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Construction Law Today

Fraud Claim Killer: The Contract Non-Reliance Clause–It’s Not Just For Securities Anymore (Part 2)

Posted in Limitation of Liability and Exculpatory Clauses

Man Pointing Finger in Viewer's FaceIn Episode 1 of Fraud Claim Killer we talked about how the contractual non-reliance clause just became a lot more potent in the Schrager v. Bailey (PDF) decision. And at the end I promised to fill you in on:

  • Limits on non-reliance clauses
  • When judges are reluctant to enforce them
  • What makes them reluctant
  • Tips to make your non-reliance clause useful and enforceable

Slack v. James: Usage Limits and Judicial Reluctance

Non-reliance clauses arouse a lot of controversy, and not all judges are eager to enforce them. They’ve been traditionally reluctant to enforce them outside of investment securities transactions and where it looks like the side invoking the clause had the power to dominate the other.

The Justices of the South Carolina Supreme Court’s decision in Slack v. James is a prime example. The Justices refused to enforce a non-reliance clause in a residential real estate purchase contract. There the buyer accused the seller of misrepresentation based on remarks the seller’s broker had made to the buyers about the absence of easements affecting the property. Turns out, there was a four inch sewer easement on the property. The contract didn’t have any representations about the presence or absence of easements, but it did have this language:

21. ENTIRE AGREEMENT. This written instrument expresses the entire agreement, and all promises, covenants, and warranties between the Buyer and Seller. It can only be changed by a subsequent written instrument (Addendum) signed by both parties. Both Buyer and Seller hereby acknowledge that they have not received or relied upon any statements or representations by either Broker or their agents which are not expressly stipulated herein.

Manhole cover that says SEWERSlack v. James: Buyers’ and Sellers’ Positions

The seller’s position: the italicized language was a non-reliance clause and that should insulate them from the buyer’s claim that the seller’s broker–acting as the seller’s agent–misrepresented the status of easements affecting the property.

The buyer’s position: The language isn’t a non-reliance clause, and even if it is, the Justices shouldn’t enforce it to subvert the buyers’ misrepresentation claims.

Slack v. James: Supreme Court Decision

The divided justices’ decision: the language used doesn’t qualify as a non-reliance clause. And they focused particular attention that the section heading. It says “ENTIRE AGREEMENT.” But it doesn’t mention anything about limiting or disclaiming reliance on information outside of the purchase contract.

The Chief Justice dissented, suggesting that the majority’s reading of the language, emphasis on a lack of signaling language in the heading, and lack of separation of non-reliance language from other contract language were absurd.

So, whether a non-reliance clause in your contract will be enforced, and whether its being enforced helps or hurts you, depends on several things. Below are tips on some of them.

Non-Reliance Clause Use Tips

Here’s some things you should be thinking about when composing or negotiating a non-reliance clause:

  • Language: Craft the language carefully! To avoid the kind of controversy in the Slack decision, you need to ensure that everyone who reads it is going to recognize it as a non-reliance clause. This is where your lawyer helps. Plus they can check applicable law for language that’s mandatory, or toxic, to the non-reliance clause in your contract
  • Heading: The Slack decision suggests that you caption your non-reliance clause as a non-reliance clause and set it out apart in its own section or sub-section with its own special US Mapheading, like “Limited Reliance” for example. These two features signal to whomever picks reads your contract that has a non-reliance clause and where to navigate to it.
  • Geography and Choice of Law: Geography and the choice of governing law in your contract affect enforceability of non-reliance clauses. So where you are, where your counterparties are, where your project is located, and which governing law you choose in your contract may affect whether a non-reliance clause will get enforced. Illinois law—for now—is non-reliance clause friendly. South Carolina is at the other end of the spectrum. You’ll need to check applicable law before you agree to it. And you’ll also need to keep in mind that many states have choice of law statutes for construction projects. These statutes say that if a project is located in a particular state, that state’s law, and only that state’s law, can apply to govern the contract for design or construction of that project
  • Other Documents: If your contract includes terms outside the principal “agreement,” you’ll need to make sure that your principal agreement refers to those documents and incorporates them by reference into your “contract.” Construction contracts and architects agreements do this very often, referring to drawings, specifications, insurance requirements. And usually, the more specific your references to these documents, the better
  • Legal Advice and Representation: The Schrager decision suggests that your odds of enforcing a non-reliance clause get a lot better if each of the contracting parties has a lawyer advise them in negotiating and preparing the contract and the contract has language affirming that. You know those clauses in contracts that recite that each party was represented by a lawyer? The ones you usually pass over with hardly any notice? Here’s where they can make a difference
  • Audit: Audit your contract and and your expectations before signing. If there’s something critical to you (e.g., price, schedule, critical assumptions) and you’re relying on it, particularly something your counterparty tells you or assures you of, you’ll usually want to add that as a representation from your counterparty to you in your contract. For example: your contractor tells you that they’ve investigated the ground at the project site and it’s suitable for building the project without any fill or compaction. This really goes for any contract, but the need for that audit is especially acute when the contract has a non-reliance clause