Misrepresentation & Fraud
Chapter 10: Misrepresentation and Fraud
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A "representation" is a statement of fact made by one party upon which the other party may reasonably rely in determining to enter into a contract. A representation is the essence of advertising---it is designed to stimulate one's interest and allay one's concerns about entering into the contract.
When a representation turns out to be false, the other party may be able to "void" the contract, i.e., to treat it as if it had never come into effect. This is also called "rescission" or "rescinding" the contract. This means undoing the contract, which is essentially the same thing as voiding it.
The R2d takes the position that the recipient of the representation may void the contract if the misrepresentation is either fraudulent or material. (R2d § 164(1)). According to R2d § 162(2), "A misrepresentation is material if it would be likely to induce a reasonable person to manifest his assent, or if the maker knows that it would be likely to induce the recipient to do so." R2d § 162(1) sets out the standards for when a misrepresentation is fraudulent. Essentially, a misrepresentation is fraudulent if it is intentional rather than innocent. So the basic rule is that if the misrepresentation is material, the recipient can void the contract even if the misrepresentation is innocent.
As an alternative to voiding the contract, the recipient can keep the contract in effect and sue for damages. The damages the recipient can recover under contract law for a misrepresentation are the difference between (1) the value of the other party's performance if the statement had been true and (2) the actual value of the other party's performance (i.e., the value given the fact that the statement is actually untrue). For example, suppose Seller sold a business to Buyer, representing that the profits were \$1,000,000 per year. In actuality, the profits were only \$800,000 per year. At trial, Buyer is able to prove that if the profits had been \$1,000,000 per year (as represented) the business would have been worth \$5,000,000 and that because the profits are only \$800,000, the business is worth only \$4,000,000. Then Buyer would be able to recover \$1,000,000, the difference between the value of the business as represented and its actual value. If the misrepresentation was fraudulent, Buyer has the option of suing in tort and recovering damages based on a slightly different formula that may include punitive damages.
286 Because fraudulent intent is usually difficult to prove, misrepresentation is more successfully pled and proven. The two causes of action, however, are generally pleaded together "on information and belief" if that is permitted in the relevant jurisdiction.
Halpert v. Rosenthal
Supreme Court of Rhode Island 107 R.I. 406, 267 A.2d 730 (1970)
Kelleher, J.
[1]This is a civil action wherein the plaintiff vendor seeks damages for the breach by the defendant vendee of a contract for the sale of real estate. The defendant filed a counter-claim in which he sought the return of his deposit. A jury trial was held in the Superior Court. The jury found for the defendant and judgment followed. The case is before us on the plaintiff's appeal. [We affirm.---Eds.]
[2]On February 21, 1967, the parties hereto entered into a real estate agreement whereby plaintiff agreed to convey a one-family house located in Providence on the southeasterly corner of Wayland and Upton Avenues to defendant for the sum of \$54,000. The defendant paid a deposit of \$2,000 to plaintiff. The agreement provided for the delivery of the deed and the payment of the balance of the purchase price by June 30, 1967.
[3]On May 17, 1967, a termite inspection was made of the premises, and it was discovered that the house was inhabited by termites. The defendant then notified plaintiff that, because of the termite infestation, he was not going to purchase the property. The defendant did not appear for the title closing which plaintiff had scheduled for June 30, 1967.
[4]The plaintiff [seller] immediately commenced this suit. Her complaint prayed for specific performance or monetary damages. When the case came on for trial, the property had been sold to another buyer for the sum of \$35,000. The plaintiff then sought to recover from defendant the \$19,0001 difference between the selling price called for in the sales agreement and the actual selling price. The defendant in his answer alleged that plaintiff and her agent had, during the preagreement negotiation, intentionally misrepresented the house as being free of termites. The defendant's counterclaim sought the return of the \$2,000 deposit.
[5]At the conclusion of the presentation of all the evidence, plaintiff made a motion for a directed verdict on the issue of the alleged fraudulent 287 misrepresentations. The trial justice reserved decision on the motion and submitted the case to the jury. After the jury's verdict, he denied the motion.
[6]This case is unique in that plaintiff made no motion for a new trial. Her appeal is based for the most part on the trial court's refusal to direct a verdict in her favor on the counterclaim. She has also alleged that the trial justice erred in certain portions of his charge to the jury and in failing to adopt some 15 requests to charge submitted by plaintiff.
[7]The absence of a motion for a new trial narrows the scope of an inquiry on appeal. Instead of being concerned with the credibility of witnesses or the weight of the evidence as we would be where we reviewing the usual motion for a new trial, we apply the standards applicable to a motion for a directed verdict. In doing so, it is our duty to consider all of the evidence and reasonable inferences deducible therefrom in the light most favorable to defendant.
