George Mason School of Law Contracts II Fraud

George Mason School of Law Contracts II Fraud Not to be shared © F. H. Buckley fbuckley@gmu. edu 1

Rational Choice: The no-duress assumption o o o Full Information Choices are Freely Made Non-satiation Completeness or comparability No third party effects (externalities) Perfect rationality 2

Rational Choice: Six Assumptions o Full Information n No mistakes (later) n No misrepresentations n And no informational asymmetries 3 3

The Elements of Fraud 1. An Assertion: § 159 2. Misrepresentation--A False Assertion: § 159 3. Scienter: Knowledge of falsity and intention to deceive and induce Π’s to enter into the contract. § 162(1) 4. Materiality: §§ 164(1), 162(2) 5. Reliance: § 164 4 4

1. Assertions o Restatement § 159: “an assertion” 5 5

2. A Misrepesentation o Restatement § 159: “an assertion that is not in accord with the facts” 6 6

3. Scienter o Restatement § 162(1)(a): A misrepresentation is fraudulent if the maker intends his assertion to induce a party to manifest his assent and the maker knows or believes that the assertion is not in accord with the facts 7 7

4. Materiality o Restatement § 162(2): A misrepresentation is material if it would be likely to induce a reasonable person to manifest his assent or if the maker knows that it would be likely to induce the respondent to do so. ” 8 8

5. Reliance o Restatement § 164: If a party’s manifestation of assent is induced by … a fraudulent … misrepresentation by the other party upon which the recipient is justified in relying, the contract is voidable by the recipient. 9 9

The Elements of Fraud o An Assertion: § 159 o Misrepresentation--A False Assertion: § 159 o Scienter: Knowledge of falsity and intention to deceive and induce Π’s to enter into the contract. § 162(1) o Materiality: §§ 164(1), 162(2) o Reliance: § 164 10 10

Does § 164 dispense with scienter if the misrepresentation is material? o Restatement § 164: If a party’s manifestation of assent is induced by either a fraudulent or a material misrepresentation by the other party upon which the recipient is justified in relying, the contract is voidable by the recipient. o “Innocent misrepresentations” 11 11

Does § 164 dispense with materiality given scienter ? o Restatement § 164: If a party’s manifestation of assent is induced by either a fraudulent or a material misrepresentation by the other party upon which the recipient is justified in relying, the contract is voidable by the recipient. o I. e. , innocent party may rely on an immaterial misrepresentation 12 12

First: What is an Assertion? 13

What is an Assertion? “It works”: You gotta problem with that? 14

Mere puffs are not assertions Simplex commendatio non obligat 15

Mere puffs Speiss v. Brandt at 421 n What were the assertions? Lake Mc. Farland 16

Mere puffs Speiss v. Brandt What was the remedy sought? 17 Lake Mc. Farland

Mere puffs Speiss v. Brandt What was the remedy sought? 18

Mere puffs Speiss v. Brandt n What if all the Δs had said was “You can make good money out of the resort”? 19 19

Mere puffs Speiss v. Brandt n “You can pay it off in five years”? 20 20

Mere puffs Speiss v. Brandt o Restatement § 168. Reliance On Assertions Of Opinion. An assertion is one of opinion if it expresses only a belief, without certainty, as to the existence of a fact or expresses only a judgment as to quality, value, authenticity, or similar matters. 21 21

Mere puffs Speiss v. Brandt o Restatement § 168(2) If it is reasonable to do so, the recipient of an assertion of a person's opinion as to facts not disclosed and not otherwise known to the recipient may properly interpret it as an assertion o (a) that the facts known to that person are not incompatible with his opinion, or o (b) that he knows facts sufficient to justify him in forming it. 22 22

Mere puffs Speiss v. Brandt n “We are making good money out of the resort. ” 23 23

Mere puffs Speiss v. Brandt n “We are making good money out of the resort. ” o Were they? Gross income of $19, 000… 24 24

Mere puffs Speiss v. Brandt n What is the optimal profit to make where there is double taxation of corporate and personal income? 25 25

Mere puffs Speiss v. Brandt n “We are making good money out of the resort. ” o What if they had said this and then provided the financials? 26 26

Mere puffs Speiss v. Brandt n “We are making good money out of the resort. ” o What do you conclude from the buyers’ willingness to do the deal even though the financials were not provided? 27 27

Mere puffs Speiss v. Brandt n “We are making good money out of the resort. ” o What do you conclude from the buyers’ willingness to do the deal even though the financials were not provided o Or to make an offer before the misrepresentations? 28 28

