Fraudulent inducement claims should always be immune from economic loss rule attack.

• Author: Schwiep, Paul J.
• Position: Florida law

As commentators have noted,(1) since the Florida Supreme Court's 1996 decision in HTP, Ltd. v. Lineas Aereas Costarricenses, S.A., 685 So. 2d 1238 (Fla. 1996), lower courts have struggled to determine when, if ever, the economic loss rule (ELR) may be cited to defeat claims for fraudulent inducement of contract. Prior to HTP, some courts had taken the view that tort claims for fraudulent inducement were barred under Florida's economic loss rule.(2) The ELR had been generally held to prohibit the assertion of tort claims to recover for purely economic injuries.(3) In HTP the court held that a "cause of action for fraud in the inducement of contract is an independent tort and is not barred by the economic loss rule."(4) While HTP announced an exception to the ELR for fraudulent inducement, the contours of the exception remain unclear.

HTP might be viewed as setting forth a bright line test: If a tort claim alleges that the defendant intentionally lied prior to the execution of a contract in order to induce the plaintiff to enter into the contract, and the plaintiff justifiably relied on the lie, a claim is stated without regard to the contract or its terms.(5) Some courts, however, have continued to apply the ELR to bar inducement claims when the allegedly false statements are "intertwined" or "interwoven" with representations or obligations in the contract.(6) This article surveys the various approaches courts have taken in determining when a plaintiff may state a fraudulent inducement claim notwithstanding a contract. The article concludes by arguing that fraudulent inducement should always be an exception to the ELR.

In HTP, the plaintiff alleged that the defendant induced the plaintiff to enter into a settlement agreement through false statements. The Supreme Court's opinion does not identify the nature of the false statements. The defendant, citing AFM Corp. v. Southern Bell, 515 So. 2d 180 (Fla. 1987),(7) argued that "because the parties were involved in a contractual relationship that preexisted the alleged fraud in the inducement, the economic loss rule should have barred an award of tort damages."(8) The Supreme Court disagreed, finding that the fraudulent inducement claim was "independent" of the contract and thus viable. The court reasoned that "[f]raudulent inducement is an independent tort in that it requires proof of facts separate and distinct from the breach of contract."(9)

In attempting to distinguish a fraudulent inducement claim from a breach of contract claim, the court approvingly quoted from a Michigan Appeals Court opinion, Huron Tool & Engineering Co. v. Precision Consulting Services, 209 Mich. App. 365, 532 N.W. 2d 541 (1995), which explained that "[t]he distinction between fraud in the inducement and other kinds of fraud is the same as the distinction ... between fraud extraneous to the contract and fraud interwoven with the breach of contract. With respect to the latter kind of fraud, the misrepresentations relate to the breaching party's performance of the contract and do not give rise to an independent cause of action in tort."(10)

Fraud Interwoven with the Contract Versus Fraud Extraneous to the Contract

The distinction articulated in HTP--fraud "extraneous" to the contract versus "interwoven fraud"--has been virtually impossible for lower courts to define consistently. At least two approaches have emerged. Some courts have taken the view that the issue is strictly temporal: If the allegedly fraudulent statement occurred prior to the execution of the contract, then the fraud is "extraneous" to the contract.(11) For instance, in Nautica Int'l, Inc. v. Intermarine USA, L.P., 5 F. Supp. 2d 1333 (S.D. Fla. 1998), the plaintiff and defendant entered into an agreement to develop rigid inflatable boats to market to the United States. In the written contract, the defendant agreed that it would use its best efforts to develop and market the boats. The defendant also allegedly represented, pre-contract, that the defendant would cooperate with the plaintiff and use its best efforts to secure a contract. The relationship fell apart and the plaintiff sued for breach and fraudulent inducement.

