1 George Mason School of Law Contracts II Fraud Not to be shared F.H. Buckley 2 Rational Choice: The no-duress assumption Full Information Choices are Freely Made Non-satiation Completeness or comparability No third party effects (externalities) Perfect rationality 3 Rational Choice: Six Assumptions Full Information No mistakes (later) No misrepresentations And no informational asymmetries 3 The Elements of Fraud 1.An Assertion: Misrepresentation--A False Assertion: Scienter: Knowledge of falsity and intention to deceive and induce s to enter into the contract. 162(1) 4.Materiality: 164(1), 162(2) 5.Reliance: 1.Assertions Restatement 159: an assertion 5 5 2.A Misrepesentation Restatement 159: an assertion that is not in accord with the facts 6 6 3.Scienter Restatement 162(1)(a): A misrepresentation is fraudulent if the maker intends his assertion to induce a party to manifest his assent and the maker knows or believes that the assertion is not in accord with the facts 7 7 4.Materiality Restatement 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 respondent to do so. 8 8 5.Reliance Restatement 164: If a partys manifestation of assent is induced by a fraudulent misrepresentation by the other party upon which the recipient is justified in relying, the contract is voidable by the recipient. 9 9 The Remedy Restatement 164: If a partys manifestation of assent is induced by a fraudulent misrepresentation by the other party upon which the recipient is justified in relying, the contract is voidable by the recipient. 10 The Elements of Fraud An Assertion: 159 Misrepresentation--A False Assertion: 159 Scienter: Knowledge of falsity and intention to deceive and induce s to enter into the contract. 162(1) Materiality: 164(1), 162(2) Reliance: Does 164 dispense with scienter if the misrepresentation is material? Restatement 164: If a partys manifestation of assent is induced by either a fraudulent or a material misrepresentation by the other party upon which the recipient is justified in relying, the contract is voidable by the recipient. Innocent misrepresentations 12 Does 164 dispense with materiality given scienter ? Restatement 164: If a partys manifestation of assent is induced by either a fraudulent or a material misrepresentation by the other party upon which the recipient is justified in relying, the contract is voidable by the recipient. I.e., innocent party may rely on an immaterial misrepresentation 13 First: What is an Assertion? 14 What is an Assertion? It works: You gotta problem with that? 15 Mere puffs are not assertions Simplex commendatio non obligat 16 Mere puffs Speiss v. Brandt at What were the assertions? Lake McFarland Mere puffs Speiss v. Brandt 18 What was the remedy sought? Lake McFarland Mere puffs Speiss v. Brandt 19 What was the remedy sought? Mere puffs Speiss v. Brandt 20 What if all the s had said was You can make good money out of the resort? 20 Mere puffs Speiss v. Brandt 21 You can pay it off in five years? 21 Mere puffs Speiss v. Brandt 22 Restatement 168. Reliance On Assertions Of Opinion. An assertion is one of opinion if it expresses only a belief, without certainty, as to the existence of a fact or expresses only a judgment as to quality, value, authenticity, or similar matters. 22 Mere puffs Speiss v. Brandt 23 Restatement 168(2) If it is reasonable to do so, the recipient of an assertion of a person's opinion as to facts not disclosed and not otherwise known to the recipient may properly interpret it as an assertion (a) that the facts known to that person are not incompatible with his opinion, or (b) that he knows facts sufficient to justify him in forming it. 23 Mere puffs Speiss v. Brandt 24 We are making good money out of the resort. 24 Mere puffs Speiss v. Brandt 25 We are making good money out of the resort. Were they? Gross income of $19,000 25 Mere puffs Speiss v. Brandt 26 What is the optimal profit to make where there is double taxation of corporate and personal income? 26 Mere puffs Speiss v. Brandt 27 We are making good money out of the resort. What if they had said this and then provided the financials? 27 Mere puffs Speiss v. Brandt 28 We are making good money out of the resort. What do you conclude from the buyers willingness to do the deal even though the financials were not provided? 28 Mere puffs Speiss v. Brandt 29 We are making good money out of the resort. What do you conclude from the buyers willingness to do the deal even though the financials were not provided Or to make an offer before the misrepresentations? 