How Express Contract Terms and the Negotiation Process May Affect Liability
Parties entering into a contract should negotiate in good faith, but parties must also perform due diligence to protect their own interests. In Texas, a claim for fraudulent inducement will fail when the alleged misrepresentations are contradicted by the express terms of the contract and when a party fails to investigate “red flags” during the course of the negotiation.
Elements of a Claim for Fraudulent Inducement
Like a common-law fraud claim, for a plaintiff to prevail on a claim for fraudulent inducement, the plaintiff must prove:[1]
- The defendant made a material misrepresentation;
- The misrepresentation was made with knowledge of its falsity or asserted without knowledge of its truth;
- The defendant made the misrepresentation with the intention that the plaintiff should rely on or act upon the misrepresentation;
- The plaintiff relied on the misrepresentation; and
- The plaintiff’s reliance on the misrepresentation caused injury.
Although a fraudulent inducement claim can occur only in the context of a contract, a plaintiff may recover for tort damages, which are separate from damages directly related to the contract itself.
Contract Terms Can Negate a Fraudulent Inducement Claim
To prevail on a claim for fraudulent inducement, the plaintiff’s reliance on the alleged misrepresentation must be justifiable.[2] Reliance is not justified when the express terms of the contract are contrary to the alleged misrepresentations. In Mercedes-Benz USA, LLC v. Carduco, Inc.,[3] the Texas Supreme Court addressed the key element of justifiable reliance. In that case, the Court reversed a multi-million-dollar judgment that Carduco, Inc., a Mercedes-Benz franchisee, had obtained against Mercedes, its franchisor. In that case, Carduco alleged that it agreed to become a Mercedes-Benz dealer at a franchise location in Harlingen, Texas, allegedly based on representations by Mercedes-Benz that Carduco could later relocate and operate as the exclusive Mercedes-Benz dealership in McAllen, Texas.
Shortly after Carduco signed the Dealer Agreement for the franchise in Harlingen, Mercedes announced that it has assigned Heller-Bird to a new dealership in McAllen. Carduco then requested to move his dealership to McAllen, and Mercedes denied his request. Carduco filed suit, alleging fraudulent inducement with respect to the Dealer Agreement. The jury awarded Carduco $15.3 million in damages and awarded $100 million in punitive damages against Mercedes and another $15 million in punitive damages against its representatives in their personal capacities. The Texas Court of Appeals affirmed the ruling but suggested lowering the punitive damages. Both parties filed petitions for review in the Texas Supreme Court.
The Texas Supreme Court concluded that, as a matter of law, Carduco could not have justifiably relied on alleged Mercedes-Benz’s alleged representations that Carduco could later move to and operate as the exclusive Mercedes-Benz dealership in McAllen because the Dealership Agreement expressly contradicted those allegations.[4] The Dealership Agreement specifically identified only Harlingen as Carduco’s dealership location, provided that Carduco could not move, relocate, or change any dealership facilities without Mercedes’s prior written consent, provided that Carduco’s right to sell cars in any specific geographic area was nonexclusive, and stated that the agreement was not intended to limit Mercedes’s right to add new dealers in the area.[5]
In addition, there is no duty to disclose certain information in the course of negotiations if no fiduciary or special relationship exists between the parties. For example, the Court in Carduco held that Mercedes had no duty to disclose that it was in discussions with Heller-Bird about the dealership in McAllen because there is no fiduciary or special relationship between a franchisor and franchisee requiring such a duty.[6]
Some agreements may even expressly disclaim reliance on certain representations. Although the law on disclaimers is not completely settled in Texas, the Texas Supreme Court has previously held that a contract containing a clause that clearly and unequivocally expresses the party’s intent to disclaim reliance on the specific representations at issue can preclude a fraudulent inducement claim.[7]
Watch Out for “Red Flags” During Negotiation
Sometimes “red flags” exist during a negotiation that should cause a party to investigate representations further.[8] Ignoring “red flags” could preclude a finding of justifiable reliance. In JPMorgan Chase Bank, N.A. v. Orca Assets G.P., L.L.C,[9] the Court found that Orca could not have justifiably relied on certain representations made by JPMorgan because Orca had expertise in the oil and gas industry and should have recognized several “red flags” related to whether the tracts it was interested in leasing were indeed available for lease.[10] Notably, either contradiction of the written contract or the existence of “red flags” alone is sufficient to negate justifiable reliance on alleged misrepresentations.[11]
Furthermore, the court will consider the nature of the parties’ relationship and the nature of the contract when evaluating justifiable reliance.[12] A court may expect a sophisticated business entity with specialized knowledge in the field to spot and investigate certain “red flags,” but not expect the same scrutiny from an ordinary person less familiar with the subject matter. A party alleging fraud “must have exercised ordinary care to protect its own interests and cannot blindly rely on the defendant’s reputation, representations, or conduct where the plaintiff’s knowledge, experience, and background warrant investigation.”[13]
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[1] Anderson v. Durant, 550 S.W.3d 605, 614 (Tex. 2018)
[2] Grant Thornton LLP v. Prospect High Income Fund, 314 S.W.3d 913, 923 (Tex. 2010).
[3] Mercedes-Benz USA, LLC v. Carduco, Inc., 583 SW3d 553 (Tex. 2019)
[4] Id. at 555.
[5] Id.
[6] Id. at 562.
[7] See Int’l Bus. Machines Corp. v. Lufkin Indus., LLC, 573 S.W.3d 224, 229 (Tex. 2019), reh’g denied (May 31, 2019).
[8] See, e.g., JPMorgan Chase Bank, N.A. v. Orca Assets G.P., L.L.C. , 546 S.W.3d 648 (Tex. 2018).
[9] Id.
[10] Id. at 655-58.
[11] Id. at 660 n.2.
[12] Carduco, 583 SW3d at 564.
[13] Id. at 564 (citing Orca Assets, 546 S.W.3d at 654).
