By Bill Cobb and Irma Jacobson

On September 3, 2013, in Lone Star Nat'l Bank N.A. v. Heartland Payment Sys., Inc., the U.S. Court of Appeals for the Fifth Circuit held that "the economic loss doctrine under New Jersey law does not preclude the Issuer Banks' negligence claim against Heartland at the motion to dismiss stage," potentially opening the door to countless future classes of plaintiffs seeking tort remedies arising out of cyber-attacks and resulting data breaches.   

 

This case arose after hackers infiltrated Heartland's data systems, causing a data breach exposing over 130 million customer records –including credit and debit card data-- resulting in over $6 billion of damages. These damages included the economic losses incurred by the Plaintiffs (known as Issuer Banks), in the form of replacement cards and reimbursements to customers for fraudulent charges associated with Visa and MasterCard credit and debit cards. 

When a customer uses a credit or debit card at a merchant, the merchant sends the customer's account information to the Acquirer Bank, which then forwards that information to a processor.  In this case, the processor was Heartland, who forwards the customer's information back to the Issuer Bank that ultimately approves or disapproves the transaction.  

In this tripartite relationship, the Plaintiff Issuer Banks did not have a contract directly with Heartland, but the Acquirer Banks required Heartland to comply with the Visa and MasterCard regulations, "which contain[ed] mechanisms for Visa and MasterCard network members to recoup losses in the event of a data breach."  Accordingly, Heartland argued that Plaintiffs' negligence claims were barred by the economic loss rule, which typically limits a plaintiff seeking to recover purely economic losses, such as lost profits, to his contractual remedies.  

While the Fifth Circuit agreed with Heartland that the "economic loss doctrine under Texas law would bar the Issuer Banks' negligence claim," it nevertheless found that the economic loss doctrine in New Jersey permits negligence claims even when the damages are purely economic.  

The Fifth Circuit relied on People Express Airlines, Inc., v. Consolidated Rail Corp., 495 A.2d 107 (N.J. 1985), where the court held "the economic doctrine does not bar tort recovery in every case where the plaintiff suffers economic harm without any attendant physical harm." In People Express, the New Jersey Supreme Court limited their holding, however, to situations where the plaintiffs consisted of an identifiable class "whom the defendant knows or has reason to know are likely to suffer such damages from its conduct." The court stressed the plaintiff must be foreseeable in the "type of persons," "the certainty or predictability of their presence, the approximate numbers of those in the class, as well as the type of economic expectations disrupted." The court did not want to impose "boundless liability."

The Court also relied on Dynalectric Co. v. Westinghouse Electric Corp., 803 F. Supp. 985, 986–87 (D.N.J. 1992) where the court interpreted People Express "as allowing tort recovery for economic losses only when the plaintiff lacks another remedy."  

In holding that the economic loss doctrine allowed the Plaintiffs' negligence claim, the Fifth Circuit reasoned the Issuer Banks were an identifiable class because they were "the very entities to which Heartland sends payment card information." Moreover, the losses to Heartland would not be "boundless," but would be limited to the number of entities to which Heartland sent the information. Finally, the Court reasoned, "in the absence of a tort remedy, the Issuer Banks would be left with no remedy for Heartland's alleged negligence, defying 'notions of fairness, common sense and morality'." The Fifth Circuit decision synchronizes with the New Jersey Supreme Court's reputation as long being a "leader in expanding tort liability." Hakimoglu v. Trump Taj Mahal Assoc., 70 F.3d 291, 295 (3rd Cir. 1995) (Becker, J., dissenting).   

For businesses operating in New Jersey, or with consumers in New Jersey, this decision foreshadows significant potential future exposure in the event of litigation arising from a cyber-attack or other data breach exposing customer information.  For other businesses, it underscores the need to conduct a "cyber audit" to prepare for, if not prevent, a financially devastating cyber-attack and data breach.

CLICK HERE to read a copy of the Fifth Circuit's Opinion. 

If you have any questions about this e-Alert, contact Irma Jacobson at 512.236.2091 or ijacobson@jw.com.

Is your company prepared to respond to a cyberattack or data breach?  Contact us about obtaining a cybersecurity crisis audit. In the event of a data breach or cyberattack, ask for the JW cybersecurity response SWAT team.

For more information regarding Jackson Walker's Cybersecurity practice, CLICK HERE.