Mere puffs Speiss v. Brandt n “We are making good money out of the resort. ” o Did the court dispense with the materiality requirement? n “One who deceives another ought not to be heard to say in defense that the other party was negligent in taking him at his word”—p. 425 29 29

Does § 164 dispense with materiality given scienter ? o Restatement § 164: If a party’s manifestation of assent is induced by either a fraudulent or a material misrepresentation by the other party upon which the recipient is justified in relying, the contract is voidable by the recipient. o I. e. , innocent party may rely on an immaterial misrepresentation 30 30

Mere puffs Speiss v. Brandt n. But what about Restatement § 172? o A recipient’s fault in not knowing or discovering the facts … does not make his reliance unjustified unless it amounts to a failure to act in good faith and in accordance with reasonable standards of fair dealing. 31 31

Mere puffs Speiss v. Brandt n What would you have advised your client to say? 32

Does a merchant have heightened duties to one who is “young and inexperienced”? 33 33

Does a merchant have heightened duties to one who is “young and inexperienced”? n Spiess: “In youth, every manifestation of friendship seems genuine and deserving of special trust and confidence. ” 34 34

Does a merchant have heightened duties to one who is “young and inexperienced”? o Restatement§ 169. When Reliance On An Assertion Of Opinion Is Not Justified. To the extent that an assertion is one of opinion only, the recipient is not justified in relying on it unless the recipient o (a) stands in such a relation of trust and confidence to the person whose opinion is asserted that the recipient is reasonable in relying on it, or o (b) reasonably believes that, as compared with himself, the person whose opinion is asserted has special skill, judgment or objectivity with respect to the subject matter, or o (c) is for some other special reason particularly susceptible to a misrepresentation of the type involved. 35 35

Mere puffs Speiss v. Brandt n Does this threaten to turn commercial relationships into fiduciary ones under Restatement § 173? o If a fiduciary makes a contract with his beneficiary within the scope of the fiduciary relation, the contract is voidable unless (a) it is on fair terms, and (b) all parties beneficially interested manifest assent with full understanding. . of all relevant facts that the fiduciary knows or should know. 36 36

How is the reliance requirement treated in Ziff-Davis at 432? 37 37

How is the reliance requirement treated in Ziff-Davis? o What is the difference between an action for misrepresentation in contract and an action for breach of contract? 38

How is the reliance requirement treated in Ziff-Davis? o What is the difference between an action of misrepresentation in contract and in tort? 39

The Merger Clause in Danann at 428 o What is a “Danann clause” and why did the parties agree to it? 40

The Merger Clause in Danann o Absent the merger clause, what result? n What is the parol evidence rule? 41

The Merger Clause in Danann o Absent the merger clause, what result? n The representations would ordinarily be excluded by the Parol Evidence Rule o Here however the fraud exception to the Parol Evidence Rule would apply. 42

The Merger Clause in Danann o Absent the merger clause, what result? n The representations would ordinarily be excluded by the Parole Evidence Rule o Here however the fraud exception to the Parole Evidence Rule would apply. o But Danann holds that the parties can bargain around this 43

The Merger Clause in Danann o Is there a logical problem in relying on a term of the contract when the fraud would impeach the entire contract? 44

The Merger Clause in Danann o What if the fraudulent misrepresentation had been incorporated in the contract? 45

The Merger Clause in Danann o What if the fraudulent misrepresentation had been incorporated in the contract? n UCC § 2 -316(1): “Words … relevant to the creation of an express warranty and words … tending to negate … liability shall be construed wherever reasonable as consistent with each other; but … negation … is inopertative to the extent that such construction is unreasonable. 46

Non est factum: Fraud in the factum n Curtis v. Curtis at 437 47 47

Non est factum: Fraud in the factum n Restatement § 166: If a party’s manifestation of assent is induced by the other party’s fraudulent misrepresentation as to the contents or effect of a writing…. n Restatement § 163: “a misrepresentation as to the character of a proposed contract” 48 48

The effect of Signing a Contract Merit Music at 438 49 Bar, 601 South Monroe St. Baltimore MD

Signing a Contract Merit Music o Were the terms harsh? 50 50

Signing a Contract Merit Music o Were the terms harsh? n And just how would you know? 51 51

Signing a Contract Merit Music o Were the terms harsh? n For the pinball machine, at $30/week and 25 cents a play, 20 plays a day n For the juke box, at $12/week and 25 cents a play, 8 plays a day 52 52

Signing a Contract Merit Music o Were the terms harsh? n Who was in the best position to determine the revenue from the machines? 53 53

