Subrogation Claims by Insurers Against Product Manufacturers and the Economic Loss Rule: Standing in the Shoes of the Insured
Product manufacturers often face the challenge of responding to tort claims brought by a plaintiff for personal injury damages, and by the plaintiff’s insurer for recovery of monies paid to the insured plaintiff by the product manufacturer. In essence, the insurer aims to step into the shoes of the plaintiff-insured by asserting claims in tort against the product manufacturer for damage to a finished product. However, an insurer acting as a subrogee merely succeeds to the legal rights or claims of a subrogor. See Trogub v. Robinson, 853 N.E.2d 59, 63 (Ill. App. Ct. 2006). “Subrogation simply means substitution of one person for another; that is one person is allowed to stand in the shoes of another and assert that person’s rights against the defendant.” Id. (internal quotations omitted). Subrogation rights originated in common law, but may also be created by statute or contract.
The insurer’s claim as subrogee is contingent on the subrogor having a cause of action against the product manufacturer. In other words, the subrogee can only recover damages when the subrogor has a legally cognizable cause of action against the product manufacturer. See Universal Underwriters Ins. v. A. Richard Racin, Inc., 916 A.2d 686, 692 (Pa. Super. Ct. 2007). Although subrogation is designed to afford relief to a third party, such as an insurer required to pay a legal obligation which ought to be met by a defendant, standing in the shoes of the insured has its limitations. Namely, while the subrogee “stands in the shoes” of the subrogor and is entitled to all of the rights of its subrogor, it is also subject to all of the limitations to which the subrogor would be subject. See, e.g., Allstate Ins. Co., v. Metro. Dade Co., 436 So. 2d 976, 978-79 (Fla. 3d DCA 1983) (affirming summary judgment in favor of the defendant because the statute of limitations had lapsed on the subrogor’s claim). Notably, the insurer’s contractual rights as subrogee do not create any independent right of recovery beyond that of the insured.
Economic Loss Rule
One significant limitation to recovery in product liability cases is the economic loss rule. Courts across the United States have held that the economic loss rule bars claims by an insured for damage to a finished product. See generally, Pugh v. Gen. Terrazzo Supplies, Inc., 2007 WL 2005063, at * 1 (Tex. Ct. App. July 12, 2007) (finding that the economic loss rule barred homeowners’ strict liability and negligence claims against a manufacturer of veneer for property damage to a home). Similarly, such claims by an insurer, as subrogee, are subject to the economic loss rule.
The economic loss rule provides that tort recovery in strict product liability and negligence against a manufacturer is not available to a downstream purchaser when the claimed losses flow from damage to a property that is the subject of a contract – here, an insurance policy – and personal injury is not alleged or at issue. See Weiss v. Polymer Plastics Corp., 21 A.D.3d 1095, 1096 (N.Y. App. Div. 2005) (holding that tort-based causes of action against a manufacturer were barred by the economic loss rule). The rule applies to economic losses to the product itself, such as repair or reconstruction, as well as consequential damages resulting from the alleged defect. Id.; see also Gunkel v. Renovations, Inc., 822 N.E.2d 150, 154 (Ind. 2005). “The insight behind the doctrine is that commercial disputes ought to be resolved according to the principles of commercial law rather than according to tort principles designed for accidents that cause personal injury or [other] property damage.” Miller v. U.S. Steel Corp., 902 F.2d 573, 574 (7th Cir. 1990) (holding that buyers could not use tort law to recover against a manufacturer the cost of replacing the defective product sold to them).
The United States Supreme Court applied the economic loss rule to a product liability case in East River Steamship Corporation v. Transamerica Delaval, 476 U.S. 858 (1986). The Supreme Court first noted that the law of product liability grew out of a public policy to offer injured persons greater protection from dangerous products than is afforded by the warranty of law. Where, however, this tort concern is not triggered and only a product is injured, a plaintiff’s loss is essentially the loss of the product, which is a loss that can be insured. See East River, 476 U.S. at 872; see also Comptech Int’l, Inc. v. Milam Commerce Park, Ltd., 753 So. 2d 1219, 1224 (Fla. 1999) (“In contrast [to the tort concern with safety], when a product injures itself, the commercial user stands to lose the value of the product, risks the displeasure of its customers who find that the product does not meet their needs, or ... experiences increased costs in performing a service. Losses like these can be insured.”). Thus, a product injuring itself is not the kind of harm against which public policy requires manufacturers to protect, particularly when a plaintiff can recover in claims for breach of contract or breach of warranty. See, e.g. Murray v. Ford Motor Co., 97 S.W.3d 888, 892 (Tex. App. 2003).
For example, in State Farm Mutual Automobile Insurance Company v. Ford Motor Company, 13 Misc. 3d 1231(A), 2006 WL 3069287, at *1 (N.Y. Civ. Ct. Oct. 20 2006), a subrogee filed suit against its subrogor’s vehicle manufacturer for strict liability and negligence. The subrogee alleged that the vehicle suffered a mechanical breakdown and failure, caught fire and sustained property damage because of its defective design. Following the U.S. Supreme Court’s East River decision, the lower court dismissed the plaintiff’s claims for strict liability and negligence because the subrogee’s claimed losses flowed from damage to the property only and no personal injury was claimed. State Farm Mutual, 2006 WL 3069287, at *1. Simply stated, because the insured had no cause of action against the vehicle manufacturer, neither did the insurer.
