Fraud in Contract Law: The Texas Elements, Fraudulent Inducement and Reliance

The elements of fraud in Texas

In JPMorgan Chase Bank v. Orca Assets, decided on 23 March 2018, the Texas Supreme Court restated the elements of a fraud claim. The plaintiff must show that:

1. the defendant made a material representation that was false;
2. the defendant knew the representation was false, or made it recklessly as a positive assertion without any knowledge of its truth;
3. the defendant intended to induce the plaintiff to act on the representation; and
4. the plaintiff actually and justifiably relied on the representation and suffered injury as a result.

Fraud compared with misrepresentation

The difference is the speaker's state of mind. Fraud needs knowledge of falsity or recklessness, plus the intent to induce action. A claim for negligent misrepresentation asks a different question. In the same opinion, the court lists its elements: a representation made in the course of the defendant's business or in a transaction in which it has a pecuniary interest; false information supplied for the guidance of others in their business; a failure to use reasonable care or competence in obtaining or communicating the information; and pecuniary loss from justifiable reliance.

Both claims require justifiable reliance, so many of the points below apply to both.

Fraudulent inducement

In Zorrilla v. Aypco Construction II, decided on 12 June 2015, the court described fraudulent inducement as a distinct category of common-law fraud that shares the same elements but involves a promise of future performance made with no intention of performing at the time it was made. Quoting Haase v. Glazner, it added that this claim arises only in the context of a contract and requires a contract as part of the proof.

The kind of contract matters for the damages. The court describes two measures that Texas recognizes for fraud: out-of-pocket damages, which compare what the injured party spent with the value it received, and benefit-of-the-bargain damages, which compare the value as represented with the value received. Where there is no enforceable contract, a fraud claimant may not recover benefit-of-the-bargain damages.

Why justifiable reliance often decides the case

Justifiable reliance usually presents a question of fact. The Supreme Court also says it can be negated as a matter of law when circumstances show that reliance cannot be justified. The court looks at the nature of the parties' relationship and the contract. In an arm's-length deal, the party that says it was defrauded must exercise ordinary care for its own protection, and confidence in the other side's honesty does not excuse a failure to use reasonable diligence.

• Red flags. A person may not justifiably rely on a misrepresentation if there are warning signs that show reliance is unwarranted. The court considers the party's sophistication and experience.
• Direct contradiction. Reliance on an oral statement that the express, unambiguous terms of the written agreement directly contradict is not justified as a matter of law. The words do not need to match exactly. The test is whether a reasonable person can read the writing and still plausibly claim to believe the earlier statement.
• Either is enough. In a footnote, the court states that red flags alone or direct contradiction alone can defeat justifiable reliance.

A worked example from Orca Assets

The lessor's agent told an oil-and-gas company that certain acreage was "open", meaning unleased. The defendants conceded the statement was made and was false. The company still lost, because its team was experienced, it had ignored warning signs, and the letter of intent and lease contained a clause disclaiming warranties of title that contradicted the statement. The Supreme Court held that the company could not justifiably rely as a matter of law and reinstated the judgment for the defendants.

Does fraud cancel the contract?

The earlier blog post said that proven fraud almost always nullifies the contract. The sources checked do not say that. In Orca Assets the court quotes Italian Cowboy Partners v. Prudential: parties can disclaim reliance, but only by clear and unequivocal language, and this requirement helps ensure that even sophisticated parties understand that the contract may be binding even if it was induced by fraud.

Proving fraud therefore does not by itself end the contract. The contract's own language, including a clear disclaimer of reliance, can limit what a fraud claim achieves.

The four-year deadline

Texas Civil Practice and Remedies Code 16.004(a)(4) requires a suit for fraud to be brought not later than four years after the day the cause of action accrues. Deciding when a claim accrues can be a separate question, so the date of the false statement should be recorded early.

Practical steps

The cases show where parties lose or win. These steps follow from them.

• Put the statements you rely on into the contract as representations and warranties. A promise made only in a meeting may be contradicted by the final document.
• Read the final document against the earlier statements. A clause that contradicts a statement can defeat a later fraud claim by the party that signed.
• Treat warning signs as a reason to investigate, and keep records of what you checked.
• Look for reliance disclaimers and negation clauses, and understand what they say before signing.
• Keep the messages, drafts and documents from the negotiation, and write down the date of each statement.