Information and Assumption Risks

• Author: Robert J. Spjut
• Pages: 81-116

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Information and Assumption Risks

INFORMATION AND ASSUMPTION HAZARDS

Incorrect Information, Processing, and Assumptions

Decisions about transactions are based on information or assumptions in

lieu of information or a combination of both. Information, here used in

the broadest sense, includes any thought communicated about a matter,

the correctness of which can be verified at contract formation or later.

Collecting and evaluating information about a transaction always

has a cost. In a complex transaction, where a party will never have all

the information that might be compiled about that deal, its diligence

costs must be controlled, especially because the marginal value of the

information collected will decrease. A party must decide when it has

sucient information to make decisions about that deal. It will usually

rely on such information unless the party doubts its reliability.

In the best case,

● all information on which a party relies is correct,

● it correctly investigates, evaluates, and processes whatever

information is received, and

● any assumption on which it relies is correct.

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In the worst case,

● any information on which a party relies is incorrect,

● it incorrectly processes some or all of the information, and

● any assumption on which it relies is incorrect.

Between these extremes are twenty-five other combinations of these

three hazards. The simplest three are the focus of this chapter.

These three combinations are (1) reliance upon incorrect

information, processed correctly, and not supplemented by assumptions;

(2) reliance upon correct information incorrectly processed; and (3)

little or no information, correct and correctly processed as far as it goes,

but supplemented by an incorrect assumption upon which a party relies.

In all instances, the hazard is the reliance upon such information or

assumption. The causes of (1) are the counterparty or third parties, and

the causes of (2) and (3) will be the party.

Following are cases that illustrate hazards (1), (2), and (3),

respectively:

● OnBank & Trust Company v. FDIC

1: A government agency became the

conservator of an insolvent savings and loan association, transferred

the mortgage loans the association had made to its customers into

a trust, oered to sell interests in the trust, and described the loans

in a prospectus that overstated the total principal amount of the

loans by approximately $1,000,000, or two percent. The buyer relied

upon the stated amount when bidding for the portfolio.

● Smith v. Zimbalist2: Zimbalist, a prominent violinist and collector

of rare violins, visited Smith, another violin collector, inspected

two of his violins, declared they were made by Stradivarius and

Guarnerius, respectively, asked Smith what price he would accept

for the violins, and agreed to pay $8,000 in installments. The buyer

made and relied entirely upon his own evaluation of the violins.

In fact, the violins were imitations. The information available, the

violins, was incorrectly examined.

● Backus v. MacLaury3: A livestock breeder decided to bid at an

auction on a calf he intended to use to breed a herd, though

1 967 F. Supp. 81 (W.D.N.Y. 1997).

2 2 Cal.App.2d 324, 38 P.2d 170 (Cal. App. 1934).

3 278 A.D. 504, 106 NYS 2d 401 (N.Y. App. 1951).

Planning and Documentation Risks

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the calf was then too young for its fertility to be determined. No

information about the fertility of that specific calf was available.

Each bidder had to make an assumption that the calf was or might

be or was not or might not be fertile. The assumption was knowingly

made. Arational bidder who assumed the calf was fertile, as did

the bidder in the case, would bid an amount higher than one who

assumed otherwise. The latter might not bid at all. The bidder’s

assumption proved incorrect.

Benefit Misconceptions

A benefit is misconceived when its expected value or utility is more or

less than can or will be realized. The misconceiving party may or may

not be the one who will realize the benefit. A hazard occurs when a party

relying upon such misconception expects to receive more value or utility

than can or will be realized. A hazard should not occur because one

party expects the other to receive less than can or will be realized unless

it would have realized extra value had such excess not accrued to the

benefit of the other party or it could also have received more value in

exchange without giving more.

A party misconceives a benefit because (1) the information the

party receives and on which it relies about such benefit is incorrect, (2)

the party incorrectly processes good information and relies upon its

conclusion about such benefit, or (3) the party makes and relies upon an

incorrect assumption about such benefit.

Following are two cases that illustrate reliance upon incorrect

information, a feature of hazard (1):

● OnBank & Trust Company v. FDIC, which is previously described.4

The prospectus overstated the total principal amount of the loans

the buyer received.

● Conti v. Winters

5: The seller stated the car had not been driven more

than 3,500 miles, and the odometer read between 3,400 and 3,500

miles, when, in fact, the car had been driven more than 15,000

miles before being purchased by the seller.

4 See text accompanying note 1.

5 86 RI 456, 136 A.2d 622 (R.I. 1957).

Information and Assumption Risks 83