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From Banking and Finance Law Daily, September 4, 2013

NJ “economic loss doctrine” does not bar banks’ negligence claim for data breach

By Thomas G. Wolfe, J.D.

New Jersey’s “economic loss doctrine” did not bar a negligence claim brought by card-issuing banks (Issuer Banks) against a payment processing company for a data breach that compromised confidential card information of the banks’ customers, the U.S. Court of Appeals for the Fifth Circuit has held. In reversing the decision of the trial court, the federal appellate court determined that, based upon the undeveloped factual record and given the early stage of the litigation, the Issuer Banks’ negligence claim should not be dismissed (Lone Star National Bank, N.A. et al. v. Heartland Payment Systems, Inc., Sept. 3, 2013, Garza, Circuit Judge).

Background. The Issuer Banks had contracts with Visa and MasterCard, allowing them to issue payment cards—including both credit and debit cards—to their customers. Separately, a payment processing company had a contract with two “acquirer banks” that were members of the Visa and MasterCard networks and facilitated card payment transactions with the Issuer Banks and the payment processor. However, the Issuer Banks themselves did not have any written contract with the payment processor.

The payment processor experienced a breach of its data systems by hackers who stole payment card information pertaining to customers of the Issuer Banks. As a result, the Issuer Banks initiated a lawsuit against the payment processor, contending that they incurred costs and expenses associated with replacing the compromised cards, reimbursing customers for fraudulent charges, and so forth. Since the Issuer Banks did not have any written contract with the payment processor, the Issuer Banks’ claims were based primarily on negligence and on a third-party beneficiary theory concerning the payment processor’s contracts with other pertinent entities.

As part of a disagreement over whether Texas or New Jersey law governed the claims, the parties agreed that the “economic loss doctrine” under Texas law would bar the Issuer Banks’ negligence claim but disagreed as to whether the New Jersey “economic loss doctrine” would bar the negligence claim. Ultimately, the federal district court dismissed all of the Issuer Banks’ claims, regardless of whether Texas or New Jersey law was operable. In appealing to the Fifth Circuit, the Issuer Banks challenged only the dismissal of the negligence claim.

Economic loss doctrine. According to the court, the “economic loss doctrine” in New Jersey usually limits a party who seeks to recover purely economic losses—such as lost profits—to contractual remedies. However, the Fifth Circuit noted that the Supreme Court of New Jersey has recognized an exception to that contractual remedy rule; the “economic loss doctrine” would not bar a recovery based on a tort theory when “the plaintiff suffers economic harm without any attendant physical harm.”

The Fifth Circuit further determined that, under New Jersey law, the “economic loss doctrine” does not bar tort recovery—such as the Issuer Banks’ negligence claim—“where the defendant causes an identifiable class of plaintiffs to which it owes a duty of care to suffer economic loss that does not result in boundless liability.”

Court’s reasoning. In ruling that the New Jersey “economic loss doctrine” did not preclude the Issuer Banks’ negligence claim against the payment processor at the motion-to-dismiss stage of the litigation, the Fifth Circuit determined that: (i) the Issuer Banks constituted an “identifiable class” as contemplated by New Jersey case law; (ii) the payment processor had reason to foresee that the Issuer Banks would likely suffer economic losses if it were negligent; (iii) viewing the pleadings in the light most favorable to the Issuer Banks, the absence of a tort remedy would leave the Issuer Banks with no recourse for the payment processor’s alleged negligence—“defying notions of fairness, common sense, and morality;” and (iv) any contractual remedies the Issuer Banks might possibly advance to recoup losses caused by the payment processor were not entirely clear because further discovery and development of a factual record was needed.

The case is No. 12-20648.

Attorneys: Michael Allen Caddell, Cynthia B. Chapman, and Cory Steven Fein (Caddell & Chapman, P.C.), Richard Lyle Coffman (Coffman Law Firm), and Joseph G. Sauder (Chimicles & Tikellis, L.L.P.) for plaintiffs. Douglas Harlan Meal, David Thomas Cohen, Seth Carlton Harrington, and Anne E. Johnson (Ropes & Gray, L.L.P.), Michael J. Conlan (Blank Rome, L.L.P.), Brant Mitchell Laue (Armstrong Teasdale, L.L.P.), and Neal Stuart Manne (Susman Godfrey, L.L.P.) for defendant.

Companies: Amalgamated Bank; Elevations Credit Union; First Bankers Trust Company National Association; Heartland Bank; KeyBank; Lone Star National Bank, N.A.; O Bee Credit Union; Pennsylvania State Employees Credit Union; Seaboard Federal Credit Union

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