[8]Since we consider only the evidence favorable to defendant, we shall set forth defendant's version of three different occasions in 1967 when the alleged misrepresentations relative to absence of any termites were made.
1.In early February, defendant and his wife inspected the Halpert home. They asked the agent about termites and he told them that there was no termite problem and that he had never experienced any termite problem with any of the houses he sold in the East Side section of Providence.
2.Later on in February, defendant, his wife, his sister-in-law and his brother-in-law met plaintiff. The brother-in-law inquired about the presence of termites; plaintiff said that there were no termites in the house.
3.When defendant was about to sign the purchase and sales agreement, he asked plaintiff's real estate agent whether it might not be advisable if the home be inspected for termites before the agreement was signed. The agent told defendant that such a step was unnecessary because there were no termite problems in the house.
[9]The plaintiff contends that any statements or representations attributed to her or her agent were qualified in that when asked about the termites, they replied that to the best of their knowledge or experience the Wayland Avenue property was termite free. What she overlooks is that in our consideration of the correctness of the denial of her motion for a direction, we can consider only that evidence and the reasonable inferences flowing therefrom which favor defendant. We do not weigh the evidence to 288 determine whether her or her agent's representations were qualified or unqualified.
[10]In contending that she was entitled to a directed verdict, plaintiff contends that to sustain the charge of fraudulent misrepresentation, some evidence had to be produced showing that either she or her agent knew at the time they said there were no termites in the house, that such a statement was untrue. Since the representations made to defendant were made in good faith, she argues that, as a matter of law, defendant could not prevail on his counterclaim.
[11]The defendant concedes that there was no evidence which shows that plaintiff or her agent knowingly made false statements as to the existence of the termites but he maintains that an innocent misrepresentation of a material fact is grounds for rescission of a contract where, as here, a party relies to his detriment on the misrepresentation.
[12]We affirm the denial of the motion for a directed verdict.
[13]The plaintiff, when she made her motion for a directed verdict, stated that her motion was restricted to the issue of "fraud." The word "fraud" is a generic term which embraces a great variety of actionable wrongs. It is a word of many meanings and defies any one all-inclusive definition. Fraud may become important either for the purpose of giving the defrauded person the right to sue for damages in an action for deceit or to enable him to rescind the contract. In this jurisdiction a party who has been induced by fraud to enter into a contract may pursue either one of two remedies. He may elect to rescind the contract to recover what he has paid under it, or he may affirm the contract and sue for damages in an action for deceit.
[14]The distinction between a claim for damages for intentional deceit and a claim for rescission is well defined. Deceit is a tort action, and it requires some degree of culpability on the misrepresenter's part. An individual who sues in an action of deceit based on fraud has the burden of proving that the defendant in making the statements knew they were false and intended to deceive him. On the other hand, a suit to rescind an agreement induced by fraud sounds in contract. It is this latter aspect of fraud that we are concerned with in this case, and the pivotal issue before us is whether an innocent misrepresentation of a material fact warrants the granting of a claim for rescission. We believe that it does.
[15]When he denied plaintiff's motion, the trial justice indicated that a false, though innocent, misrepresentation of a fact made as though of one's knowledge may be the basis for the rescission of a contract. While this issue is one of first impression in this state, it is clear that the trial judge's action finds support in the overwhelming weight of decisional and textual authority which has established the rule that where one induces another to enter into a contract by means of a material misrepresentation, the latter 289 may rescind the contract. It does not matter if the representation was "innocent" or fraudulent.
In 12 Williston, Contracts, § 1500 at 400--01, Professor Jaeger states:
It is not necessary, in order that a contract may be rescinded for fraud or misrepresentation, that the party making the misrepresentation should have known that it was false. Innocent misrepresentation is sufficient, for though the representation may have been made innocently, it would be unjust and inequitable to permit a person who has made false representations, even innocently, to retain the fruits of a bargain induced by such representations.
This statement of law is in accord with Restatement of Contracts, § 476 at 908 which states:
Where a party is induced to enter into a transaction with another party that he was under no duty to enter into by means of the latter's fraud or material misrepresentation, the transaction is voidable as against the latter . . .
Misrepresentation is defined as
. . . any manifestation by words or other conduct by one person to another that, under the circumstances, amounts to an assertion not in accordance with the facts.
Restatement of Contracts, § 470 at 890--91.
[16]The comment following this section explains that a misrepresentation may be innocent, negligent or known to be false. A misrepresentation becomes material when it becomes likely to affect the conduct of a reasonable man with reference to a transaction with another person. Restatement of Contracts, § 470 (2) at 891. Section 28 of Restatement of Restitution is also in accord with this proposition of law that a transaction can be rescinded for innocent misrepresentation of a material fact.
