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Fraud in Inducement and Integration Clause

July 6, 2011 | By James D. Johnson

James D. Johnson         812-422-9444          jdj@rfpj.com

Introduction

A client comes into your office with a contract dispute. As he begins telling his story you peruse the contract to see the representations or warranties section and then go to the back of the document to review the boiler plate language. You find the Integration Clause:

Entire Understanding. The parties hereby acknowledge and represent, each to the other, that this Agreement constitutes a full, final, complete, and entire understanding of the agreement among them concerning the subject matter hereof; that this Agreement expressly supersedes any previous agreements and before execution of this Agreement the parties have read it and have fully informed themselves of its contents, meaning, and legal effect, and have understood the same; that their execution of this Agreement is their own free act and deed and that the terms of the Agreement are contractual and not a mere recital. The undersigned respectfully warrant that no promise or inducement has been offered to them except as herein set forth; that this Agreement is executed without reliance upon any statement or representation concerning the nature and extent of any claims and/or damages or legal liability therefore; that this Agreement evidences the resolution of all claims disputed both as to the liability and to amount.

The client then tells you that the other party to the contract made a representation that was not true. If not for the representation, the client would not have entered into the contract. After the execution of the contract, the client discovers that the representation was untrue and now wants to get out of the contract. The question is: how do you get around the integration clause.

Fraud and the Inducement

The general principle is that fraud in the inducement vitiates a contract. Prall v. Indiana Nat’l Bank, 627 N.E.2d 1374 (Ind. Ct. App. 1994). The elements of fraud are:

(1) a material misrepresentation of past or existing facts which (2) was false (3) was made with knowledge of reckless ignorance of its falsity (4) was made with the intent to deceive, (5) was rightfully relied upon by complaining party, and (6) proximiately caused injury to the complaining party.

Fraudulent inducement occurs when a party is induced through fraudulent misrepresentation to enter in to a contract. A party claiming fraudulent inducement must be generally elect between two remedies: 1) rescission of the contract or 2) damages.

Indiana has historically held that a fraud in the inducement case as barred by a contract integration clause. Prall, 627 N.E.2 1374; Circle Ctr. Dev. Co. v. Y/G Ind. L.P., 782 N.E.2d 176 (Ind. Ct. App. 2002). In Circle Ctr. Dev. Co. the court stated:

The exception for a party who ‘has been induced by a fraudulent misrepresentation to enter the contract,’ must not be stretched or inflated in a way that ‘would severely undermine the policy of the parol evidence rule, which is grounded in the inherent reliability of a writing as opposed to the memories of contracting parties.’

However, the courts in Prall and Circle Ctr. but stated a party could overcome the effect of an integration clause if it could show it had a right to rely upon the alleged misrepresentations and did rely on them in executing the contract/integration clause.

In 2009, Indiana courts moved a different direction concerning the effect of an integration clause in fraudulent inducement case. In Tru-Cal, Inc. v. Conrad Kacisk Instrument Systems, Inc., 905 N.E.2d. 40 (Ind. Ct. App. 2009) the court held that a settlement agreement could be invalidated by fraudulent inducement, despite the inclusion of an integration clause in the agreement, where one party shows that it had the right to rely upon representation, and did rely upon the misrepresentations made by the counterparty to induce execution of the agreement. The issue was the viability of an employment agreement which was the basis of a settlement agreement. It was determined that after the settlement agreement was executed, the signature on the employment agreement was a forgery. The dispute was whether Tru-Cal could rightfully or reasonably rely on CKI’s false representation, i.e. the forged employment agreement. CKI contended that as a matter of law, Tru-Cal did not reasonably rely on the false representations because integration clause in the settlement agreement, which clearly stated Tru-Cal had no right to rely on any statement or misrepresentation concerning the nature of the claims.

The Indiana Court of Appeals found that the fraud (forged employment agreement) either directly induced or contributed to the execution of the settlement agreement. The court also found that the false representations were made to Tru-Cal the intent that they should be acted on. Thus, the court held that Tru-Cal has presented material issues of fact as to whether it had the right to rely on the employment agreement and other related misrepresentations. The court noted that the designated evidence indicated that the president of Tru-Cal believed the employment agreement was valid when he executed the settlement agreement. 

Most importantly, the Court stated:

“Moreover, unlike the plaintiff in Prall, we observe that Tru-Cal did not plainly have the means at hand to unearth the fraud before executing the release.  Further, the boilerplate integration clause did not expressly indicate that Tru-Cal had independently investigated the validity of the signature on the employment agreement.” 

Id. at 46.

Thus, the court held that a party can overcome an integration clause if it can show it did not specifically acknowledge the alleged misrepresentation.

Impact of Tru-Cal

Prior to Tru-Cal, if the contract contains both an integration clause and a no reliance clause, you could tell your client he has a less than 50 percent chance of surviving summary judgment. Now, you can tell him there is a better than 50 percent chance he will survive summary judgment.

An attorney drafting contracts (Tru-Cal was a settlement agreement) must realize the impact of using Indiana law in the choice of law paragraph. Other drafting suggestions should be considered.

This article was originally published in the July 2011 issue of the Tri-State Better Business Bureau newsletter Better Business Builder.

This article was written by James D. Johnson, a partner with Rudolph, Fine, Porter & Johnson, LLP in Evansville, Indiana. For additional information, you may contact James D. Johnson at (812) 422-9444 (e-mail: jdj@rfpj.com). His practice areas include commercial litigation, appeals, employment law (covenants and trade secrets), insurance law, and products liability.  

This article is intended solely as an information source and its contents should not be construed as legal advice. Readers should not act upon the information presented without professional counsel.