Signing a Contract Merit Music o Were the terms harsh? n Who was in the best position to determine the revenue from the machines? n Were the Sonneborns inexperienced? 54 54

Signing a Contract Merit Music o Were the terms harsh? n Who was in the best position to determine the revenue from the machines? n Were the Sonneborns inexperienced? n Did they have any reason to think that what they signed was not a contract? 55 55

Signing a Contract Merit Music o Have you ever signed a contract without reading it? What effect did you think the printed language had? 56 56

Signing a Contract Merit Music o Restatement § 211(1): STANDARDIZED AGREEMENTS Except as stated in Subsection (3), where a party to an agreement signs or otherwise manifests assent to a writing and has reason to believe that like writings are regularly used to embody terms of agreements of the same type, he adopts the writing as an integrated agreement with respect to the terms included in the writing. 57 57

Signing a Contract Merit Music o Restatement § 211(3) Where the other party has reason to believe that the party manifesting such assent would not do so if he knew that the writing contained a particular term, the term is not part of the agreement. 58 58

Standard Form Contracts Birmingham TV v. Water Works at 443 o Were the terms reasonable? 59

Standard Form Contracts Birmingham TV v. Water Works o How would you expect bailees to react to the decision? 60 60

Standard Form Contracts o How would you expect bailees to react to the decision? n Is the world now a better place? 61

Thank God for proper warning signs 62

Thank God for proper warning signs 63

George Mason School of Law Contracts II Fraud Not to be shared © F. H. Buckley fbuckley@gmu. edu 64

For next day, under Unconscionability o Add ”Signaling, ” at blog 65

What a future earnings distribution won’t look like 66

What a future earnings distribution will look like Y = Percent of individuals 67 X = Non-digitalalizable skills

Are you training for a job that can be replaced by a computer? 68

Should outfielders be permitted to wear Google Glasses? 69

What Law Isn’t like 70

Standard Form Contracts o Restatement § 211(1): STANDARDIZED AGREEMENTS Except as stated in Subsection (3), where a party to an agreement signs or otherwise manifests assent to a writing and has reason to believe that like writings are regularly used to embody terms of agreements of the same type, he adopts the writing as an integrated agreement with respect to the terms included in the writing. 71 71

Standard Form Contracts as Fascism 72 Friedrich Kessler 1901 -98

Why Employ Standard Form Contracts? 73

Why Employ Standard Form Contracts? o Economize on negotiations 74 74

Why Employ Standard Form Contracts? o Economize on negotiations o Police consumer fraud 75 75

Why Employ Standard Form Contracts? o Economize on negotiations o Police consumer fraud o Economize on litigation 76 76

Why Employ Standard Form Contracts? o Economize on negotiations o Police consumer fraud o Economize on litigation o Police agency costs of merchant 77 77

What about emergency cases? o St. John’s Episcopal at 444 78 78

Suppose the consumer is illiterate or can’t speak English 79 Elbonians 79

The blind and elderly o Pirkle v. Gurr at 446 80 80

Rational Choice: Six Assumptions o Full Information n No mistakes (later) n No misrepresentations n And no informational asymmetries 81 81

Non-disclosure o When does the duty to speak arise? 82 82

Informational Asymmetry o “I’ll pay $500 for the rug” [but will go as high as $1, 000]. 83

Informational Asymmetry o Coca-Cola sells you a bottle of Coke but refuses to disclose the secret formula it uses to make it. 84

Non-disclosure o What happened in Laidlaw? P. 460 Treaty of Ghent 1815 85

The siege of Rhodes 86

Non-disclosure Cicero, Offices III A corn-merchant arrives at the famine-stricken city of Rhodes, before a great number of other vessels loaded with corn; and offers his corn for sale. Is he obliged to inform the buyers that there a great number of other vessels about to arrive, laden with food? Diogenes thought not. But Cicero thought, on the contrary, that this dissimulation was against good faith. There ought to exist among men a concord and affection which cannot permit us to prefer our private interest to the interest of our neighbor. 87

Non-disclosure Aquinas, Summa Theologica Need the seller disclose where “the goods are expected to be of less value at a future time, on account of the arrival of other merchants, which was not foreseen by the buyers”? 88 Summa theologica II. 2 77. 3 88

Non-disclosure Aquinas, Summa Theologica Need the seller disclose where “the goods are expected to be of less value at a future time, on account of the arrival of other merchants, which was not foreseen by the buyers”? The seller, since he sells his goods at the price actually offered him, does not seem to act contrary to justice through not stating what is going to happen. Summa theologica II. 2 77. 3 89 89

