Is the source-of-duty rule a defense to fraudulent inducement claims?
Updated: Nov 28, 2019
S. Wallace Edwards & Sons v. Selective Way Insurance (Va. Nov. 14, 2019)
An insurer reviews a company's operations and recommends a $6 million policy, which the company buys. Uh-oh. An accident causes the company loses of more than $35 million. The company sues, alleging that it was fraudulently induced into the contract. Is this tort action barred by the source-of-duty rule or economic loss doctrine? Virginia Supreme Court: No.
Under the source-of-duty rule, if the duty that the defendant violated arises from a contract, the action rests in contract, and a tort action is barred. For example, if a plaintiff buys an insurance policy, suffers a loss, and submits a claim, which the defendant negligently fails to process, the plaintiff has an action for breach of contract, not negligence. The duty that the defendant violated arose from the contractual relationship, not the common law. Conversely, if the plaintiff meets with the defendant about the claim, tempers flare, and the defendant punches the plaintiff, the plaintiff has a tort action (for battery), not a contract action. The defendant violated a duty imposed by the common law (to not cause harmful or offensive contact with another person), not a contract duty.
The economic loss doctrine is a remedy-specific application of the source-of-duty rule. It provides that when a plaintiff suffers disappointed economic expectations assumed by a contract, then contract law, not tort law, provides the remedy. For example, if the defendant fraudulently misrepresents how it handled the claim, the action still rests in contract, not tort, if the damages arise solely out of the underlying contractual relationship.
But neither the source-of-duty rule nor the economic loss doctrine bar claims for fraudulent inducement into contract. These claims, the Virginia Supreme Court explains, focus on “the purportedly fraudulent actions that were perpetrated before the contract existed.” And because they "logically preexist before the contract allegedly induced," they "thus stand as a viable tort claim."
Bottom line: The source-of-duty rule and economic loss doctrine are not defenses to fraudulent inducement claims.
Epilogue: The trial court in Edwards had dismissed the company's fraudulent inducement claim. Last week, the Virginia Supreme Court reversed the trial court's decision and sent the case back, where the company will now have the opportunity to pursue the claim.