Reframing the Question: Why Florida Courts Should Enforce Nonreliance Clauses.

Author:Ross, Ian M.
 
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"If you tell the truth, you don't have to remember anything."--Mark Twain

A nonreliance clause is an agreement by a contracting party that it is not relying on any representations other than those set forth in the contract. Stated differently, a nonreliance clause means that a party has acted on its own, free of influence or interference from its counterparty. Although nonreliance clauses are increasingly used by parties in complex commercial contracts and securities transactions, these clauses are not always enforced by courts, and parties are often cautioned by their attorneys that these clauses may not prevent a subsequent lawsuit in an investment gone wrong.

Consider this example: A promising Florida company is raising money. A wealthy investor flies in. He tours the company's facilities and has lunch with management. A young vice president tells the investor that the company recently developed computer software that should boost its revenue over time. Days later, after reviewing the company's financial statements, the investor decides to invest.

As the attorneys negotiate a subscription agreement, the company's attorneys insist on a comprehensive nonreliance provision. Under the provision, the investor agrees that, except for the specific representations made in the agreement, it is not relying on any other representation made by the company. The investor releases the company from any claim relating to any oral representations not embodied in the agreement. The subscription agreement does not mention the computer software.

Two years later, the company is struggling. Revenue has not increased, and the company's computer software was less popular than anticipated. The investor files suit, claiming the investor was defrauded. The company meets with its counsel and asks whether it can have the lawsuit dismissed based on the nonreliance provision in the subscription agreement. "Well," counsel begins, "that's a complicated question...."

Florida courts have historically tried to balance two competing policy goals when deciding whether to enforce a nonreliance provision. First, courts have consistently recognized that they should respect parties' freedom of contract --especially when the parties are sophisticated--and enforce contracts as written. (1) Second, courts have identified the public policy goal of preventing parties from trying to "contract against their own fraud." (2) The tension between these competing principles has been recognized but not resolved; the result is a body of well-reasoned decisions that nonetheless provide companies with little clarity regarding when and how a nonreliance provision will be enforced. (3)

This article offers an alternative framework for evaluating the enforceability of nonreliance clauses in fraud cases. Rather than focusing on the primacy of freedom of contract or the public policy justifications for refusing to enforce certain contracts, courts should reframe their evaluation of nonreliance clauses around the question of reliance. Reliance is a legal element unique to fraud-based claims that asks whether the defendant's misrepresentation induced the plaintiff to believe it. Specifically, reliance focuses on the duties the parties agree to owe to one another in a transaction.

Every transaction presents risk. In the scenario above, the investor may worry that he is being lied to, that the company may not intend to perform under the contract, or that the company simply is not as competent as the investor hopes. The company has its own concerns: The investor may be too focused on a bit of puffery or optimism expressed during diligence by one of its executives, or as time passes and memories fade, may remember such a statement differently than it was intended at the time. Both parties likely want to guard against the possibility that, if their deal goes bad, one will look to blame the other. When that moment arrives, human nature comes with it. Suddenly, the investor may remember that bit of optimism expressed during diligence as the statement that induced it to invest, or the investor may look to past negotiations and decide that some additional duty of disclosure was owed to it. If a dispute arises, both sides will look back to their negotiations, back to their agreement, and years later try to redefine the duties that they owed to one another.

A written nonreliance provision--one that identifies the specific representations relied upon and limits reliance to those specific representations --allows the investor and the company to decide how to allocate these risks among themselves, and to define their duties to one another. In this sense, a court considering whether to enforce a nonreliance provision is not simply deciding a question of contract, because the parties, by negotiating that provision, have defined their own relationship in tort as well. By negotiating the specific representations the seller has made, the parties have identified for the court the representations the buyer wanted to ensure were accurate. Additionally, by negotiating the terms of the buyer's reliance, they have defined the limits of any relational harm that the buyer can later claim it suffered. If courts reframe this enforceability question around the element of reliance, they may find a firmer and more defensible pathway toward enforcing parties' allocations of the risks of a future dispute how they see fit, by disclaiming reliance beyond specifically identifiable representations.

Reframing the Question: What We Mean When We Say "Reliance"

A fraud claim requires a plaintiff to prove that 1) a defendant made a misrepresentation (or omission) of material fact to the plaintiff; 2) the misrepresentation (or omission) was intentional; (4) 3) the plaintiff relied on the misrepresentation (or omission); and 4) the plaintiff suffered damages as a result of the misrepresentation (or omission). (5) The third element is commonly referred to as "reliance." (6)

Courts often note that reliance, which involves a consideration of whether the misrepresentation at issue led to a plaintiff's decision to enter a contract, can be understood as an aspect of causation. For example, in securities cases, courts distinguish between transactional causation--whether the alleged fraud caused the plaintiff to purchase the security--and loss causation--whether the alleged fraud caused the plaintiff's loss. Reliance, courts find, fills the place of transactional causation: "[R]eliance focuses on the front-end causation question of whether the defendant's fraud induced or influenced the plaintiff's stock purchase." (7) Courts also compare reliance to causation outside of the securities context, explaining that reliance occurs when a misrepresentation is "an immediate cause of [a plaintiff's] conduct, which alters his legal relations," and when, absent such representation, "he would not, in all reasonable probability, have entered into the contract or other transaction." (8)

Although proving reliance in a fraud claim is structurally similar to proving the "but for," or transactional, causation link in a negligence claim, conceptually, reliance is asking something else. (9) As the U.S. Supreme Court found in Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. 804 (2010), "when considering whether a plaintiff has relied on a misrepresentation, we have typically focused on facts surrounding the investor's decision to engage in the transaction." (10) This focus on the investor's decision, and how it was made, turns on the representations made to the investor and the care with which those representations were made. (11) Implicitly, reliance assumes that a defendant making a representation that may induce a plaintiff's investor has a duty of care to make those representations truthfully--the duty of care that exists between two parties in a fraud claim, then, is not entirely different than the duty of care in other tort claims. In a negligence claim, for example, we ask if X owes Y a duty of care. The reliance element in a fraud claim implies that X owes Y a duty to tell the truth when he or she speaks. (12)

Stated differently, when common law assumes that a plaintiff relied on someone else's representation, the idea is that the other person had a right to count on the person to tell the truth and fulfill their duty. (13) In a recent law review article, "The Place of Reliance in Frauds," the authors suggest that the question of whether a plaintiff has been defrauded is akin to whether he or she is a victim of trespass:

To defraud someone is to trick them by means of misrepresentation into making a decision that they would not otherwise have made. If the tricking of...

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