Non-disclosure Aquinas, Summa Theologica Need the seller disclose where “the goods are expected to be of less value at a future time, on account of the arrival of other merchants, which was not foreseen by the buyers”? The seller, since he sells his goods at the price actually offered him, does not seem to act contrary to justice through not stating what is going to happen. If however he were to do so, or if he lowered his price, it would be exceedingly virtuous on his part: although he does not seem to be bound to do this as a debt of justice. Summa theologica II. 2 77. 3 90 90

Non-disclosure o What happened in Laidlaw? P. 460 n Did Organ lie? 91

Silence as an Assertion o Might silence constitute an assertion? o Restatement § 160: “Action intended or known to be likely to prevent another from learning a fact is equivalent to an assertion that the fact does not exist” 92 92

Restatement § 161: When non-disclosure is equivalent to an assertion o A person's non-disclosure of a fact known to him is equivalent to an assertion that the fact does not exist in the following cases only: (a)where he knows that disclosure of the fact is necessary to prevent some previous assertion from being a misrepresentation or from being fraudulent or material. 93 93

Restatement § 161: When non-disclosure is equivalent to an assertion o A person's non-disclosure of a fact known to him is equivalent to an assertion that the fact does not exist in the following cases only: (b) where he knows that disclosure of the fact would correct a mistake of the other party as to a basic assumption on which the party is making the contract and if non-disclosure of the fact amounts to a failure to act in good faith and in accordance with reasonable standards of fair dealing. 94 94

Restatement § 161: When non-disclosure is equivalent to an assertion o A person's non-disclosure of a fact known to him is equivalent to an assertion that the fact does not exist in the following cases only: (c) where he knows that disclosure of the fact would correct a mistake of the other party as to the contents or effects of a writing, evidencing or embodying an agreement in whole or in part. 95 95

Restatement § 161: When non-disclosure is equivalent to an assertion o A person's non-disclosure of a fact known to him is equivalent to an assertion that the fact does not exist in the following cases only: (d) where the other person is entitled to know the fact because of relation of trust and confidence between them. 96 96

Non-disclosure o What should the buyer have concluded from the seller’s silence about changed market conditions? 97

Non-disclosure o Which rule better promotes efficiency in Laidlaw? 98 98

Non-disclosure o Which rule better promotes efficiency in Laidlaw? o Under which rule is the famine soonest over? 99 99

Non-disclosure o Which rule better promotes efficiency in Laidlaw? n The incentive to acquire information 100

Non-disclosure o Which rule better promotes efficiency in Laidlaw? n Litigation over nondisclosures 101

Non-disclosure o An industry analyst discovers that a public firm has fraudulently inflated its profits, and shorts its stock without disclosing his find. 102

Non-disclosure o An industry analyst discovers that a public firm has fraudulently inflated its profits, and shorts its stock without disclosing his find. n If this were illegal, what would happen to his incentive to discover the information? 103

Non-disclosure o A company discovers minerals under a farm and buys the land. Problem? 104

Non-disclosure o A company executive in the same firm buys shares in the firm without making disclosure. Problem? 105

Non-disclosure o Kronman: was there a cost to production of the information? 106

Non-disclosure o Kronman: was the a cost to production of the information? n Whatever--Under which rule is the information processed in the market most quickly? 107

Restatement § 160: When action is equivalent to an assertion (concealment) o Action intended or known to be likely to prevent another from learning a fact is equivalent to an assertion that a fact does not exist 108

Restatement § 160 In some states, bondo is a primary color 109

Obde v. Schlemeyer at 449 o Just what did the Schlemeyers know? 110 Termites

Non-disclosure o Did they suppress the termite condition? 111 Termites

The rejection of “an individualistic philosophy based on freedom of contract” We see it from a moral point of view… unlike Aquinas 112

Non-disclosure o Should Obde be confined to its special facts? And these were? 113

Non-disclosure o Should Obde be confined to its special facts? n Does it matter that this was an apartment house? 114

Non-disclosure o Should Obde be confined to its special facts? n Does it matter that this was an apartment house? n Does it matter that it was termites? 115

Non-disclosure o Should Obde be confined to its special facts? n Does it matter that this was an apartment house? n Does it matter that it was termites? n Does it matter that the seller made the defect harder to discover? 116

Non-disclosure o Should Obde be confined to its special facts? n Does it matter that this was an apartment house? n Does it matter that it was termites? n Does fault matter? Should this be a warranty? 117

Reed v. King at 452 O. J. ’s House 118

Strambovsky: 456 119

Strambovsky 120