29 Mere puffs Speiss v. Brandt 30 We are making good money out of the resort. Did the court dispense with the materiality requirement? One who deceives another ought not to be heard to say in defense that the other party was negligent in taking him at his wordp Does 164 dispense with materiality given scienter ? Restatement 164: If a partys manifestation of assent is induced by either a fraudulent or a material misrepresentation by the other party upon which the recipient is justified in relying, the contract is voidable by the recipient. I.e., innocent party may rely on an immaterial misrepresentation 31 Mere puffs Speiss v. Brandt 32 But what about Restatement 172? A recipients fault in not knowing or discovering the facts does not make his reliance unjustified unless it amounts to a failure to act in good faith and in accordance with reasonable standards of fair dealing. 32 Mere puffs Speiss v. Brandt 33 What would you have advised your client to say? Does a merchant have heightened duties to one who is young and inexperienced? 34 Does a merchant have heightened duties to one who is young and inexperienced? 35 Spiess: In youth, every manifestation of friendship seems genuine and deserving of special trust and confidence. 35 Does a merchant have heightened duties to one who is young and inexperienced? 36 Restatement 169. When Reliance On An Assertion Of Opinion Is Not Justified. To the extent that an assertion is one of opinion only, the recipient is not justified in relying on it unless the recipient (a) stands in such a relation of trust and confidence to the person whose opinion is asserted that the recipient is reasonable in relying on it, or (b) reasonably believes that, as compared with himself, the person whose opinion is asserted has special skill, judgment or objectivity with respect to the subject matter, or (c) is for some other special reason particularly susceptible to a misrepresentation of the type involved. 36 Mere puffs Speiss v. Brandt 37 Does this threaten to turn commercial relationships into fiduciary ones under Restatement 173? If a fiduciary makes a contract with his beneficiary within the scope of the fiduciary relation, the contract is voidable unless (a) it is on fair terms, and (b) all parties beneficially interested manifest assent with full understanding.. of all relevant facts that the fiduciary knows or should know. 37 Why was the reliance requirement ignored in Ziff-Davis at 432? 38 Why was the reliance requirement ignored in Ziff-Davis at 432? 39 What is the difference between a representation and a term of the contract? How is the reliance requirement treated in Ziff-Davis? In terms of remedies, what is the difference between an action for misrepresentation in contract and an action for breach of contract? 40 The Merger Clause in Danann at 428 What is a Danann clause and why did the parties agree to it? 41 The Merger Clause in Danann Absent the merger clause, what result? What is the parol evidence rule? 42 The Merger Clause in Danann Absent the merger clause, what result? The representations would ordinarily be excluded by the Parol Evidence Rule Here however the fraud exception to the Parol Evidence Rule would apply. 43 The Merger Clause in Danann Absent the merger clause, what result? The representations would ordinarily be excluded by the Parole Evidence Rule Here however the fraud exception to the Parole Evidence Rule would apply. But Danann holds that the parties can bargain around this 44 The Merger Clause in Danann Is there a logical problem in relying on a term of the contract when the fraud would impeach the entire contract? 45 The Merger Clause in Danann What if the fraudulent misrepresentation had been incorporated in the contract? 46 The Merger Clause in Danann What if the fraudulent misrepresentation had been incorporated in the contract? UCC 2-316(1): Words relevant to the creation of an express warranty and words tending to negate liability shall be construed wherever reasonable as consistent with each other; but negation is inopertative to the extent that such construction is unreasonable. 47 Non est factum: Fraud in the factum Curtis v. Curtis at Non est factum: Fraud in the factum Restatement 166: If a partys manifestation of assent is induced by the other partys fraudulent misrepresentation as to the contents or effect of a writing. Restatement 163: a misrepresentation as to the character of a proposed contract 49 The effect of Signing a Contract Merit Music at Bar, 601 South Monroe St. Baltimore MD Signing a Contract Merit Music Were the terms harsh? 51 Signing a Contract Merit Music Were the terms harsh? And just how would you know? 52 Signing a Contract Merit Music Were the terms harsh? For the pinball machine, at $30/week and 25 cents a play, 20 plays a day For the juke box, at $12/week and 25 cents a play, 8 plays a day 53 Signing a Contract Merit Music Were the terms harsh? Who was in the best position to determine the revenue from the machines? 54 Signing a Contract Merit Music Were the terms harsh? Who was in the best position to determine the revenue from the machines? Were the Sonneborns inexperienced? 