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Authored - NJ Contract Law Update - Difficulties in Contracting Away Misrepresentations
MAY 02, 2012 | Windels Marx - Commercial Litigation

Walid v. Yolanda For Irene Couture, Inc., ____ N.J.Super. _____, 2012 WL 1123232 (App.Div. April 5, 2012), highlights the difficulty of contracting away the effect of prior misrepresentations. This article explores the jurisprudence governing such attempts, and suggests possible litigation approaches and enhanced draftsmanship that may anticipate all but the worst problems.

The Walid Case

In Walid, the seller of a business had, according to the trial judge, been proven "by clear and convincing evidence" to have "fraudulently misrepresented the gross revenues" of the entity being purchased, "by depositing checks issued to [a related company, not included in the sale]...into the bank account [of the company being sold]".

The primary contract law issue was whether the fraud claim was precluded by "the provision in the contract"--sometimes referred to as integration clause1 --stating that plaintiffs were relying upon their own 'evaluation, inspection, and legal search of the business'", rather than "rely[ing] upon any representations that are not contained in writing in this contract of sale". Id. at *7. The Appellate Division concluded, in effect, that the cited clause was unenforceable because it sought to exculpate the seller's misrepresentation of "specific facts ... peculiarly within" the "knowledge" of that misrepresenting party. That preclusion from express exculpation is based implicitly upon protection of the vulnerable, and expressly upon what courts have deemed the commercially-prohibitive cost of having to investigate such matters2. Another implicit factor is the longstanding strain of New Jersey law that a defrauder cannot defend a fraud claim by alleging that his/her victim should have been more circumspect. Id. at *5, citing Jewish Center of Sussex County v. Whale, 86 N.J. 619 (1981).

Walid adopted the trial court's finding of misrepresentation, but reversed that court's finding of no reliance. In finding fraud under these circumstances, the Appellate Division cited two New York Federal cases: Solutia, Inc. v. FMC Corp., 385 F.Supp.2d 324, 340 (S.D.N.Y. 2005), and Warner Theatre Assocs. P'ship v. Metro Life Ins. Co., 149 F.3d 134, 136 (2d Cir. 1998).

The Walid Court emphasized the fact that the "integration" cause set forth above (disclaiming the significance of any extracontractual representations) was merely "a general integration clause". Id. at *8, emphasis added. However, the Walid Court went on to add that when dealing with misrepresentations of facts "peculiarly within [the misrepresenting] ... party's knowledge", id., "even a specific disclaimer will not undermine another party's allegations of reasonable reliance on the misrepresentation." Id. (emphasis in original), citing Warner.

In connection with the proposed Walid sale, the buyers received a "fact sheet" incorrectly aggregating the two related businesses; as well as tax returns, which presumably may have done so, although the Opinion is not clear on this point. The buyers (the plaintiffs, Mr. and Mrs. Walid) also seem to have been highly sophisticated, including direct expertise in the industry. Moreover, the seller was willing to:

  1. allow the business to be "review[ed]" by accountants and attorneys for the buyers, and
  2. provide "pro[of] of sales". Id. at *1.

For reasons unexplained, only part of this opportunity was accepted: the Walids hired an attorney; the attorney advised the Walids to retain an accountant or the like "to examine the finances [of] the business"; but the Walids elected to review the finances themselves. Somehow--notwithstanding all the detail that the seller provided--the seller (according to the trial judge, as affirmed on appeal) also managed to provide misinformation that aggregated the receipts of the two related businesses, only one of which was being sold. This, even though the seller seems to have been willing to have the true facts discovered, certainly by the buyers' accountant (if the buyers had spent the money to hire one).

Under these unique facts, Walid turned in part on the "tort" issue of whether reliance had been reasonable under these unique circumstances, where the opportunity to review was:

  1. partially exercised, and
  2. partially waived though available.

(The trial court felt that reliance was unreasonable under these facts; the appellate court reached an opposite conclusion.) However, it is worth considering that tort issue, along with the contract issue, in evaluating the problem facing the contract drafter.

