The Economic Loss Rule: Why Some Fraud and Negligence Claims Fail in Texas

What the rule is for

Tort law and contract law allocate risk differently. Contract law lets the parties set their own terms, limits and remedies; tort law imposes duties and remedies the parties never bargained for, including exemplary damages. The economic loss rule keeps the two in their places. It prevents a party from converting an ordinary breach of contract into a tort by relabeling it, and it limits negligence claims for pure financial loss between parties who never dealt with each other. Texas applies it, but, as the Texas Supreme Court has stressed, not as a single rule that bars every tort claim for money.

The first limit: contract parties

When two parties have a contract and the plaintiff's only injury is the economic loss to the subject of that contract, Texas treats the claim as one for breach of contract. The Texas Supreme Court set out the test in 1991: look to the source of the duty and the nature of the injury. If the defendant's duty arose only from the contract, and the loss is only the benefit of that bargain, the action sounds in contract alone. A delivery that was late, software that did not perform, a service done poorly, a payment that was short: these are contract claims even if the plaintiff pleads them as negligence.

Two consequences follow. The plaintiff is held to the contract's remedies, limitations of liability and fee provisions, and cannot reach exemplary damages. And a plaintiff who wants a tort must identify a duty independent of the contract and an injury beyond the contract's subject matter.

Where the parties have a contract covering the subject, Texas courts generally bar negligent misrepresentation claims that complain of the same failure. A statement about what the defendant would do under the contract is a promise, enforceable in contract, not a tortious misrepresentation of fact. The claim and its limits are covered in negligent misrepresentation in Texas.

The second limit: strangers to the contract

The other branch applies where the plaintiff has no contract with the defendant. In LAN/STV v. Martin K. Eby Construction Co. (Tex. 2014) a general contractor sued the project architect, with whom it had no contract, for negligence, claiming the architect's defective plans caused it millions in delay and rework costs. The Texas Supreme Court held the claim barred. The contractor's losses were purely economic, it had a contract with the owner that allocated the risk of defective plans, and allowing a negligence claim across the contractual chain would upset the allocation the parties had made. The court explained that the rule reflects a judgment that economic losses on a construction project are best managed through the chain of contracts rather than through tort duties among parties who never agreed with each other.

The same reasoning limits a subcontractor's negligence claim against a design professional, a buyer's negligence claim against a remote manufacturer for a product that merely fails to perform, and similar claims. The remedy for a stranger is to pursue the party it did contract with, who in turn pursues the next link.

Not a general bar: Sharyland

Defendants sometimes argue that the economic loss rule bars any tort claim for financial loss. The Texas Supreme Court rejected that in Sharyland Water Supply Corp. v. City of Alton (Tex. 2011). A water supply corporation sued contractors who, under a contract with the city, installed sewer lines over its water lines in violation of regulations, creating a contamination risk that required costly remediation. The contractors argued the rule barred the negligence claim because the losses were economic. The court disagreed: the rule had been applied in Texas in specific contexts, principally between contracting parties and in products liability cases where a defective product damages only itself, and it had never been extended to bar every negligence claim for economic loss by a party outside the contract. Sharyland's water lines were its property, the contractors owed it a duty not to damage them, and the claim proceeded.

Read together, Sharyland and LAN/STV draw the line. A stranger whose property was damaged by the defendant's negligence has a claim. A stranger whose only loss is the cost of a contract made worse by the defendant's negligence usually does not.

The exception that matters most: fraudulent inducement

The economic loss rule does not bar a fraud claim based on a false statement that induced the plaintiff to enter the contract. In Formosa Plastics Corp. v. Presidio Engineers and Contractors (Tex. 1998) the Texas Supreme Court held that the duty not to fraudulently procure a contract is independent of the contract itself, and that a party who was induced to sign by a knowing misrepresentation may recover tort damages for the fraud even though the damages are economic and even though a contract claim also exists. The reasoning is that the fraud occurred before the contract and corrupted the agreement itself; the plaintiff is not complaining that the defendant performed poorly but that there should never have been a bargain on those terms.

The exception has edges. It covers fraud in the inducement, not every fraud pleaded after a contract fails. A statement about future performance is fraud only if the speaker had no intention of performing when made; mere nonperformance is not evidence of that. That line is drawn in fraud versus a broken promise. And a clear, negotiated disclaimer of reliance can bar even a fraudulent inducement claim on separate grounds.

Other claims the rule does not reach

• Breach of fiduciary duty. The duty arises from the relationship, not the contract, so a partner or agent who breaches it is liable in tort even where a partnership or agency agreement exists.
• Conversion and civil theft. Taking the plaintiff's property is an independent wrong.
• Statutory claims. The DTPA, the Theft Liability Act and statutory fraud under section 27.01 of the Business and Commerce Code create their own duties; whether a statutory claim survives alongside a contract is governed by the statute's own terms and exemptions rather than the economic loss rule.
• Damage to other property. A product or service that damages property other than itself supports a negligence claim for that damage, as Sharyland illustrates.
• Tortious interference. A third party who induces a breach of your contract owes you a duty independent of any contract with you.

Example

Suppose a McKinney logistics company contracts with a software vendor for a routing system. The vendor's salesperson said before signing that the system "handles 5,000 stops a day"; the vendor's own testing, found later in discovery, showed it failed above 1,500. After signing, the vendor also missed two delivery milestones. The company sues for breach of contract, negligence, negligent misrepresentation and fraud. The negligence and negligent misrepresentation claims about the missed milestones and poor performance are barred: the duty came from the contract and the loss is the contract's subject. The fraud claim about the 5,000-stop statement survives under Formosa, because it induced the contract and the vendor knew it was false, unless the contract contains an enforceable disclaimer of reliance. The company ends up with a contract claim, subject to the contract's limitation clause, and a fraudulent inducement claim that is not.

How the rule is used in a case

Defendants raise it early: in a Rule 91a motion to dismiss tort counts that merely restate the contract claim, and at summary judgment once the record shows the source of the duty and the nature of the loss. Plaintiffs answer by identifying an independent duty, an injury to person or other property, a pre-contract misrepresentation of fact, or a statutory claim. The pleading matters: a petition that alleges the defendant "negligently failed to perform the contract" invites dismissal; one that alleges a false statement of existing fact before signing, with the facts showing knowledge, does not. In federal court the same substantive rule applies to Texas-law claims, with Rule 9(b) requiring the fraud to be pleaded with particularity.

What it means for a business weighing a claim

Before pleading a tort, ask three questions. Did the defendant's duty exist apart from the contract? Is the loss something other than the benefit of the bargain? Did a false statement of fact induce the agreement? If the answer to all three is no, the case is a contract case, and it should be evaluated as one: the contract's remedies, its limits, and its fee clause set the stakes. If the answer to any is yes, a tort claim is available and changes the exposure, including the possibility of exemplary damages. Tina Wysk represents businesses in contract disputes and fraud claims in Dallas state and federal courts, and the first task in many of them is deciding which the case really is.