Giddings & Lewis Inc. (a Wis. Corp..) v. Indus. Risk Insurers (an Unincorporated Ass'n)

• Decision Date: 16 June 2011
• Docket Number: 2009–SC–000825–DG.,Nos. 2009–SC–000485–DG,s. 2009–SC–000485–DG
• Court: United States State Supreme Court — District of Kentucky
• Parties: GIDDINGS & LEWIS, INC. (A Wisconsin Corporation), et al., Appellants/Cross–Appellees,v.INDUSTRIAL RISK INSURERS (An Unincorporated Association), et al., Appellees/Cross–Appellants.

348 S.W.3d 729

GIDDINGS & LEWIS, INC. (A Wisconsin Corporation), et al., Appellants/Cross–Appellees,

v.INDUSTRIAL RISK INSURERS (An Unincorporated Association), et al., Appellees/Cross–Appellants.

Nos. 2009–SC–000485–DG

2009–SC–000825–DG.

Supreme Court of Kentucky.

June 16, 2011.

John Lewis Tate, Jason Patrick Thomas, Jamie Kristin Neal, Stites & Harbison, PLLC, Louisville, KY, Counsel for Appellants/Cross–Appellees.Richard C. Roberts, Whitlow, Roberts, Houston & Straub, PLLC, Paducah, KY, James J. Bigoness, Edward M. Kay, Kimberly A. Hartman, Clausen Miller P.C., Chicago, IL, Counsel for Appellees/Cross–Appellants.

Opinion of the Court by Justice ABRAMSON.

The “economic loss rule” prevents the commercial purchaser of a product from suing in tort to recover for economic losses arising from the malfunction of the product itself, recognizing that such damages must be recovered, if at all, pursuant to contract law. Twenty-five years ago, when the United States Supreme Court unanimously adopted the economic loss rule as a common-law aspect of admiralty law, Justice Blackmun observed that while product liability law grew out of a concern that “people need more protection from dangerous products” than might be afforded by warranties, if tort principles were extended too far then “contract law would drown in a sea of tort.” East River Steamship Corp. v. Transamerica Delaval, Inc., 476 U.S. 858, 866, 106 S.Ct. 2295, 90 L.Ed.2d 865 (1986). Aligning itself with what over two decades later is clearly the majority position nationwide, the Supreme Court held that whether a product deteriorates over time or destroys itself in a “calamitous event,” the rule precludes recovery in tort for repair costs, lost profits and other items that essentially equate with “the failure of the purchaser to receive the benefit of its bargain-traditionally the core concern of contract law.” Id. at 870, 106 S.Ct. 2295. Damages for injuries to persons or “other property” may be recovered in tort but a case involving purely economic losses requires resort to the parties' contract and any express or implied warranties. A decade later in Saratoga Fishing Co. v. J.M. Martinac & Co., 520 U.S. 875, 879, 117 S.Ct. 1783, 138 L.Ed.2d 76 (1997) the Supreme Court confronted what constitutes the “product itself” for purposes of the economic loss rule and, ultimately, held that “[w]hen a manufacturer places an item in the stream of commerce by selling it to an Initial User, that item is the ‘product itself.’ ” While neither opinion is binding on this Court, each is instructive in deciding the commercial dispute currently before us.

The Supreme Court of Kentucky has not heretofore charted a course in what commentators and courts across the country have referred to as the “choppy waters” of the economic loss rule. Although our Court of Appeals applied it in a classic commercial transaction context some twenty years ago, Falcon Coal Co. v. Clark Equipment Co., 802 S.W.2d 947 (Ky.App.1990), this Court denied discretionary review of that case and then hinted that Falcon Coal's holding was too broad in Real Estate Marketing, Inc. v. Franz, 885 S.W.2d 921 (Ky.1994), a case regarding the sale of a defective house where the economic loss rule was really never implicated. In the midst of this confusion, numerous federal courts have attempted to predict what this Court would do if squarely confronted with a commercial case where the economic loss rule would potentially apply. This case presents that opportunity. Today we hold that the economic loss rule applies to claims arising from a defective product sold in a commercial transaction, and that the relevant product is the entire item bargained for by the parties and placed in the stream of commerce by the manufacturer. Further, the economic loss rule applies regardless of whether the product fails over a period of time or destroys itself in a calamitous event, and the rule's application is not limited to negligence and strict liability claims but also encompasses negligent misrepresentation claims. As for the impact of the rule on fraud claims, that issue awaits another case because the plaintiffs in this case pled fraud by omission, a claim that is unsustainable on the record before us, irrespective of the economic loss rule.