Solutia and Warner

Solutia involved not only a general integration clause (expressly disclaiming "all prior representations, discussions, and negotiations"), but also a separate disclaimer of the impermissibility of relying upon "any statement, promise, agreement or understanding, whether oral or written", unless contained in the documents. 385 F.Supp.2d at 339-340. (The Court's implication was that the latter was a "specific" disclaimer, though it doesn't sound like one; presumable, a "specific" disclaimer would mention the precise topic and/or prior statement being subsumed by the integrated agreement.)

The Solutia Court emphasized the principle that "a party to a fully integrated contract can [nonetheless] assert a claim of fraud, unless the contract specifically disclaims reliance on the representations at issue." Id. at 340 (emphasis added.) The initial argument discussed in Solutia, thus, was whether the disclaimer was "specific" enough. However, the Court immediately turned away from that issue to the question of whether the facts were "within the 'peculiar knowledge'" of the allegedly misrepresenting party; in which case "even a specific disclaimer as to reliance on those representations does not bar a fraud claim". Id.

The rationale for the "peculiar knowledge" exception recited in Solutia is less than convincing in reasonably sophisticated commercial contexts, particularly in light of the Warner case relied upon by both Solutia and Walid. The cases' discussion of the issue leaves one with the sense that a more meticulously drafted contract could avoid the problem in most circumstances.

The supposed purpose of the "peculiar knowledge" exception is that "[a]lthough sophisticated parties can normally verify each other's representations or bargain for specific contractual warranties, the peculiar knowledge exception applies if 'a party would face high costs in determining the truth or falsity' of representations." Id., citing Warner, 149 F.3d at 136. But the Warner Court delved further into the "high costs" issue, blazing the path for a more effective disclaimer. Warner stated that the "circumstances" in which a fraud claim should be permitted to be tried, in the face of even a specific disclaimer, would be those in which the "high costs [of] ... determining the truth or falsity or an oral representation" "are sufficiently great to render reliance on the representation reasonable". Id. The Warner Court concluded that the costs facing the parties before it were "not high". The Court added that the sophisticated party now claiming fraud should have "insisted that the written contract terms reflect any oral undertaking" if the issue were so important. 149 F.3d at 136.3

Most of these considerations were not mentioned in Walid, leaving us to wonder whether they were developed by the parties.

Building Better Contract Disclaimers -- Litigation Issues

Taking into account all of the above considerations, one could easily imagine a much more specific disclaimer than those in any of the cited cases--and even a stipulation by the parties that the costs of analyzing any applicable materials would not be "high", either in absolute numbers or relative to the value of the contract. Indeed, in a setting where:

  1. the extracontractual representations in question are obvious to all parties, such as the Walid fact sheet (as opposed to an oral statement, later alleged, that arguably could not have been anticipated)--and
  2. the transaction is not one in which there is a true intent to defraud --this author belies there likely can be effective disclaimers.

This would entail disclaimers or acknowledgements specific enough to preclude a sincere-sounding fraud claim in a commercial case, notwithstanding the ostensible breadth of the principles announced in Walid. For example, a party could be asked to represent that he/she:

  1. has adequately investigated, and/or has consciously waived the offer and right to investigate "despite urging" by the other party; including specific issues such as income, finances, etc.;
  2. is not relying on specific types of statements and specific documents seen prior to contract (such as the Walid fact sheet); and
  3. agrees that the costs of investigation would not be high, relative to the amounts at issue.

In sum, Walid issues can likely be protected by enhanced draftsmanship; and if litigated (under any contractual phrasing), can be argued more along the lines of the Warner exceptions. However, where there is (1) actual fraud (as the trial court found in Walid), and (2) less-than-explicit disclosure or disclaimer in the contract, the road will be rough notwithstanding herculean efforts by counsel.

Contact & Legal Disclaimer

Clark Alpert is the author of Guide to New Jersey Contract Law, published by the New Jersey Institute for Continuing Legal Education, originally published in 2007 and updated in November 2011. His updates on New Jersey contract law are based in recent issues and practical methods for addressing similar situations in your practice or business. They are not intended to serve as legal advice. Clark welcomes your questions and comments.

 


1 Integration clauses more broadly state that a particular writing constitutes the entire agreement of the parties, and that there are no other agreements, understandings or representations on the same subject matter that are not contained in that writing.

2 This consideration seems inapplicable to modern commercial transactions.




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