55 Signing a Contract Merit Music Were the terms harsh? Who was in the best position to determine the revenue from the machines? Were the Sonneborns inexperienced? Did they have any reason to think that what they signed was not a contract? 56 Signing a Contract Merit Music Have you ever signed a contract without reading it? What effect did you think the printed language had? 57 Signing a Contract Merit Music Restatement 211(1): STANDARDIZED AGREEMENTS Except as stated in Subsection (3), where a party to an agreement signs or otherwise manifests assent to a writing and has reason to believe that like writings are regularly used to embody terms of agreements of the same type, he adopts the writing as an integrated agreement with respect to the terms included in the writing. 58 Signing a Contract Merit Music Restatement 211(3) Where the other party has reason to believe that the party manifesting such assent would not do so if he knew that the writing contained a particular term, the term is not part of the agreement. 59 Standard Form Contracts Birmingham TV v. Water Works at 443 Were the terms reasonable? 60 Standard Form Contracts Birmingham TV v. Water Works How would you expect bailees to react to the decision? 61 Standard Form Contracts How would you expect bailees to react to the decision? Is the world now a better place? 62 Thank God for proper warning signs 63 Thank God for proper warning signs 64 Standard Form Contracts Restatement 211(1): STANDARDIZED AGREEMENTS Except as stated in Subsection (3), where a party to an agreement signs or otherwise manifests assent to a writing and has reason to believe that like writings are regularly used to embody terms of agreements of the same type, he adopts the writing as an integrated agreement with respect to the terms included in the writing. 65 Standard Form Contracts as Fascism 66 Friedrich Kessler Why Employ Standard Form Contracts? 67 Why Employ Standard Form Contracts? Economize on negotiations 68 Why Employ Standard Form Contracts? Economize on negotiations Police consumer fraud 69 Why Employ Standard Form Contracts? Economize on negotiations Police consumer fraud Economize on litigation 70 Why Employ Standard Form Contracts? Economize on negotiations Police consumer fraud Economize on litigation Police agency costs of merchant 71 What about emergency cases? St. Johns Episcopal at Suppose the consumer is illiterate or cant speak English 73 Elbonians 73 The blind and elderly Pirkle v. Gurr at 75 Rational Choice: Six Assumptions Full Information No mistakes (later) No misrepresentations And no informational asymmetries 75 76 Non-disclosure When does the duty to speak arise? 76 Informational Asymmetry Ill pay $500 for the rug [but will go as high as $1,000]. 77 Informational Asymmetry Coca-Cola sells you a bottle of Coke but refuses to disclose the secret formula it uses to make it. 78 Non-disclosure What happened in Laidlaw? P Treaty of Ghent 1815 80 The siege of Rhodes Non-disclosure Cicero, Offices III A corn-merchant arrives at the famine-stricken city of Rhodes, before a great number of other vessels loaded with corn; and offers his corn for sale. Is he obliged to inform the buyers that there are a great number of other vessels about to arrive, laden with food? Diogenes thought not. But Cicero thought, on the contrary, that this dissimulation was against good faith. There ought to exist among men a concord and affection which cannot permit us to prefer our private interest to the interest of our neighbor. 81 Non-disclosure Aquinas, Summa Theologica Need the seller disclose where the goods are expected to be of less value at a future time, on account of the arrival of other merchants, which was not foreseen by the buyers? Summa theologica II Non-disclosure Aquinas, Summa Theologica Need the seller disclose where the goods are expected to be of less value at a future time, on account of the arrival of other merchants, which was not foreseen by the buyers? The seller, since he sells his goods at the price actually offered him, does not seem to act contrary to justice through not stating what is going to happen. Summa theologica II Non-disclosure Aquinas, Summa Theologica Need the seller disclose where the goods are expected to be of less value at a future time, on account of the arrival of other merchants, which was not foreseen by the buyers? The seller, since he sells his goods at the price actually offered him, does not seem to act contrary to justice through not stating what is going to happen. If however he were to do so, or if he lowered his price, it would be exceedingly virtuous on his part: although he does not seem to be bound to do this as a debt of justice. Summa theologica II Non-disclosure What happened in Laidlaw? P. 460 Did Organ lie? 85 86 Restatement 161: When non-disclosure is equivalent to an assertion A person's non-disclosure of a fact known to him is equivalent to an assertion that the fact does not exist in the following cases only: (a)where he knows that disclosure of the fact is necessary to prevent some previous assertion from being a misrepresentation or from being fraudulent or material. 