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[17]It is true that some courts require proof of knowledge of the falsity of the misrepresentation before a contract may be invalidated. However, the weight of authority follows the view that the misrepresenter's good faith is immaterial. We believe this view the better one.
[18]A misrepresentation, even though innocently made, may be actionable, if made and relied on as a positive statement of fact. The question to be resolved in determining whether a wrong committed as the result of an innocent misrepresentation may be rectified is succinctly stated in 12 Williston, supra, § 1510, at 462 as follows:
290 When a defendant has induced another to act by representations false in fact although not dishonestly made, and damage has directly resulted from the action taken, who should bear the loss?
[19]The question we submit is rhetorical. The answer is obvious. Simple justice demands that the speaker be held responsible. Accordingly, we hold that here defendant vendee could maintain his counterclaim.
[20]The plaintiff's second contention is to the effect that even if an innocent misrepresentation without knowledge of its falsity may under certain circumstances entitle the misrepresentee to relief by way of rescission, defendant cannot maintain his action because the sales agreement contains a merger clause. This provision immediately precedes the testimonium clause and provides that the contract " . . . contains the entire agreement between the parties, and that it is subject to no understandings, conditions or representations other than those expressly stated herein." The plaintiff argues that in order to enable a purchaser to rescind a contract containing a merger clause because of a misrepresentation, proof of a fraudulent misrepresentation must be shown. We find no merit in this argument.
[21]If, as plaintiff concedes, a merger clause, such as is found within the sales contract now before us, will not prevent a rescission based on a fraudulent misrepresentation, there is no valid reason to say that it will prevent a rescission of an agreement which is the result of a false though innocent misrepresentation where both innocent and fraudulent misrepresentations render a contract voidable. As we observed before, the availability of the remedy of rescission is motivated by the obvious inequity of allowing a person who has made the innocent misrepresentation to retain the fruits of the bargain induced thereby. If we are to permit a party to rescind a contract which is the result of an innocent misrepresentation, the "boiler plate" found in the merger clause shall not bar the use of this remedy.
* * * [22]Before leaving this phase of plaintiff's appeal, we think it appropriate that we allude to the tendency of many courts to equate an innocent misrepresentation with some species of fraud. Usually the word "fraud" connotes a conscious dishonest conduct on the part of the misrepresenter. Fraud, however, is not present if the speaker actually believes that what he states as the truth is the truth. We believe that it would be better if an innocent misrepresentation was not described as some species of fraud. Unqualified statements imply certainty. Reliance is more likely to be placed on a positive statement of fact than a mere expression of opinion or a qualified statement. The speaker who uses the unqualified statement does so at his peril. The risk of falsity is his. If he is to be liable for what he states, the liability is imposed because he is to be held strictly 291 accountable for his words. Responsibility for an innocent misrepresentation should be recognized for what it is---an example of absolute liability rather than as many courts have said, an example of constructive fraud.
Problem 10-1
Seller Corporation entered into a contract to sell one of its subsidiaries to Buyer Corporation. The contract contained a representation that all of the subsidiary's patents were valid. Before making the representation, Seller Corporation received assurances from its patent counsel that all of the patents were in fact valid. If, before the time Buyer Corporation is to perform its obligations under the contract (i.e., to pay the purchase price and take title to the stock of the subsidiary), Buyer Corporation discovers that some of the patents are invalid, can it refuse to perform? See R2d § 164(1); UNIDROIT articles 3.5--3.8.
Problem 10-2
Seller entered into a contract to sell his small hotel to Buyer. In the course of the negotiations, Seller deliberately overstated the profits in his attempt to induce Buyer to purchase the business. In fact, Buyer was never concerned about the profits of the hotel. She was planning to tear it down and use the land as part of a major resort she was developing.
Buyer's plans have now fallen apart because she could not get the adjoining landowners to sell and therefore she could not put together a large enough parcel of land for her resort. Can she use Seller's fraudulent misrepresentation to get out of the contract to buy his property? See R2d § 164(1); UNIDROIT articles 3.5--3.8.
Leasco Corp. v. Taussig
United States Court of Appeals, Second Circuit 473 F.2d 777 (1972)
Timbers, Circuit Judge:
[1]The essential questions presented on this appeal from a judgment for damages in amount of \$669,0002, entered in this diversity action in favor of plaintiff Leasco Corporation against defendant Peter T. Taussig, following a 4 day nonjury trial in the Southern District of New York, Harold L. Tyler, District Judge, are the propriety of the district court's rulings that 292 defendant's claim of rescission based on mutual mistake and misrepresentation was without merit; that defendant had breached his agreement to purchase the stock of one of plaintiff's subsidiaries; and that, defendant having failed specifically to perform such agreement, plaintiff was entitled to damages. Finding no error, we affirm.
