, the claim will usually fail. You need a recognised exception. Foreseeability on its own never gets you there.

The foundational case is from 1875. A contractor was building a tunnel under a road for a fixed price. A water company had laid a nearby main carelessly, it leaked, and the works flooded. The job took longer, cost more, and the contractor lost his profit. He had no proprietary interest in the flooded land. No recovery.

Try that rule on harder facts. A ferry company works from a jetty under a contractual licence, owning no part of it. A ship is navigated carelessly into the jetty, which is out of use for two months, and the ferry loses a great deal of trade. Recoverable? No. A licence is a personal permission, not an interest in the property that was damaged.

Then the case that gave us the working test. An excavator cut a cable and cut off electricity to a steel factory. Lord Denning divided the loss in three. One: damage to the metal being melted in the furnace at the time, recoverable as physical damage. Two: lost profit on that metal, recoverable, because it flows from the damage. Three: lost profit on metal they could not melt at all. Not recoverable. Spartan Steel v Martin, from 1973.

Which answers the bakery. The ruined batch is physical damage to its own property. The profit on that batch flows from the damage, so it comes too. The bread never baked stands on its own. Same accident. Same carelessness. Two heads paid, one refused.

Why draw the line there? Because of what happens if you do not. A haulage company carelessly delays a delivery to a car factory and the line stands idle for a week. The parts supplier due to deliver that week loses its orders. The firms supplying that supplier lose theirs. None of them owned anything that was damaged. Where does it stop?

Two words carry the answer in an exam. Floodgates. And indeterminate liability. Behind them sit allocation of risk, fairness to defendants, and the difficulty of measuring the loss at all.

Most of these claims come from careless statements. But careless acts cause pure economic loss too, and the great example is the defective building. That story is an arc. A bold expansion, then a long retreat. You need both ends of it.

In 1978 the House of Lords held that a local authority owed a duty to later purchasers of flats when it approved defective foundations. The cost of underpinning was pure economic loss, and Lord Wilberforce got there with a two-stage test. Is there a prima facie duty, on foreseeability and proximity? Then, does policy take it away? A duty was found.

By 1989 the retreat had begun. A claim over defective plasterwork in a block of flats failed, and the reason matters. The claim was for the cost of the defective work itself, not for damage that defect had done to anything else.

Then in 1990 the House of Lords overruled the 1978 decision outright. A local authority owes no duty of care in negligence to the purchaser of a building for pure economic loss caused by structural defects. Lord Keith put it plainly: the cost of repairing a defective building is pure economic loss. The remedy lies in contract, against the builder. Not in tort, against the authority. Murphy v Brentwood DC.

Candidates try to escape Murphy with a clever argument. A defective beam cracks the walls around it, so surely that is damage to other property? No. A building is treated as a single thing, so a defect that damages the rest of it is not damage to separate property.

So is the owner of a badly built house left with nothing? Not necessarily. Section 1 of the Defective Premises Act 1972 imposes a duty on anyone doing work on a dwelling. Do it in a workmanlike manner, with proper materials, so the dwelling is fit for habitation. It is owed to whoever ordered the work and to everyone who later acquires an interest.

One narrow survivor remains for careless acts, from 1983. A specialist flooring contractor laid a floor carelessly and it had to be relayed. There was no contract between that firm and the building owner. The House of Lords still found a duty, because the relationship was equivalent to contract. The owner had chosen the firm for its specialist skill, dealt with it directly, and relied on it, and the firm knew as much.

Test whether you have it. A woman engages a builder for an extension. The builder picks a plumbing firm for its reputation and engages it as a sub-contractor, and she never deals with anyone from it. The pipework is laid carelessly and has to be replaced. Duty? No. She neither chose the firm nor relied on its skill. The exception needs both.

Now the main exception, and the one that matters most. The careless statement. An advertising agency wanted to know whether a customer was good for its bills, so it asked its bank to get a credit reference. The customer's own bankers replied that the customer was respectably constituted and good for their ordinary business engagements. The agency extended credit. The customer went into liquidation, and the agency lost its money.

The House of Lords held that a duty of care can exist for a careless statement, but only where there is a special relationship between the maker and the recipient. Then the twist. The bankers had written that the reference was given without responsibility. The disclaimer worked and the claim failed. The principle was born in a case the claimant lost. Hedley Byrne v Heller, from 1964.

Four requirements. One: a special relationship, where the maker has special knowledge or skill and the recipient reasonably relies on it. Two: assumption of responsibility, express or implied from the circumstances. Three: reliance, meaning the claimant actually relied on the statement in deciding what to do. Four: foreseeability that the claimant would suffer economic loss if the statement was wrong.

Assumption of responsibility does the real work. The maker has taken it upon themselves to see that the statement is accurate. Express, where a professional agrees to advise. Implied, where a surveyor knows a lender will rely on the valuation. Carelessness alone is not enough. Something about the relationship has to justify the duty.

Here is one that catches people. A woman who knows nothing about cars asks a friend, not a mechanic but known to be knowledgeable, to find her a good second-hand one. She says plainly that she is relying on his judgement. He inspects a car, misses clear evidence that it had been in a serious crash and badly repaired, and recommends it. No fee. No professional relationship. Duty? Yes. He had relevant knowledge, and her reliance was reasonable.

Now the case on the other side of that line. A company considering a takeover bid relied on the target's audited accounts, which showed a profit when the company was making a loss. It bought, and lost heavily. The House of Lords held the auditors owed it no duty. The accounts were prepared for the company and its shareholders as a body, not for the purposes of a bidder. Caparo v Dickman, from 1990.

That case gave us the three-part test as well. Foreseeability, proximity, and whether a duty would be fair, just and reasonable.

