Private Equity

Can you ignore the written words of a contract that directly contradict what you are being told by your counterparty is the real deal?  Stated differently, can you execute a written agreement with a counterparty that says one thing, rely on oral statements from your counterparty saying something completely different, and then ask a court to ignore the written agreement and claim you were defrauded by your counterparty’s inconsistent oral statements?  A recent Texas Supreme Court opinion, Mercedes-Benz USA, LLC v. Carduco Inc., No. 16-0644, 2019 WL 847845 (Tex. Feb. 22, 2019), answered that question with a definitive No!  And while it is an unremarkable decision, because it is consistent with long-held common law principles, it is an important reminder of the degree to which the term fraud is often bandied about unmoored from those common law principles. 

While it is often said that fraud vitiates a contract that was entered into based upon that fraud (and such fraud would also trump the parol evidence rule),^[1] that statement is only true if there was actually legally-recognized fraud that induced the making of the contract.  But a fraud cause of action does not consist simply of an allegation that the defendant made a false statement of fact to the plaintiff, knowingly or recklessly.  Indeed, one of the most critical and long-held requirements for a finding of common-law fraud (as well as for equitable fraud and negligent misrepresentation) is that the recipient of the false statement has “justifiably relied” upon that false statement to its detriment.^[2]  It is for that reason that non-reliance clauses are effective in many states in eliminating claims of fraud based upon any extra-contractual statements that may have been made in connection with the negotiation of a private company acquisition agreement.  Courts have held that a party is not justified in relying on any such extra-contractual statement in view of its contractual promise not to rely upon any such statements.^[3]

But even in the absence of an effective non-reliance clause, recipients of a purported representation of fact that turns out to have been false cannot close their eyes to ascertainable facts and blindly “rely” upon that purported representation.  If a recipient of a false statement knows the statement to be false or in the exercise of reasonable diligence could have ascertained its falsity, the law has typically not allowed the recipient to recover for fraud or avoid a contract entered into on that basis.  And courts, including those in New York and Delaware, have previously held that supposed oral representations that are directly contrary to what the written agreement says cannot serve as a basis for a claim of fraud.^[4]  After all, “reliance upon an oral representation that is directly contradicted by the express, unambiguous terms of a written agreement between the parties is not justified as a matter of law.”^[5] And “[t]o hold otherwise … would be to reward a party for signing a contract under false pretenses, promising to abide by the written terms while secretly intending to enforce the conflicting terms of an unwritten bargain.”^[6]

In Mercedes-Benz, the plaintiff successfully convinced a jury that the defendants had misled the plaintiff into believing that the plaintiff had been promised the right to relocate a Mercedes-Benz dealership the plaintiff was purchasing to another city and to become the exclusive dealer in that city.  Because the defendants refused to approve that relocation and instead awarded a dealership to a third party in that city, the jury awarded the plaintiff $15.3 million in actual damages and more than $100 million in punitive damages.^[7]  The written agreement, however, stated that the plaintiff was granted a dealership only in the current city in which it was located, and provided that the dealership could not be moved without the defendants’ prior written consent, and that the defendants could add whatever new dealerships in the area they desired.  The intermediate appeals court affirmed the trial court’s judgment.  But the Texas Supreme Court reversed, stating that “[b]ecause the conduct and action of [the defendants] on which [the plaintiff] relies to establish its fraudulent-inducement claim are directly contrary to the unambiguous terms of the contract it signed, we conclude that [the plaintiff’s] reliance thereon was unjustified as a matter of law.”^[8]

The law may abhor fraud (at least fraud based on misrepresentations coupled with justifiable reliance), but it also upholds the sanctity of a voluntarily-made agreement entered into by sophisticated parties.  And courts do not typically allow parties to ignore their written agreements in favor of some supposed other deal that was alleged to have been made orally.  Indeed, as a general rule, a written agreement purporting to reflect the deal is, in fact, the deal.^[9]  A party cannot enter into a written agreement and then claim that it was fraudulently induced to do so based on an extra-contractual representation about a state of affairs that the contract itself contradicts.