I.Background Facts
[2]Leasco Corporation (Leasco) is a Delaware corporation with its principal place of business in New York City. Prior to 1969, Leasco had acquired Louis Berger, Inc. (Berger, Inc.), a firm engaged on an international basis in civil engineering and consulting. Louis Berger Associates (Associates), a wholly owned subsidiary of Berger, Inc., also was acquired by Leasco and, together with Berger, Inc., constituted the "Berger division" of Leasco.
[3]In July 1969, Leasco engaged appellant Peter T. Taussig as vice president and counsel to Berger, Inc. Taussig, a citizen of New Jersey, had civil engineering and law degrees and had practiced law---primarily concerned with construction contracts---in New York City for several years. Leasco hired him through the efforts of Frederick A. Jackson, vice president and corporate counsel for Leasco, who had become acquainted with Taussig when they were both associates in the early 1960's in a New York City law firm.
[4]Shortly after joining Berger, Inc., Taussig became involved in the efforts of Berger, Inc. to acquire the assets of McCreary-Koretsky Engineers, Inc. (MKE), a California corporation engaged in civil engineering and consulting work. Leasco and Berger, Inc. were interested in acquiring MKE's assets in order to expand Leasco's "Berger division" and to make it more efficient. In late 1969 and early 1970, Taussig was asked to investigate MKE. He examined the service contracts held by MKE, as well as its balance sheets and income statements.
[5]MKE at that time was facing bankruptcy because of income taxes due the federal government and a major lawsuit brought by one of its clients. A wholly owned subsidiary of Berger, Inc., McCreary-Koretsky International, Inc. (MKI), was able to acquire the contracts and personnel of MKE as part of a reorganization agreement. MKI had been incorporated specifically for the purpose of acquiring the assets of MKE. MKE was to be paid a percentage of the profits made by MKI on the acquired MKE contracts. The reorganization agreement was closed on September 16, 1970, effective as of April 1, 1970.
[6]Taussig became a vice president of MKI. He acted as a liaison executive between MKI, the Berger companies, and Leasco. His task was to keep Leasco informed about MKI's activities, including its financial condition.
293 [7]In early December 1970, Leasco began to consider divestiture of its entire Berger division. Leasco's management did not like the severe income fluctuations which are characteristic of the civil engineering and consulting business. They also believed that Leasco did not have enough experience to effectively run these businesses.
[8]When Taussig learned that Leasco intended to divest itself of MKI, he offered to purchase it. In late December 1970, Jackson and Taussig discussed the possibility of a sale to Taussig. Taussig estimated that MKI's pre-tax earnings for the fiscal year ending September 30, 1971 would be about \$200,000. Jackson suggested that an appropriate sales price would be 10 times these projected pre-tax earnings, or \$2,000,000. They then cut this amount in half, to \$1,000,000, because, pursuant to the reorganization agreement with MKE, MKI was required to transfer approximately 50% of its profits to MKE. Taussig generally agreed to these price terms, but suggested a package of \$625,000 cash combined with a release by Taussig of Leasco's guarantee of an outstanding loan of \$375,000 to MKI from The Bank of America. Jackson agreed to these terms.
[9]With the basic terms agreed upon, the parties began to draft a formal agreement. Taussig at the time was no longer formally employed by Berger, Inc. In April 1970, he had informed Mr. Louis Berger, chief executive of the Berger operations, that he would resign on November 2, 1970. His resignation was finally accepted in late December 1970, but he continued to work unofficially for Leasco. He moved into offices at Leasco in New York and worked closely with Jackson. He thus had access to the same financial data and other information concerning MKI as did the officers of Leasco.
[10]On February 26, 1971, an agreement was entered into for the sale of MKI to Taussig. The closing date was to be April 15, but later was changed by mutual consent to May 28. The price for MKI was \$625,000, plus Taussig's release of Leasco from its guarantee to The Bank of America of its outstanding loan of \$375,000 to MKI. Two days later, in order to increase the working capital of MKI, Taussig authorized an additional loan of \$200,000 by The Bank of America to MKI, with a guarantee by Leasco. Later, another \$25,000 was loaned by The Bank of America to MKI and guaranteed by Leasco.
[11]On March 12, 1971, Taussig received the February financial statement for MKI. It disclosed a net loss of \$4,702. Taussig traveled to San Francisco where the headquarters of MKI were located. There he learned that a design error in the Fruitvale Bridge job, one of MKI's construction projects, had caused a substantial carry-back loss which accounted for the income loss reflected in the February financial statement. This error also resulted in net losses for the months of March and April.