Professionals now, and three positions worth holding. A building society instructs a surveyor to value a modest house for mortgage purposes. He knows that buyers of houses like this almost always rely on the mortgage valuation instead of paying for a survey of their own. He overvalues it. She relies on the report and buys. Duty owed to her, though she never instructed him. Smith v Eric S Bush, from 1990.

Second. A testator instructed his solicitor to change his will to leave legacies to two of his daughters. The solicitor delayed. The testator died before the new will was executed, and the daughters lost their legacies. The House of Lords held the solicitor owed them a duty. Lord Goff's reasoning was practical. The estate had lost nothing, so it had no claim, and the daughters had no contract. Tort was the only remedy available. White v Jones, from 1995. An exception, not a rule about solicitors generally.

Third. An employer who gives a reference about a former employee owes that employee a duty to take reasonable care over it. A careless reference will be relied on, and will cost the employee the job. Same principle, from 1995.

Disclaimers next, and they are a real defence. A disclaimer works by negativing the assumption of responsibility, so no duty ever arises. But it has to earn that. It must be communicated to the recipient before they rely. It must be clear and unambiguous. And it must actually be brought to their attention. There is also one thing no disclaimer can do, and we will come to it.

Which decides this one. A man asks accountants for a report before investing. It runs to forty pages, with a line in small print below the appendices on the last page saying no responsibility is accepted. He never sees it. Effective? No. Present in the document is not the same as brought to his attention.

One last idea, and it is where the modern cases have gone. Even where a duty exists and has been broken, the defendant answers only for loss within the scope of that duty. A valuer overvalues a property, the lender lends, the borrower defaults, and by the time of sale the market has fallen sharply. The valuer pays for the valuation being wrong. Not for the market.

Lord Hoffmann's example makes it stick. A doctor negligently passes a climber's knee as fit. The climber goes to the mountains and is injured in an avalanche. The doctor is not liable, because the knee was the only risk he undertook to guard against.

In 2021 the Supreme Court restated the point. The decisive question is the purpose of the duty. What risk was the defendant undertaking to guard against? In one of those cases a doctor failed to warn a patient that she carried the gene for a serious blood disorder. Her child was born with that disorder and, by unrelated chance, a separate disability. The doctor answered for the first. Not the second.

So the method, in four steps. Is this pure economic loss, or does it flow from physical damage? If pure, was it a careless act or a careless statement? If a statement, run the four requirements. Then check for a disclaimer. In that order, these questions become mechanical.

A word on how SQE1 tests this. You will not be asked to name a case or quote a section number. You get a scenario, five answers, and one instruction: pick the best one. So learn the rules, and how they decide facts. The names in this episode are memory pegs, nothing more.

If you keep only three. Spartan Steel v Martin, for the three heads of loss, because that is where most of these questions begin. Hedley Byrne v Heller, for the exception that covers the most ground. And Caparo v Dickman, for the line that exception stops at.

Four traps the examiners set. One: pure and consequential economic loss are not the same thing. Consequential loss flows from physical damage and is recoverable. Pure economic loss stands alone. Before anything else, ask whether the claimant's own person or property was damaged.

Two: the two-stage test from 1978 is not the law. A prima facie duty on foreseeability and proximity, unless policy takes it away, was departed from in 1990. An established category is decided by precedent, and only a genuinely novel one reaches for fairness.

Three: auditors owe nothing to individual shareholders or to would-be investors. Their duty runs to the company and the shareholders as a body. Buy shares on the strength of published accounts that turn out to be wrong, and you generally cannot sue the auditor.

Four, and this is the thing no disclaimer can do. Under section 2(1) of the Unfair Contract Terms Act 1977, liability for death or personal injury resulting from negligence cannot be excluded or restricted. However widely it is drafted. For other loss it may still work, if it is reasonable.

Quick check. A bank is asked to lend a substantial sum to a trading company. Before deciding, it obtains the company's most recent audited accounts from the public register and reads them carefully. Those accounts were prepared to meet the company's statutory reporting obligations, and the auditors were never told of the bank or of the proposed loan. The accounts carelessly overstate the profits. The bank lends, the company fails, and the loan is not repaid.

Three candidate answers. One: it will succeed, because the auditors could foresee that a lender might read the published accounts. Two: it will fail, because the audit was for the company's statutory purposes, not to guide the bank. Three: it will succeed, because the accounts were careless and the bank lost its money relying on them. Pause here if you want a moment.

The answer is two. An auditor owes no duty to a third party who reads statutory accounts and relies on them for a transaction of its own. The audit is provided so that the members as a body can control the company. There is neither proximity nor an assumption of responsibility towards a lender the auditor knew nothing about.

Why the others fail. One rests on foreseeability alone, and foreseeability does not create proximity for pure economic loss. If it did, published accounts would found duties to the world. Three stops at carelessness and loss. Neither is enough without a duty owed to this claimant, for this purpose.

Five things to take away. One: pure economic loss is financial loss with no physical damage behind it, and no duty is owed. Two: loss flowing from damage to your own person or property is recoverable. That is the bakery.

Three: the cost of putting right a defective building is pure economic loss, so the claim lies in contract, or under the Defective Premises Act 1972 for a dwelling. Four: the careless statement is the great exception, on a special relationship, an assumption of responsibility, reliance, and foreseeable loss. Five: a disclaimer can stop the duty arising, but only if it reaches the recipient before they rely.

And the bakery? Ruined batch, paid for. Profit on that batch, paid for. Bread never baked, refused. Ask what was damaged before you ask what was lost. Next time, Employers' and Vicarious Liability.

Practise this topic with exam-style questions at sqe1prep.co.uk. This episode is for education and exam revision only, not legal advice, and we are not affiliated with or endorsed by the SRA or Kaplan.