COURT CLARIFIES “PROXIMATE CAUSATION”

The traditional approach to proximate causation focuses on the foreseeability of the harm suffered by the plaintiff. For example, Illinois Pattern Jury Instruction (Civil) 15.01 defines “proximate cause” as “a cause that, in the natural or ordinary course of events, produced the plaintiff’s injury.”

Rejecting the old terminology as confusing, Section 29 of the new Restatement (Third) of Torts explains that the phrase “proximate cause” is “a poor one to describe limits on the scope of liability.” Comment b.

“Even if judges and lawyers understand the term,” the Restatement explains, “it is confusing for a jury. Courts should craft instructions that inform the jury that, for liability to be imposed, the harm that occurred must be one that results from the hazards that made the conduct tortious in the first place.” Comment b.

To clarify causal limits on tort liability, the new Restatement focuses on risk of harm – and whether the injury suffered by the plaintiff was within the category of harms that were threatened by the type of tortious conduct engaged in by the defendant.

As articulated in Section 29:

“An actor’s liability is limited to those physical harms that result from the risks that made the actor’s conduct tortious.”

Providing a useful review of the new approach to proximate cause, the Iowa Supreme Court reversed a judgment of $838,000 for fraud.

The case involved an alleged misrepresentation by a bank president about the plaintiff’s liability on a personal guaranty. Yet the verdict included damages for the insolvency of a new business venture.

Although the plaintiff was entitled to some damages for fraud by the bank, the harm suffered by the plaintiff when his new business became insolvent was not within the risk of harm presented by the banker’s misrepresentation about liability under a personal guaranty. So the case was remanded for re-trial on damages.

As the Iowa Supreme Court explained:

“The modern trend is to refocus the analysis of legal causation from the foreseeability of harm to a risk-based standard. See Restatement (Third) of Torts, Liability for Physical Harm § 29 cmt. j (Proposed Final Draft No. 1 2005).

“In negligence cases causing physical harm, tort liability now focuses on whether the risk that produces liability actually caused the damages suffered. The scope of liability is limited to harms that result from the risks that made the actor’s conduct tortious.

“The shift in analysis has primarily occurred to clarify the often confusing concept of legal causation, not to change the substantive scope of liability.”

“Stated in terms of risk instead of foreseeability,” the high court continued, “this principle limits the scope of liability for tortious conduct by requiring the conduct to have enhanced (at the time the defendant acted) the chances of the harm occurring or that it would increase the chances (risk) of a similar accident (harm) in the future if the defendant should repeat the same wrong.

“In other words, a tortfeasor is not liable to a person whom he intended to harm and who has been harmed, unless from the standpoint of a reasonable man, his act has in some degree increased the risk of that harm.” Spreitzer v. Hawkeye State Bank, 2009 WL 3486740 (Iowa) (October 30, 2009).

Joseph Spreitzer alleged that he signed a personal guaranty for a $1.5 million loan to a new business – Walker Manufacturing – because of a deceptive statement by a bank president, Ray Glass, about Spreitzer’s potential liability.

Although the guaranty said that Spreitzer was 100% liable as guarantor on the entire $1.5 million loan, Spreitzer testified that Glass told him that he would only be liable for $750,000 if there was a default – and that the bank would pursue the co-guarantor (Byron Ross) for $750,000.

Glass was a friend of Ross and, at the time, Glass reportedly knew – but failed to inform Spreitzer – that Ross had arranged his financial affairs so that he was judgment proof.

According to Spreitzer, “but for” the fraud involving the guaranty, he would not have signed the guaranty – and would not have pumped $663,000 into Walker Manufacturing.

When Walker tanked and the bank sued Spreitzer on the guaranty, he wound up settling with the bank for $750,000.

Spreitzer nevertheless sued the bank for fraud, contending that – but for the deceit – he would not have signed the guaranty, and would not have invested $663,000 in the new business.

Meanwhile, as the result of separate litigation that netted $319,000, Spreitzer wound up mitigating his investment loss.

Back in the fraud case, the verdict for Spreitzer – $838,000 – included damages for his investment of $663,000 in the defunct firm.

Reversing, the Iowa Supreme Court explained that a fraudulent statement caused Spreitzer to sign the guarantee – and might have been a cause-in-fact of the investment loss.

Applying the harm-within-risk analysis, though, the high court concluded that Spreitzer’s damages were limited to the type of damages that were within the risk of harm that was threatened by the fraudulent statement about the guaranty.

Here are highlights of the Iowa Supreme Court’s opinion (with omissions not noted in the text):

As with other torts, it is generally recognized the causation element of a fraud claim is composed of both factual and legal causation of the loss. See W. Page Keeton, Prosser & Keeton on the Law of Torts § 110, at 767 (5th ed.1984) [hereinafter Prosser & Keeton].

Under the Restatement, the fraudulent misrepresentation must not only be a factual cause of the loss, but it must also be a legal cause. Restatement (Second) of Torts §§ 546 (factual cause), 548A (legal cause). Each must be satisfied.

The factual causation component addresses the question whether the representation, that is believed to be true but is actually fraudulent, caused the losses in some way. If the plaintiff did not rely on the representation in entering into the transaction in which the losses were suffered, the representation is not in fact a cause of the loss. Restatement (Second) of Torts § 546 cmt. a.

In this case, sufficient evidence was presented to support a finding by the jury that the misrepresentation to equally enforce the personal guaranty was a factual cause of the losses suffered by Spreitzer.