86 87 Restatement 161: When non-disclosure is equivalent to an assertion A person's non-disclosure of a fact known to him is equivalent to an assertion that the fact does not exist in the following cases only: (b) where he knows that disclosure of the fact would correct a mistake of the other party as to a basic assumption on which the party is making the contract and if non-disclosure of the fact amounts to a failure to act in good faith and in accordance with reasonable standards of fair dealing. 87 88 Restatement 161: When non-disclosure is equivalent to an assertion A person's non-disclosure of a fact known to him is equivalent to an assertion that the fact does not exist in the following cases only: (c) where he knows that disclosure of the fact would correct a mistake of the other party as to the contents or effects of a writing, evidencing or embodying an agreement in whole or in part. 88 89 Restatement 161: When non-disclosure is equivalent to an assertion A person's non-disclosure of a fact known to him is equivalent to an assertion that the fact does not exist in the following cases only: (d) where the other person is entitled to know the fact because of relation of trust and confidence between them. 89 Non-disclosure What should the buyer have concluded from the sellers silence about changed market conditions? 90 Non-disclosure Which rule better promotes efficiency in Laidlaw? 91 Non-disclosure Which rule better promotes efficiency in Laidlaw? Under which rule is the famine soonest over? 92 Non-disclosure Which rule better promotes efficiency in Laidlaw? The incentive to acquire information 93 Non-disclosure Which rule better promotes efficiency in Laidlaw? Litigation over nondisclosures 94 Non-disclosure An industry analyst discovers that a public firm has fraudulently inflated its profits, and shorts its stock without disclosing his find. 95 Non-disclosure An industry analyst discovers that a public firm has fraudulently inflated its profits, and shorts its stock without disclosing his find. If this were illegal, what would happen to his incentive to discover the information? 96 Non-disclosure A company discovers minerals under a farm and buys the land. Problem? 97 Non-disclosure A company executive in the same firm buys shares in the firm without making disclosure. Problem? 98 Non-disclosure Henry G. Manne, Insider Trading and the Stock Market 99 100 George Mason School of Law Contracts II Fraud Not to be shared F.H. Buckley 101 Fraud: Three Remaining Questions Nondisclosure: Silence and a duty to correct Nondisclosure: Silence vs. Concealment Nondisclosure: Silence vs. Warranty 101 102 Restatement 161: A Duty to Correct A person's non-disclosure of a fact known to him is equivalent to an assertion that the fact does not exist in the following cases only: (a)where he knows that disclosure of the fact is necessary to prevent some previous assertion from being a misrepresentation or from being fraudulent or material. 102 103 Restatement 160: Silence vs. Concealment Action intended or known to be likely to prevent another from learning a fact is equivalent to an assertion that a fact does not exist 103 Restatement 160 In some states, bondo is a primary color 104 Obde v. Schlemeyer at 449 Just what did the Schlemeyers know? 105 Termites Non-disclosure Did they suppress the termite condition? 106 Termites Non-disclosure Should Obde be confined to its special facts? And these were? 107 Non-disclosure Should Obde be confined to its special facts? Does it matter that this was an apartment house? 108 Non-disclosure Should Obde be confined to its special facts? Does it matter that this was an apartment house? Does it matter that it was termites? 109 Non-disclosure Should Obde be confined to its special facts? Does it matter that this was an apartment house? Does it matter that it was termites? Does it matter that the seller made the defect harder to discover? 110 Non-disclosure Should Obde be confined to its special facts? Does it matter that this was an apartment house? Does it matter that it was termites? Does fault matter? 111 Silence vs. Warranty Reed v. King at O.J.s House Reed v. King at O.J.s House Why is land different? Caveat emptor doesnt apply in California land sales Strambovsky: Strambovsky 115 Strambovsky 116 In New York caveat emptor does apply in land sales So how did the court get around it?