294 [12]In April 1971, Taussig, in conversations with Jackson and others, indicated that he might not go through with the purchase. On May 28, a representative of Leasco attended the closing and tendered to Taussig the stock as required by the contract. Taussig refused to accept the tender or to perform as required under the contract.
[13]On June 8, Leasco commenced this action seeking specific performance or damages. It claimed that Taussig had wrongfully refused to purchase all the shares of MKI. Taussig by way of defense claimed rescission of the agreement on the grounds of mutual mistake and misrepresentation with regard to material facts. On September 21, the district court denied Leasco's motion for summary judgment, but ordered discovery limited to the issue of the meaning of certain contract provisions and to the issue of mitigation of damages.
[14]After a nonjury trial in January 1972, the district court filed an opinion on February 23, 1972 holding that there was no misrepresentation or mutual mistake and that Taussig had breached the agreement without factual or legal justification. The court ordered specific performance by Taussig at a reduced price of \$169,000, together with a release by Taussig of Leasco from the \$500,000 bank loan guarantee; or, if Taussig should fail to perform, a judgment for damages equal to the sales price plus the amount of the loan guarantee, for a total of \$669,000. When Taussig failed to perform, a judgment in amount of \$669,000 was entered against him.3
II.Defendant's Claim of Rescission
[15]It is undisputed that the contract between Leasco and Taussig was properly executed, and that Leasco made a proper tender of MKI stock on the closing date. Taussig contends here, as he did below, however, that the agreement should be rescinded because the contracting parties were mutually mistaken about a fact material to the agreement or because Leasco negligently misrepresented material facts. These allegedly mistaken or misrepresented facts relate to the projected and actual earnings of MKI.
295 (A)Alleged Mutual Mistake
[16]When Jackson and Taussig first discussed the sale to Taussig of MKI in late December 1970, Taussig estimated that the projected pretax earnings for MKI for fiscal year 1971 would be about \$200,000. MKI's budget in fact showed \$197,000 as the anticipated pre-tax earnings for MKI. When Taussig examined Leasco's management reports in January 1971, a graph representing MKI's financial condition showed the line for actual earnings through January approaching the line for anticipated earnings to that date. No doubt the \$200,000 estimated earnings figure was one of several factors which determined the sales price of MKI. From these circumstances, Taussig argues that a basic assumption of both parties in negotiating the contract was that they were dealing with a company which would earn \$200,000 in the fiscal year ending September 30, 1971. MKI in fact lost \$12,000 during that fiscal year. Taussig contends therefore that the agreement should be rescinded because both parties were mistaken about this material fact. [17]The legal concept of "mistake" is similar to the legal concept of "misrepresentation" in that, under each, a party to a contract may be relieved from his obligations if he was unaware of certain material facts. "Mistake," however, is only such error as is made without representation or deception by the other party to the transaction. Where the mistake is unilateral, the contract is not voidable. But where both parties assume a certain state of facts to exist, and contract on the faith of that assumption, they can be relieved from their obligations if the assumption is erroneous.
[18]In the instant action, we hold that there was no mutual mistake. Both Taussig and Leasco may have hoped, but surely could not have been certain, that MKI would earn \$200,000 in fiscal 1971. Neither party intended to allow rescission of the agreement if, as it turned out, one party got a better bargain than had been anticipated. The civil engineering and consulting business is personalized, highly technical, and extremely risky. Neither party could safely assume that the projected earnings would be realized. Both parties had equal access to information indicating that such a projection would be highly unreliable. Indeed, Taussig probably knew more about the business of MKI than anyone else at Leasco since he originally had investigated it, he served as its vice president and he was a liaison executive between Leasco and MKI.
[19]The facts here are analogous to those in Backus v. MacLaury, 278 App.Div. 504, 106 N.Y.S.2d 401 (4th Dept. 1951). There the defendant sold a two week old bull calf to the plaintiff who planned to use it for breeding. The price paid, \$5,000, was the usual price paid for a breeding bull. Both parties were aware that the earliest at which it can be determined whether a bull is fertile is approximately twelve months. Eighteen months after the sale the plaintiff discovered that the bull was sterile. He sued the 296 defendant for damages. The court held that, since the parties had equal skill and knowledge on the subject of breeding bulls, a warranty of fitness for purpose could not be implied. With regard to the plaintiff's claim of mutual mistake, the court held determinative the fact that, on the day of sale, both parties were aware that the fertility of the bull was uncertain:
"Where the parties know that there is doubt in regard to a certain matter and contract on that assumption, the contract is not rendered voidable because one is disappointed in the hope that the facts accord with his wishes. The risk of the existence of the doubtful fact is then assumed as one of the elements of the bargain." 278 App.Div. at 507, 106 N.Y.S.2d at 404, quoting Restatement of Contracts § 502(f), at 964 (1934).
