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Construction Law Today

Fraud Claim Killer: The Contract Non-Reliance Clause–It’s Not Just For Securities Anymore (Part 1)

Posted in Limitation of Liability and Exculpatory Clauses

Fraud Complaint Non-Reliance clauses: language in a contract where one (or more) of the parties affirms that in making their decision to enter into the contract, they’re relying exclusively on what’s written on the paper in the contract, and nothing else. Why have them? To cut off claims. Particularly the kind that involve a lot of “he said, she said” About what one side said they’d do, or wouldn’t do, but what they’re alleged to have said didn’t make it into the contract. It’s a situation that comes up most often in misrepresentation claims.

Judges have long enforced non-reliance clauses to nip misrepresentations claims in the bud and early in a case. But that’s usually been in securities fraud cases. Recently though, a panel of Illinois Appellate Court judges expanded non-reliance clause enforcement far beyond securities cases, in a way that suggests they’ll be just as potent in contracts used in the design and construction industries. The decision: Schrager v. Bailey (PDF), where the judges applied a non-reliance clause to summarily dismiss misrepresentation claims in a legal malpractice case.

Reliance: Vital Ingredient For Misrepresentation

Before we dig into non-reliance clauses and the Schrager v. Bailey decision, we first have to talk about misrepresentation claims, both intentional misrepresentation—fraud—and its close cousins, like negligent misrepresentation. Regardless of which branch of the misrepresentation family the erstwhile victim claims they’re in, they’ll need to allege and prove a vital ingredient: that they justifiably relied on a their opponent’s misrepresentation.

And there’s where the non-reliance clause comes in. It’s supposed to subvert the “I justifiably relied on what s/he said” ingredient. Under the non-reliance clause, the party claiming that they’re the victim of an extra-contractual misrepresentation that they justifiably relied on, has already affirmed earlier—back in the contract—that they weren’t relying on any extra-contractual information when they decided to sign on the dotted line. And now later on, they can’t go back and repudiate their affirmation saying something like: “well, I didn’t really mean that!” or “it was just some boilerplate; I shouldn’t be held to that!”

Backstory: Schrager v. Bailey

The non-reliance clause in the Schrager decision doesn’t appear in a securities offering, or subscription or purchase agreement. Instead it appears in a legal malpractice settlement agreement in a lawsuit between a group of lawyers and their former—and dissatisfied—client. That settlement agreement included this non-reliance clause:

Client agrees and warrants that in entering into this Agreement, client is solely relying upon the information contained in this Agreement and not in reliance upon any other information.

Angryman YellingAs part of the settlement negotiations, the client insisted that his former lawyers provide affidavits about the facts and circumstances that originally gave rise to the malpractice claim. Some  lawyers provided their affidavit before everyone signed the settlement agreement, some afterwards. Critically, the settlement agreement didn’t refer to, or incorporate, any of the affidavits. Nor did the settlement agreement have any representations from the lawyers, or other terms, consistent with what the client expected to see in the affidavits.

Later, after everyone signed the settlement agreement, another affidavit arrived. The client said that affidavit contradicted earlier ones. He accused his former lawyers of defrauding him, and sued them.

Invoking the Non-Reliance Clause

The lawyers opposed, invoking the non-reliance clause. The affidavits, the lawyers argued, were just the sort of thing that the client, in the non-reliance clause, had affirmed he was not relying on when he (the client) decided to sign the settlement agreement.

Justice Hall’s Decision

Writing for the three judges hearing this case, Justice Shelvin Louise Marie Hall agreed with the lawyers. They enforced the non-reliance clause—early in the case—to deny the client’s fraud claim. They observed that because the client had agreed to the non-reliance clause in the settlement agreement, he could not show that he justifiably relied on any misrepresentations that he alleged were in the affidavits. The judges emphasized:

  • This is a logical rule. It’s hardly justifiable for someone to agree not to not rely on certain things, and then later say they relied on what they earlier agreed not to rely on. And without justifiable reliance, there can be no fraud
  • There’s “sound policy reasons” for denying fraud claims based on oral statements outside the written agreement where the agreement includes a non-reliance clause. The notion of placing primacy on the written word:
    • Is a primary function of contract law
    • Reduces the possibility of faulty memories and fabrication
    • Is not limited to just contracts involving securities transactions
  • The client had new lawyers to advise him when he negotiated the settlement agreement with his former lawyers

These judges held that the non-reliance clause precludes the client from proving justifiable reliance. And that is fatal to his fraud claim.

Arguments in Vain Against the Non-Reliance Clause

The client made each of the following arguments opposing the non-reliance clause. The judges rebuffed each one:

  • The language of the non-reliance clause says that it applies only to pre-settlement agreement representations and information. And because the conflicting affidavit came after the client and lawyers signed the settlement agreement, the non-reliance clause shouldn’t affect a fraud claim based on the post-signing affidavit. Not only did the judges substantively reject this argument, re-reading the clause above reveals that it’s not limited to pre-settlement agreement representations and information
  • Other decisions hold that merger and integration clauses don’t stop misrepresentation claims. But the judges explained that their decision is not dependent on a merger and integration clause. This case is about a non-reliance clause. And though these two types of clauses often travel together—and are often causally mistaken for each other—they are substantively different, particularly in how they affect the justifiable reliance ingredient of a misrepresentation claim. So, earlier judicial decisions on merger and integration clause don’t affect analysis of the non-reliance clause in this case
  • Enforcing the non-reliance clauses allows wrongdoers to profit by their wrongdoing, contrary to a core principle of Anglo-American jurisprudence. Mentioning that under the settlement agreement the lawyers had paid their former client $985,000, the judges said that the record in this case didn’t support that argument

Critical Observation on Non-Reliance Clause Enforcement

Finally, it’s worth pausing here to note that the judges didn’t expand the potency of a non-reliance just a little beyond securities law into another area of hyper-technical and esoteric law where both sides negotiated a contract represented by legions of high priced lawyers.They did it in a case where a client accused his lawyers of defrauding him. Traditionally, the judiciary affords a heightened protection to clients against both under-performance, and overreaching, by their lawyers, putting clients into a de facto specially protected class.

Yet despite the client’s membership in that protected class, the judges in this case still imposed the non-reliance clause against him. The upshot for you: if judges can overcome reluctance to enforcing a non-reliance clause against a client accusing his former lawyers of defrauding him, odds are they’ll be even less reluctant to enforce a similar clause in a design, construction, or loan agreement against an owner, prime or sub-contractor, material supplier, architect, engineer, borrower, lender……

Coming-Up in Part 2

Next in Part 2 we’ll look at:

  • Some of the limits on non-reliance clauses
  • Places where, and reasons why, judges have decided not to enforce them
  • Tips for:
    • Preparing a better non-reliance clauses that helps instead of hurts you
    • Preparing a non-reliance clause with better odds of being enforced