Based on the evidence, the jury could have found Spreitzer would not have suffered the losses he claims because he would not have invested in the business and would not have signed the new personal guaranty that was ultimately enforced against him if he had known the representation was false.

In applying the “but for” test of factual causation, we conclude there was sufficient evidence that the losses claimed would not have occurred “but for” Spreitzer’s reliance on the false representation.

The legal causation component goes further to address the question whether the losses that in fact resulted from the reliance were connected to the misrepresentation in a way to which the law attaches legal significance.

Legal causation is a critical component of the causation element of the tort of fraud. Without legal causation, the chain of losses resulting from an investment would be virtually limitless. See Movitz v. First Nat’l Bank of Chicago, 148 F.3d 760, 762 (7th Cir.1998) (explaining importance of requiring more than mere “but for” causation in assigning legal responsibility for a plaintiff’s loss).

Contractual counterparties would become virtual insurers against the risks inherent in business investing.

The modern trend is to refocus the analysis of legal causation from the foreseeability of harm to a risk-based standard. See Restatement (Third) of Torts, Liability for Physical Harm § 29 cmt. j (Proposed Final Draft No. 1 2005). In negligence cases causing physical harm, tort liability now focuses on whether the risk that produces liability actually caused the damages suffered. The scope of liability is limited to harms that result from the risks that made the actor’s conduct tortious. The shift in analysis has primarily occurred to clarify the often confusing concept of legal causation, not to change the substantive scope of liability.

We readily acknowledge legal causation for intentional torts often reaches a broader range of damages for harm than legal causation reaches in cases involving unintentional torts. This principle may also apply to intentional torts involving nonphysical harm, including fraud actions involving lost investments. Nevertheless, the cases are in accord that even a willful or intentional tortfeasor does not become an insurer of the safety of those whom he has wronged.

As with the scope of liability for unintentional torts, “intentional and reckless tortfeasors are not liable for harms whose risks were not increased by the tortious conduct, even if that conduct was a factual cause of the harm.” Restatement (Third) of Torts, Liability for Physical Harm § 33(c) & cmt. f.

Even though the authors of the venerable Prosser treatise on torts have traditionally used foreseeability to frame this component of legal causation, the substantive rule that has been charted essentially remains unchanged:

“In general and with only a few exceptions, the courts have restricted recovery to those losses which might have expected to follow from the fraud and from those events that are reasonably foreseeable. But if false statements are made in connection with the sale of corporate stock, losses due to a subsequent decline in the market, or insolvency of the corporation brought about by business conditions or other factors that in no way relate to the representations, will not afford any basis for recovery. It is only where the fact misstated was of a nature calculated to bring about such a result that damages for it can be recovered.” Prosser & Keeton, at 767.

Stated in terms of risk instead of foreseeability, this principle limits the scope of liability for tortious conduct by requiring the conduct to have “enhanced (at the time the defendant acted) the chances of the harm occurring or that it would increase the chances (risk) of a similar accident (harm) in the future if the defendant should repeat the same wrong.” Zuchowicz v. United States, 140 F.3d 381, 388 n. 7 (2d Cir.1998).

In other words, a tortfeasor is not liable to a person whom he intended to harm and who has been harmed, unless from the standpoint of a reasonable man, his act has in some degree increased the risk of that harm.

This risk-based approach is compatible with a long-established principle of legal causation, reflected in time-honored cases. For example, in Berry v. Sugar Notch Borough, 191 Pa. 345, 43 A. 240 (Pa.1899), a speeding trolley car was struck by a falling tree. The court held the causation requirement was not met. Id. at 240.

“This result was correct since, although the accident would not have occurred but for the trolley’s speeding, speeding does not increase the probability of trees falling on trolleys.” Zuchowicz, 140 F.3d at 388 n. 7.

Legal causation in fraudulent-representation cases requires, at a minimum, that the tortious aspect of the conduct increased the risk of the damages claimed. This amount of damage is distinguishable from the greater universe of losses caused by the mere fact that a false representation induced the investment.

Generally, an investor invests in a business operation to obtain a return on the investment through the receipt of profits from the operation of the business, through the future sale of the business at a profit, or through the sale of the investor’s interest in the business.

In this case, the business purchased by Spreitzer failed within a relatively short period of time, and Spreitzer never realized any operational business profits from his investment of $663,000.

Spreitzer failed to explain how the false promise to equally enforce the personal guaranty of the business debt between the coguarantors increased the risk of unprofitability of the business, and we can discern no such explanation from the record.

While some damages relating to the diminution of company assets could satisfy the legal causation standard, the amount would be limited by legal causation to those assets that were likely diminished by the tortious aspect of the bank’s conduct.

The tortious aspect of Glass’ conduct was the falsity of his representation regarding equal enforcement of the guaranty.

Even though the falsity of the promise increased the likelihood the bank would forego satisfaction from Ross, the falsity of the promise did not affect the amount of money the bank would have actually collected from Ross were the guarantee to be enforced equally.

Consequently, Spreitzer’s losses cannot exceed the amount of money he would have recovered from the company if the bank had equally pursued both coguarantors as promised.
We conclude there was insufficient evidence to support the jury award of $838,000. The record does not contain evidence of $838,000 of damages that were increased by the tortious aspect – the falsity – of the fraudulent misrepresentation at issue.