RELEVANT FACTS

Appellee Ingersoll Rand purchased from Appellant Giddings & Lewis, Inc. a Diffuser Cell System for use in its Mayfield, Kentucky plant. The Diffuser Cell System, which consisted of a vertical turning lathe, two vertical machining centers, and a material handling system, was used to cut and shape metal parts through a series of steps. First, the operator would secure a block of metal onto the large pallet with a clamp. The material handling system then automatically shuttled the pallet and block of metal into the vertical turning lathe, which spun the pallet and metal block while computer-controlled cutting tools shaped the metal block. Next, the material handling system automatically shuttled the pallet and shaped metal into the vertical machining center, where the shaped metal was finished into its final form.

Ingersoll Rand's engineers provided Giddings & Lewis with extensive specifications for the Diffuser Cell System, including the requirement that the vertical turning lathe operate at a maximum of 690 RPM (revolutions per minute), a speed that was considerably faster than the 400 RPM customary on Giddings & Lewis machines. Giddings & Lewis apparently redesigned the bearings, transmission, and the pallet material to accommodate Ingersoll Rand's specifications, and then manufactured the Diffuser Cell System generally to the specifications provided by Ingersoll Rand in an eight-page document. The parties' written contract included an express warranty that provided inter alia that the goods furnished were “the best quality of their respective kinds and ... free of defects in design, workmanship, or material.”

After seven years of virtually continuous operation, by which time the express warranty had expired, an incident occurred in which the clamp, the pallet and a large chunk of spinning metal flew off the vertical turning lathe and catapulted around the workspace in Ingersoll Rand's plant. The clamp weighed 3400 pounds, the pallet 1500 pounds and the chunk of metal approximately 300 pounds. No one was injured and damage to property beyond the Diffuser Cell System itself, if any, appears to have been minimal. Ingersoll Rand engaged Giddings & Lewis to rebuild the System and filed a claim with its (Ingersoll Rand's) insurers, which paid $2,798,742.00 for repairs to the damaged machinery, overtime payments to employees and related expenses.

The insurers, now the Appellees and collectively referred to as Industrial Risk Insurers,¹ then sued Giddings & Lewis to recover the amount paid, claiming breach of implied warranty, breach of contract, negligence, strict liability, negligent misrepresentation and fraud by omission. Giddings & Lewis moved for summary judgment, which was initially denied by the trial court but granted upon reconsideration.² The trial court agreed Industrial Risk Insurers' implied warranty claim was barred by the statute of limitations and held that the economic loss rule, which it found was implicitly adopted by the Court of Appeals in Falcon Coal Co. v. Clark Equip. Co., barred the tort claims, including those for fraud and negligent misrepresentation. The trial court considered but declined to adopt the “calamitous event” exception to the economic loss rule. Finally, the trial court held the vertical turning lathe, the two vertical machining centers, and the material handling system constituted the product, effectively preventing Industrial Risk Insurers from recovering for damage to any part of the Diffuser Cell System.

The Court of Appeals affirmed the trial court's explicit adoption and application of the economic loss rule and agreed the calamitous event exception should be rejected. However, relying on Justice Keller's dissent in Presnell Construction Managers, Inc. v. EH Construction, LLC, 134 S.W.3d 575 (Ky.2004), the Court of Appeals found the economic loss rule did not bar Industrial Risk Insurers' negligent misrepresentation and fraud claims because they arise in tort, independent of any contractual duty. The Court of Appeals also reversed with respect to whether the components of the Diffuser Cell System constituted one product or several individual products, finding this a question of fact for the jury.

This Court granted Giddings & Lewis' ensuing motion for discretionary review as well as Industrial Risk Insurers' cross-motion. Giddings & Lewis argues the negligent misrepresentation and fraud claims should be barred by the economic loss rule because they are not distinct tort claims arising independent of the contract. Rather, both claims reference the quality or character of the Diffuser Cell System and are thus simply the warranty claims “repackaged” which causes them to fall squarely within the ambit of the economic loss rule. Industrial Risk Insurers counters that the tort claims are not based solely on the product's failure to perform but are premised on classic tort theories beyond the scope of the economic loss rule. Industrial Risk Insurers posits that if this Court does adopt the economic loss rule, it should include exceptions for negligent misrepresentation and fraud claims and, further, an exception for “calamitous events.”

Giddings & Lewis also maintains that the Diffuser Cell System constituted one product and the component parts should not be considered “other property” for purposes of the economic loss rule. Noting that the Court of Appeals' view is contrary to established precedent, Giddings & Lewis argues that that court's position would bring only the simplest of machines, those with no components, within the purview of the economic loss rule. Industrial Risk Insurers maintains the individual components...