United States: The Tennessee Supreme Court Finally Weighs In On Whether And How The Discovery Rule Applies In Breach-Of-Contract Claims

Last Updated: March 11 2019
Article by Michael B. Schwegler

A. Background.

For the last couple of years, Tennessee practitioners have been waiting for the Tennessee Supreme Court to resolve the debate as to whether the Discovery Rule applies to toll the six-year statute of limitations in breach-of-contract cases. In fact, I wrote a blog post about it in 2018. That post is archived here.

B. Individual Healthcare Specialists, Inc.

On January 18, 2019, the Tennessee Supreme Court addressed the issue in a case that primarily seeks to clarify, once and for all, when extrinsic evidence is admissible in breach-of-contract cases, Individual Healthcare Specialists, Inc. v. BlueCross BlueShield of Tennessee, Inc., 2019 Tenn. LEXIS 7 (Tenn. Jan. 18, 2019). (The Court's opinion on admissibility of extrinsic and parol evidence in breach-of-contract cases is very important in itself, will control an entire area of evidence jurisprudence, and will be addressed in a future legal update.) But for now, I want to focus on the words "inherently undiscoverable," and what the Court's analysis of those words means for future breach-of-contract cases where the statute of limitations is at issue. In short, the Court's strict reading of this phrase is a welcome development for those of us who value the public policy of statutes of limitation, are concerned about the notion of open-ended contractual liability, and who worry about the expensive litigation of stale, or even ancient, claims.

The accrual statute for breach-of-contract claims is found at Tennessee Code Annotated § 28-1-102 and reads:

28-1-102. Commencement at time of right to make demand.

When a right exists, but a demand is necessary to entitle the party to an action, the limitation commences from the time the plaintiff's right to make the demand was completed, and not from the date of the demand.

(Emphasis added.)

The threshold timeliness issue in breach-of-contract cases is, therefore, the date that plaintiff's right to make demand was completed; that is, the accrual date in breach-of-contract cases typically occurs upon the breach(es) that gives rise to the claim. Usually, a plaintiff will know it is injured because it has not been paid or some other performance obligation under the contract has not been completed. The Discovery Rule is a creature of common law that identifies the accrual date for a claim and requires that "the statute of limitations begins to run when the plaintiff knows or has reason to know of the injury which is the basis for its action," but is traditionally applied in tort cases where the existence of an injury or a breach of a standard of care may not be immediately apparent.

Until Individual Healthcare Specialists, the only guidance we had as to the application of the Discovery Rule to breach-of-contract cases was in a group of Tennessee Court of Appeals and federal court opinions, starting with Goot v. Metropolitan Government of Nashville and Davidson County, Tennessee, 2005 Tenn. App. LEXIS 708 (Tenn. Ct. App. Nov. 9, 2005). This line of cases applied the Discovery Rule to toll the accrual date for the six year breach-of-contract statute of limitations—as set forth at Tennessee Code Annotated § 28-3-109(a)(3)—when the breach is "inherently undiscoverable" by the plaintiff. Cases interpreting the "inherently undiscoverable" element then construed contractual due diligence waivers to find that a breach is inherently undiscoverable when the plaintiff had no obligation to perform the diligence that would have revealed the existence of the breach.

Although the Individual Healthcare Specialists Court expressly refused to approve the application of the Discovery Rule to breach-of-contract cases, 2019 Tenn. LEXIS 7, at *89, it nevertheless clarified that the phrase "inherently undiscoverable" means what it says and creates a very high burden for a breach-of-contract plaintiff to avail itself of the Discovery Rule. Id. at *93. In that case, defendant BlueCross argued that damages for which it could be liable should be limited to the six-year period falling within the statute of limitations. Id. at *80-*81. The plaintiff, Individual Healthcare Specialists ("IHS"), countered that the Discovery Rule tolled the accrual of its claim against BlueCross such that plaintiff could recover damages stretching back for a 13-year period. Id. at *80-*83. The plaintiff argued that the defendant's breach—in the form of systemic underpayments—was "inherently undiscoverable" because:

(1) BlueCross made "non-routine" errors spanning hundreds of thousands of commission transactions; (2) the information BlueCross provided to IHS was faulty and unreliable; and (3) BlueCross had exclusive possession of systems and information necessary to determine the underpayment amounts. IHS contends that BlueCross was aware that its own accounting system, called Facets, was faulty and unreliable, but it nevertheless withheld this information from IHS. Consequently, despite having exercised extreme diligence throughout the contractual relationship, IHS could not have discovered the information needed to verify the commission payments due.

Id. at *81-*82

The trial and intermediate appellate courts agreed and adopted IHS's arguments. Id. at *89-*92. But the Supreme Court disagreed. Id. at *93. Instead, the Supreme Court explained that while the facts shown in the record created "numerous obstacles" to IHS's efforts to identify the breach and showed that identifying the breach(es) was "not easy" and a "difficult task," those same facts did not rise to the level of being "inherently undiscoverable." Id. at *93, *95. Accordingly, Tennessee's high court reversed the lower courts on the application of the Discovery Rule and held that plaintiff's claim for damages resulting from systemic underpayments more than six years earlier were untimely. Id.

C. What Individual Healthcare Specialists Means Moving Forward.

In mortgage putback cases, courts—especially the courts making up the Middle District of Tennessee—have held that the parties' diligence waiver made discovery of offending breaches "undiscoverable" because the plaintiff had no reason to conduct a due diligence examination and therefore never did so; in the absence of due diligence, the offending breach cannot be discovered. But the Individual Healthcare Specialists opinion should make it more difficult for mortgage putback and other breach-of-contract plaintiffs to avail themselves of the Discovery Rule to avoid an untimeliness defense. In short, just because a contract between the parties excuses the plaintiff from doing any due diligence as a performance requirement under the contract, that circumstance does not mean it is impossible for the plaintiff to conduct due diligence and discover the underlying breach, especially when (as in the mortgage putback cases) the plaintiff contends that the breach—had diligence been performed—is so relatively easy to detect that the defendant should have noticed it in the first place.

There may be one caveat, however, that is certain to be argued by those advancing the application of the Discovery Rule: namely, the Supreme Court's use of the word "expected" when it stated in Individual Healthcare Specialists that, "[when t]he breach at issue arises from a commercial contract between two sophisticated business entities, each [is] expected to use due diligence to protect its own interests." Id. at *93 (emphasis added). "Expected" could be read to imply that the converse controls the issue: that in the absence of an expectation of due diligence, the failure to conduct diligence is appropriate and the Discovery Rule may apply. Id. I think this (admittedly speculative) reading may be a bridge too far, as the remainder of the Supreme Court's carefully worded sentence explains that diligence is used "to protect its own interests," so that regardless of whatever contractual duty or non-duty the plaintiff may have, it should nonetheless be expected to perform diligence under the basic principles of self-interest. Id.

For those readers more interested in seeing if I can shoehorn in a reference of Thanos's acts in Avengers: Infinity War, as I did in my 2018 blog post, I would note that Individual Healthcare Specialists clarifies that the legal world's time travel rules—the statutes of limitations—are hard to overcome in breach-of-contract cases, even if the Discovery Rule applies to them. Similarly, Avengers: Endgame is likely to involve some kind of time travel plot device—probably starting with Ant-Man's discovery and use of the Quantum Realm's time travel rules—so that the remaining Avengers can rewind history and stop The Snap—almost certainly utilizing Captain Marvel's immense cosmic powers. We will have to wait until March and April to know for sure.

If you are a lender or mortgage originator facing one or more mortgage putback claims, or if you are a business facing timeliness issues in your breach-of-contract case, call or email us to discuss how we can help you manage the Discovery Rule.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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