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Can You Agree to Be Defrauded?

Can you agree to be defrauded? This may sound like an odd question. But, in this space showed before, the law of business fraud can lead us into some odd places.

It is no spoiler to say that the answer is “yes.” You can actually agree to be defrauded. Many courts, including Illinois (where I practice), allow parties to insert “no-reliance” clauses into contracts.

In a “no-reliance” clause, the signatories expressly agree that they entered into their agreement without reliance on the non-contractual representations of the other.

Put another way, each side can agree that the other’s non-contractual fraud is not actionable.

How You Can Agree to be Defrauded

This formulation is a bit extreme and a bit oversimplified. So let’s break it down a little bit using a recent example.

Raymond L. v. VRE Chicago Eleven, LLC, No. 16-cv-4048, 2016 U.S. LEXIS 134552 (N.D. Ill. Sept. 29, 2016). The District Court faced a motion to dismiss fraudulent inducement claims brought by the purchaser of a KFC restaurant against the seller. The purchaser alleged that the seller knew the restaurant-operator tenant was in poor financial health when the sale was consummated. Purchaser said the seller made misrepresentations and fraudulent omissions regarding the tenant’s financial condition. This resulted in a fraudulent induction into the sale.

The seller moved to dismiss based on the “no-reliance” clause in the purchase agreement. That clause stated (in all caps, not reproduced here) that,

“except for those representations and warranties made by seller in this contract or any closing documents, Purchaser acknowledges that it is not relying on any representations or warranties whatsoever by Seller or any agent or employee thereof regarding the project.”

The District Court denied the seller’s motion to dismiss. In so doing, it conducted a helpful analysis of the no-reliance clause. The Court first acknowledged that

“the purpose of a ‘no-reliance’ clause is to head off a suit for fraud,”

and that

“[s]uch clauses serve an important function under contract law, which is to ensure that both the transaction and any subsequent litigation proceed on the basis of the parties’ writings, which are less subject to the vagaries of memory and the risks of fabrication.”

The sellers’ motion to dismiss was nevertheless denied because the no-reliance clause at issue was ambiguous, and its application to the claims at hand could not be determined without discovery.

The Problem of Ambiguity

The ambiguity issue is a live one for no-reliance clauses. As the Court noted, such clauses are exculpatory. Therefore, they arestrictly construed. They

“must have clear, explicit, and unequivocal language showing that it was the intent of the parties.”

This “elevated requirement of precise language” exists because a no-reliance clause, if applied, can defeat an otherwise meritorious fraud claim.

In the Raymond L case, the court also found — among other ambiguities — that the no-reliance clause may not speak to the purchaser’s allegation of fraud by omission.

The Court also conducted a careful textual analysis of the precise scope of the clause, and the relation between that clause and the fraud alleged. Because

“the Court must consider all of the surrounding circumstances in deciding whether a no-reliance clause is enforceable,”

it could not dismiss the purchaser’s fraud claims at the pleading stage. The Court thought this warranted discovery regarding the precise misrepresentations at issue and the extent and nature of the purchaser’s pre-contract due diligence.

What You Can Learn

What can be learned from this well-reasoned opinion?

First, with a well-drafted no-reliance clause, parties to an agreement can absolutely agree to be defrauded.

Second, drafting a no-reliance clause well is hard. The clause must be, in the Court’s words, “clear, explicit and unequivocal,” and there will be a high bar for enforceability that will consider “all of the surrounding circumstances.”

It is risky to assume that a generic no-reliance clause will apply in all situations, or that the clause that worked for your last deal will, without revision, work for the next one.

 

 

About Adam Hirsch

Adam represents a wide variety of clients, ranging from individuals to small business owners to large corporations. He has a particular focus on business and investment disputes, and has experience litigating such disputes in numerous state and federal courts. He has also represented business clients in arbitration and mediation proceedings. Adam also represents employees in…

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