Similarly, in American Universal Insurance Group v. General Motors Corporation, 578 So. 2d 451, 453 (Fla. 1st DCA 1991), an allegedly defective oil pump failed and caused damage to the entire engine. The plaintiff sued the manufacturer of the completed product in tort for the value of the damage to the property. The American Universal court held that when the engine was destroyed by the allegedly defective oil pump, this constituted damage to the product itself and was therefore an economic loss for which recovery in tort was barred. Id. The court found that the oil pump was an “integral or component part of the engine ... and thus the damage to the engine caused by this component part was not damage to ‘other property.’” Id. at 453. Thus, damage to the finished product was insufficient to overcome the economic loss rule because the allegedly defective product was an integral part of the finished product. See, e.g., Am. Eagle Ins. Co. v. United Tech. Corp., 48 F.3d 142, 144-45 (5th Cir. 1995) (affirming summary judgment in favor of a manufacturer where the allegedly defective engine was an integral part of the damaged aircraft hull; the plaintiff could not recover under negligence and strict liability theories for such damage).
Moreover, even when the product and component part have been destroyed, a court may find the economic loss rule to bar a subrogee’s tort claims against the product and component part manufacturers, despite the loss of the entire product and without finding that the component part was an integral part of the final product. The Third District Court of Appeal of Florida affirmed summary judgment in favor of manufacturers of a boat and a component part in National Marine Underwriters, Inc. v. Donzi Marine Corporation, 655 So. 2d 176 (Fla. 3d DCA 1995), where a fire caused by the malfunctioning of the electrical component destroyed the boat at a storage facility. The boat owner’s insurer paid the owner for the destruction of the vessel itself, and then asserted tort claims against the boat manufacturer and the manufacturer of the allegedly defective electrical component which caused the fire. The fire also destroyed personal property aboard the vessel, which was not covered by the insurer. The appellate court found that it was not enough to overcome the economic loss rule that the vessel fire caused damage to contents. See Nat’l Marine Underwriters, 655 So. 2d at 177. The subrogee had to actively assert a claim for property damage other than to the product itself or personal injury in order to proceed in tort. Id. The insurer’s failure to pay the owner for the vessel’s contents proved fatal to the insurer’s subrogation action against the manufacturers on a tort theory.
Nonetheless, the economic loss rule has limitations. In particular, when an insurer issues a warranty for a product, a court may be less inclined to find the economic loss rule applicable. For example, in Ohio Casualty Insurance Company v. Vermeer Manufacturing Co., 298 F. Supp. 2d. 575 (W.D. Ky. 2004), the Western District of Kentucky concluded that the economic loss rule barred a subrogee’s claim for negligent misrepresentation against a manufacturer; the economic loss rule did not apply, however, to the subrogee’s warranty claim. Ohio Casualty involved a tub grinder destroyed by a fire. The insurer sought reimbursement from the tub grinder’s manufacturer for the cost of the tub by “stepping into the shoes” of the insured-purchaser. Ohio Cas. Ins. Co., 289 F. Supp. 2d at 577. The district court applied the economic loss rule and granted summary judgment in favor of the manufacturer on the subrogee’s negligent misrepresentation claim because “misrepresentation is essentially the defendant failing to meet the plaintiff’s commercial expectations, which were covered by warranty and because the plaintiff was seeking purely economic loss ... .” Id. at 578. The court went on to state that even a fraudulent inducement claim would not survive the economic loss rule. Id. at 579.
In contrast, the Western District of Kentucky determined in the same case that “common sense” rendered the economic loss role inapplicable to the subrogee’s warranty claims. The economic loss rule did not bar the insurer’s warranty claim in subrogation against the manufacturer because the insurer had bargained for the benefit that the product would function properly. Ohio Cas. Ins. Co., 298 F. Supp. 2d at 579. “The essence of a warranty is to offer repayment for the damage to the product itself premised on the implicit bargain between the buyer and seller. “For the economic loss rule to apply to warranty claims would effectively end all warranty.” Id. Thus, in the absence of precedent, the district court favored a public policy of enforcing contractual obligations.
Another limit to the economic loss rule may be the Restatement (Second) Torts § 402A. The District Court of Colorado interpreted § 402A to “give rise to duties independent of those manufacturers may to choose to assume or disclaim in a warranty ... .” U.S. Aviation Underwriters, Inc. v. Pilatus Bus. Aircraft, Ltd., 358 F. Supp. 2d 1021, 1024 (D. Colo. 2005). In essence, the court used § 402A as support for its position that an insurer suffered more than economic damages when its insured’s aircraft crashed and fell to the bottom of the sea following engine failure. Invoking its subrogation rights, the insurer had commenced a product liability action for strict liability and negligence against the engine’s manufacturer. The district court distinguished East River as barring negligence and strict liability claims “where economic damage is caused by a breach of duty voluntarily assumed in contract and which results from a failure of the purposes or expectancies under the contract.” Id. at 1025. Where an insured’s loss exceeds the limits of those expectancies or is the result of a breach of duties arising independently of the contract, such as under § 402A, the economic loss rule does not apply. Id. The district court denied the manufacturer’s motion for summary judgment and allowed the subrogee’s tort claims to proceed because the loss of the entire product was exactly “the kind of harm against which” public policy requires manufacturers to protect, independent of any contractual obligation.” Id. at 1027.
In sum, an insurer may find it easy to step into the shoes of its insured to assert a subrogation claim for strict liability and negligence against a product manufacturer to recover money paid to its insured pursuant to a policy of insurance on the finished product. However, asserting the claim is only the first step. Along the way, the economic loss rule is a significant pitfall which an insurer will have to overcome if it is seeking recovery of losses to the finished product only. By not considering the economic loss rule and any other limitations on its tort claims, an insurer may fail to recover in subrogation to the benefit of a manufacturer.