[20]In the instant action, the parties cannot be said to have been without doubt that MKI's pre-tax earnings for fiscal 1971 would turn out to be \$200,000. As we hold below, there was no warranty by Leasco that MKI actually would earn that amount. Taussig assumed "as one of the elements of the bargain" the risk that a considerably lesser amount would be realized.
[21]We therefore agree with the district court that there was no mutual mistake of fact.
(B)Alleged Misrepresentation
[22]Taussig also contends that MKI's financial statement for the month of January 1971 misrepresented MKI's financial condition. He claims that since this deceptive statement induced him to buy MKI he should be allowed to rescind the agreement.
[23]MKI's January 1971 statement showed earnings of \$49,000 for the fiscal year to date. In fact, however, one of the MKI projects had a serious design error that apparently was discovered by MKI project engineers in January but did not come to the attention of MKI's financial officer until February.4
[24]The project on which the design error was made was the Fruitvale Bridge. The contract for this bridge was entered into in October 1970. By January 1971, it was determined that it was more than half completed. The accounting treatment for the project was the cost of completion method. Under that method, an accountant determines the revenues earned on the job to date by calculating the percentage of total estimated costs thus far incurred. MKI's financial officer calculated that by January 31 about 59% of the anticipated cost of constructing the bridge had been incurred. 297 Accordingly, he determined that about 59% of the revenues from the project, or \$77,000, should be credited to MKI's earnings. In January, however, MKI's chief project engineer discovered a design error in the bridge sufficiently serious to require that most of the bridge be reconstructed. As a result, MKI's profit and loss statement for February showed a loss of \$4,702 primarily attributable to a "prior period adjustment" on the Fruitvale Bridge project. The statement showed a \$13,290 reduction in revenue without a corresponding reduction of cost. The March and April statements also showed net losses primarily caused by the design error.
[25]Taussig does not claim that Leasco deliberately failed to disclose the design error. Nor does he contend that those Leasco officers with whom he dealt knew about the design error at the time the contract was entered into. Nevertheless, MKI's January financial statement was misleading. Furthermore, MKI was negligent in failing to discover and to take account of the error. MKI's financial officer failed to check, as he normally did, with MKI's chief engineer before preparing the January statement.
[26]The question is who should bear a loss attributable to an error committed prior to the sale but not reported until after the sale. Under New York law, such a loss often is borne by the seller even if the misrepresentation is innocent. When a person has induced another to act by representations which are false in fact, although not dishonestly made, and damage has resulted directly from the action taken, the person making such representations often bears the loss. Before a court will grant rescission based on unilateral mistake, however, there must be a showing of equitable considerations which favor the party seeking rescission. And the injured person can rescind only if the misstatement induced him to enter into the contract.
[27]In the instant case, the misleading MKI earnings statement did not induce Taussig to enter into the contract. Several facts lead us to this conclusion. Before entering into the agreement, Taussig was well aware that many of the MKI projects received cost of completion accounting treatment.5 Thus he knew that the profit and loss statements were potentially misleading. He knew that the actual revenues might have been substantially higher or lower than those reported. Taussig also had access, not only to the books and records of MKI, but to its operating personnel as well. He was on Leasco's distribution list for financial statements and short form profit and loss reports. He requested and was given the detailed work sheets from which the December financial reports were prepared. These work sheets disclosed the Fruitvale Bridge project and the accounting treatment of the project. The only restriction imposed upon Taussig was 298 that he could not inform the personnel of MKI that he was purchasing the company, because of the possible disruption this might cause.
[28]If Taussig had taken advantage of the sources of information available to him, he probably would have learned about the design error. Under these circumstances, he should not be heard to complain that he relied upon the financial statements as an accurate and complete description of MKI's financial condition. Moreover, the error in the financial statement was not material. The Fruitvale Bridge project was due for completion in fiscal 1971 and was expected to produce revenues of \$130,000. MKI's total projected annual revenues were \$2,757,000. Thus, the Fruitvale Bridge project was expected to produce only about 5% of the total revenues. This cannot be said to be material.
[29]We do not rely solely upon these circumstances to support our holding that Taussig was not justified in relying upon MKI's financial statements. The agreement itself specifically disclaimed any warranties or representations concerning MKI's financial condition. See Danann Realty Corp. v. Harris, 5 N.Y.2d 317, 184 N.Y.S.2d 599, 157 N.E.2d 597 (1959).
Paragraph 5(d) of the agreement provided:
5.REPRESENTATIONS AND WARRANTIES OF LEASCO---Leasco represents and warrants to Taussig as follows:
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(d)Disclaimer---Except as set forth in this Agreement, Leasco makes no other representations and warranties with respect to MKI and the business thereof.