The defendant moved to dismiss the inducement claim arguing that the plaintiff relied on the same allegations--failure to use best efforts--to support both the fraud and breach claims. The court found that the inducement claim was not barred by the ELR because the allegedly fraudulent statements were made prior to contracting: "The analysis presents a question of timing: does this tort claim that Defendants fraudulently induced Plaintiffs to contract ... arise from conduct prior to, and distinct from, the alleged willful breach of contract?"(12) The court held that because plaintiff's fraud claim "attacks conduct prior to any alleged agreement between the parties" it survived the ELR.(13)

At the other end of the spectrum are cases like Hotels of Key Largo v. RHI Hotels, 694 So. 2d 74 (Fla. 3d DCA), review denied, 700 So. 2d 685 (Fla. 1997), in which courts are less concerned with timing than they are with a substantive comparison of the allegedly fraudulent statements against the contract's provisions. Hotels of Key Largo involved a licensing and marketing agreement between a Keys hotel owner and a division of Radisson Hotels. Under the agreement, the Keys hotel became part of the Radisson system with access to Radisson's reservation system and travel agents. The plaintiff alleged that the defendant's representatives--prior to execution of the contract--falsely represented that upon execution of the licensing agreement 40 percent of the plaintiff's room reservations would be generated by the defendant's reservation system. The plaintiff alleged that, in fact, it had lost money on the licensing contract and that the defendant had failed to produce the promised reservations.

The Third District Court of Appeal held that the ELR barred the fraud claim. Quoting a pre-HTP Fourth District Court of Appeal case, the court stated: "A party may not recover in fraud for an alleged oral misrepresentation which is adequately dealt with in a later written contract."(14) The court rejected the argument that HTP stood for the proposition that "one can always avoid operation of the economic loss doctrine by merely pleading fraud in the inducement."(15) Reasoning that "a critical distinction must be made where the alleged fraudulent misrepresentations are inseparably embodied in the parties' subsequent agreement," the court found that representations "embodied" in the agreement could not support a fraud claim.(16) The court held: "[W]here the only alleged misrepresentations concern the heart of the parties' agreement, simply applying the label of `fraudulent inducement' to a cause of action will not suffice to subvert the sound policy rationales underlying the economic loss doctrine."(17)

Hotels of Key Largo has spawned many similar cases(18) when courts, in determining whether a fraud in the inducement claim survives the ELR, "consider the relationship between the inducing representation and the essential requirements, express or implied, of the contract agreed to by the parties."(19) Under Hotels of Key Largo, the inducement claim should be dismissed if the representations are "intertwined"(20) or "inseparably embodied"(21) in the contract. These courts are clearly troubled by the prospect of an artful pleader merely recasting his breach case as a fraud claim seeking punitive damages. Another court, reviewing the cases, complained that "there is a lot of loose language being used to describe these principles and the confusion is compounded with almost every case."(22) Most judges would concur with the sentiment.

An even more lenient standard for rejection of a fraud claim is set out in Greenfield v. Manor Care, 705 So. 2d 926, (Fla. 4th DCA 1997), which held: "When the misrepresentations are related to the breaching party's performance of the contract, they do not give rise to an independent cause of action in tort."(23) Under this approach, if it can be said the alleged fraudulent statements and the failure to perform are merely "related," the fraud claim fails.

When, if Ever, Should Fraudulent Inducement Claims be Barred?

An example illustrates the problems generated by these various approaches to applying the ELR to fraud cases. Buyer negotiates to purchase seller's business. Buyer advises that he requires the business to generate at least $100,000 in annual profit. Seller, knowing that the statement is false and intending to induce buyer to go forward, represents that the business generates profits well over that amount. The parties later sign an integrated contract.(24)

Regardless of the contract, under Nautica, the buyer could state a claim for fraudulent inducement because the seller's representation regarding revenues: 1) was made prior to the contract's execution; 2) was knowingly false; 3) was made with the intent to induce reliance; 4) was (allegedly) justifiably relied upon; and 5) did, in fact, induce the contract. Under cases like Straub Capital Corp. v. L. Frank Chopin, 724 So. 2d 577 (Fla. 4th DCA 1999), and Greenfield, however, buyer likely could not state a claim because the statement is "related" to the contract to purchase and sell.

Under Hotels of Key Largo, a court might need to know more to resolve a motion to dismiss. For instance, if the contract contained a "no warranties" provision stating that the seller makes no representations about revenues, certainly the Hotels of Key Largo approach would require dismissal of the fraud count because the false representation inducing the contract is "interwoven" with statements in the contract. What if the contract lacked a "no warranties" provision, but contained a paragraph granting the buyer rights to conduct a full audit prior to closing in order to determine revenues? Probably, there would be no fraud claim under a Hotels of Key Largo...