[30]Nowhere in the agreement is there set forth a warranty that the profit and loss or other financial statements accurately represented the financial condition of MKI.
[31]The question as to who should bear the loss attributable to an error committed prior to the sale but not reported until thereafter is not one that the parties failed to consider when the agreement was entered into. The parties in their good faith bargaining anticipated the problem and allocated the risk of loss to Taussig. Absent any showing that this was unfairly done, the obligations assumed by the parties themselves will be enforced.
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[32]We agree with the district court that there was no material misrepresentation relied upon by defendant.
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Affirmed.
299 ---------
Danann Realty v. Harris
Court of Appeals of New York 5 N.Y.2d 317, 184 N.Y.S.2d 599, 157 N.E.2d 597 (1959)
Burke, J. [1]The plaintiff in its complaint alleges, insofar as its first cause of action is concerned, that it was induced to enter into a contract of sale of a lease of a building held by defendants because of oral representations, falsely made by the defendants, as to the operating expenses of the building and as to the profits to be derived from the investment. Plaintiff, affirming the contract, seeks damages for fraud.
[2]At Special Term, the Supreme Court sustained a motion to dismiss the complaint. On appeal, the Appellate Division unanimously reversed the order granting the dismissal of the complaint. Thereafter the Appellate Division granted leave to appeal, certifying the following question: "Does the first cause of action in the complaint state facts sufficient to constitute a cause of action?" We reverse and answer the question: no.
[3]The basic problem presented is whether the plaintiff can possibly establish from the facts alleged in the complaint (together with the contract which was annexed to the complaint) reliance upon the misrepresentations.
[4]We must, of course, accept as true plaintiff's statements that during the course of negotiations defendants misrepresented the operating expenses and profits. Such misrepresentations are undoubtedly material. However, the provisions of the written contract which directly contradict the allegations of oral representations are of equal importance in our task of reaching a decisive answer to the question posed in these cases.
[5]The contract, annexed to and made a part of the complaint, contains the following language pertaining to the particular facts of representations:
The Purchaser has examined the premises agreed to be sold and is familiar with the physical condition thereof. The Seller has not made and does not make any representations as to the physical condition, rents, leases, expenses, operation or any other matter or thing affecting or related to the aforesaid premises, except as herein specifically set forth, and the Purchaser hereby expressly acknowledges that no such representations have been made, and the Purchaser further acknowledges that it has inspected the premises and agrees to take the premises "as is" . . . It is understood and agreed that all understandings and agreements 300 heretofore had between the parties hereto are merged in this contract, which alone fully and completely expresses their agreement, and that the same is entered into after full investigation, neither party relying upon any statement or representation, not embodied in this contract, made by the other. The Purchaser has inspected the buildings standing on said premises and is thoroughly acquainted with their condition.
[6]Were we dealing solely with a general and vague merger clause, our task would be simple. A reiteration of the fundamental principle that a general merger clause is ineffective to exclude parol evidence to show fraud in inducing the contract would then be dispositive of the issue. To put it another way, where the complaint states a cause of action for fraud, the parol evidence rule is not a bar to showing the fraud---either in the inducement or in the execution---despite an omnibus statement that the written instrument embodies the whole agreement, or that no representations have been made.
[7]Here, however, plaintiff has in the plainest language announced and stipulated that it is not relying on any representations as to the very matter as to which it now claims it was defrauded. Such a specific disclaimer destroys the allegations in plaintiff's complaint that the agreement was executed in reliance upon these contrary oral representations (Cohen v. Cohen, supra [1 A.D.2d 586, 151 N.Y.S. 2d 949]). The Sabo case, supra [Sabo v. Delman, 3 N.Y.2d 155, 164 N.Y.S. 2d 714, 143 N.E. 2d 906] dealt with the usual merger clause. The present case, as in the Cohen case, additionally, includes a disclaimer as to specific representations.
[8]This specific disclaimer is one of the material distinctions between this case and Bridger v. Goldsmith, supra [143 N.Y. 424, 38 N.E. 458] and Crowell-Collier Pub. Co. v. Josefowitz (5 N. Y. 2d 998). In the Bridger case, the court considered the effect of a general disclaimer as to representations in a contract of sale, concluding that the insertion of such a clause at the insistence of the seller cannot be used as a shield to protect him from his fraud. Another material distinction is that nowhere in the contract in the Bridger case is there a denial of reliance on representations, as there is here. Similarly, in Crowell-Collier Pub. Co. v. Josefowitz, supra, decided herewith, only a general merger clause was incorporated into the contract of sale. Moreover, the complaint there additionally alleged that further misrepresentations were made after the agreement had been signed, but while the contract was held in escrow and before it had been finally approved.
[9]Consequently, this clause, which declares that the parties to the agreement do not rely on specific representations not embodied in the 301 [10]The complaint here contains no allegations that the contract was not read by the purchaser. We can fairly conclude that plaintiff's officers read and understood the contract, and that they were aware of the provision by which they aver that plaintiff did not rely on such extra contractual representations. It is not alleged that this provision was not understood, or that the provision itself was procured by fraud. It would be unrealistic to ascribe to plaintiff's officers such incompetence that they did not understand what they read and signed. Although this court in the Ernst case discounted the merger clause as ineffective to preclude proof of fraud, it gave effect to the specific disclaimer of representation clause, holding that such a clause limited the authority of the agent, and hence, plaintiff had notice of his lack of authority. But the larger implication of the Ernst case is that, where a person has read and understood the disclaimer of representation clause, he is bound by it. The court rejected, as a matter of law, the allegation of plaintiff's "that they relied upon an oral statement made to them in direct contradiction of this provision of the contract." The presence of such a disclaimer clause "is inconsistent with the contention that plaintiff relied upon the misrepresentation and was led thereby to make the contract." Kreshover v. Berger, 135 App.Div. 27, 28.
[11]It is not necessary to distinguish seriatim the cases in other jurisdictions as they are not, in the main, in point or, in a few instances, clash with the rule followed in the State of New York. The marshaling of phrases plucked from various opinions and references to generalizations, with which no one disagrees, cannot subvert the fundamental precept that the asserted reliance must be found to be justifiable under all the circumstances before a complaint can be found to state a cause of action in fraud. We must keep in mind that "opinions must be read in the setting of the particular cases and as the product of preoccupation with their special facts." Freeman v. Hewit, 329 U.S. 249, 252. When the citations are read in the light of this caveat, we find that they are generally concerned with factual situations wherein the facts represented were matters peculiarly within the defendant's knowledge, as in the cases of Sabo v. Delman, supra, and Jackson v. State of New York, supra [210 App. Div. 115, 205 N.Y.S. 658].
[12]The general rule was enunciated by this court over a half a century ago in Schumaker v. Mather, 133 N.Y. 590, 596, that "if the facts represented are not matters peculiarly within the party's knowledge, and the other party has the means available to him of knowing, by the exercise of ordinary intelligence, the truth or the real quality of the subject of the representation, he must make use of those means, or he will not be heard to complain that he was induced to enter into the transaction by misrepresentations."
302 [13]Very recently this rule was approved as settled law by this court in the case of Sylvester v. Bernstein, 283 App.Div. 333, affd. 307 N.Y. 778.
[14]In this case, of course, the plaintiff made a representation in the contract that it was not relying on specific representations not embodied in the contract, while, it now asserts, it was in fact relying on such oral representations. Plaintiff admits then that it is guilty of deliberately misrepresenting to the seller its true intention. To condone this fraud would place the purchaser in a favored position. This is particularly so, where, as here, the purchaser confirms the contract, but seeks damages. If the plaintiff has made a bad bargain he cannot avoid it in this manner.
[15]If the language here used is not sufficient to estop a party from claiming that he entered the contract because of fraudulent representations, then no language can accomplish that purpose. To hold otherwise would be to say that it is impossible for two businessmen dealing at arm's length to agree that the buyer is not buying in reliance on any representations of the seller as to a particular fact.
[16]Accordingly, the order of the Appellate Division should be reversed and that of Special Term reinstated, without costs. The question certified should be answered in the negative.
Fuld, J. (dissenting).
[17]If a party has actually induced another to enter into a contract by means of fraud---and so the complaint before us alleges---I conceive that language may not be devised to shield him from the consequences of such fraud. The law does not temporize with trickery or duplicity, and this court, after having weighed the advantages of certainty in contractual relations against the harm and injustice which result from fraud, long ago unequivocally declared that "a party who has perpetrated a fraud upon his neighbor may [not] . . . contract with him in the very instrument by means of which it was perpetrated, for immunity against its consequences, close his mouth from complaining of it and bind him never to seek redress. Public policy and morality are both ignored if such an agreement can be given effect in a court of justice. The maxim that fraud vitiates every transaction would no longer be the rule but the exception." Bridger v. Goldsmith, 143 N.Y. 424, 428. It was a concern for similar considerations of policy which persuaded Massachusetts to repudiate the contrary rule which it had initially espoused. "The same public policy that in general sanctions the avoidance of a promise obtained by deceit", wrote that state's Supreme Judicial Court in Bates v. Southgate, 308 Mass. 170, 182, "strikes down all attempts to circumvent that policy by means of contractual devices. In the realm of fact it is entirely possible for a party knowingly to agree that no representations have been made to him, while at the same time believing and relying upon representations which in fact have been made and in fact are false but for which he would not have made the agreement. To deny 303