Fraud, Economic Loss and Contractual Integration Clauses (And More): Illinois Fed Court Provides Primer

Plaintiff purchased the defendant’s nation-wide network of auto collision centers as part of a complicated $32.5M asset purchase agreement (APA).   A dispute arose when the plaintiff paid $9.5M to a paint supply company and creditor of the defendant in order to consummate the APA.  The plaintiff argued that the defendant breached the APA by not satisfying the paint supply debt and securing a release from the paint supplier before the APA’s closing date.  Plaintiff sued on various tort and contract theories.  Defendant countersued for reformation, rescission and breach of contract.  Both parties moved to dismiss.

In granting the bulk of the defendant’s motion to dismiss, the court in Boyd Group, Inc. v. D’Orazio, 2015 WL 3463625 (N.D.Ill. 2015) examines the interplay among several recurring commercial litigation issues including the economic loss doctrine as it applies to negligent misrepresentation claims, the impact of a contractual integration clause, and the pleading requirements for fraud in Illinois.

The court dismissed the breach of contract claim based on the APA’s integration clause.  Where parties insert an integration clause into their contract, they are manifesting their intent to guard against conflicting interpretations that could result from extrinsic evidence.  If a contract has a clear integration clause, the court cannot consider anything beyond the “four corners” of the contract and may not address evidence that relates to the parties’ understanding before or at the time the contract was signed.1

Here, the plaintiff’s breach of contract claim was based in part on e-mails authored by the defendant the same day the APA was signed.  Since the APA integration clause clearly provided that the APA was constituted the entire agreement between the parties, the court found that the defendant’s e-mails couldn’t be considered to vary the plain language of the APA.2.

The plaintiff’s negligent misrepresentation claim was defeated by the economic loss doctrine, which posits that where a written contract governs the parties’ relationship, a plaintiff’s remedy is one for breach of contract, not one sounding in tort.  An exception to this rule is where the defendant is in the business of providing information for the guidance of others in their business transactions.

Case law examples of businesses that the law deems information suppliers (for purposes of the negligent misrepresentation/economic loss rule) include stockbrokers, real estate brokers and terminate inspectors.  Conversely, businesses whose main product is not information include property developers, builders and manufacturers.

Here, the in-the-business exception (to the economic loss rule) didn’t apply since defendant operated car collision repair businesses.  He did not supply information for others’ business guidance.  The court found the defendant more akin to a manufacturer of a product and that any information he furnished was ancillary to his main collision repair business.3

The one claim that did survive the motion to dismiss was plaintiff’s fraud claim.  To plead common law fraud under Illinois law, the plaintiff must establish (1) a false statement of material fact, (2) defendant’s knowledge the statement was false, (3) defendant’s intent to induce action by the plaintiff, (4) plaintiff’s reliance on the truth of the statement, and (5) damages resulting from reliance on the statement.  Fraud requires heightened pleading specificity and it must be more than a simple breach of contract.  A fraud claim must also involve present or past facts; statements of future intent or promises aren’t actionable. 4

The plaintiff’s complaint allegations that the defendant factually represented to the plaintiff that he was in the process of securing the release of the paint supply contract as an inducement for plaintiff to enter into the APA were sufficiently factual to state a fraud claim under Federal pleading rules.

Afterwords:

  • The economic loss rule bars negligent misrepresentation claim where the defendant’s main business is providing a tangible product rather than information;
  • A clearly drafted integration clause will prevent a party to a written contract from introducing evidence (here, emails) that alters a contract’s plain meaning;
  • The failure of a condition precedent won’t equate to a breach of contract where the party being sued isn’t responsible for the condition precedent;
  • A plaintiff successfully can plead fraud where it involves a statement concerning a present or past fact, not a future one.

References:
1.  2015 WL 3463625, * 7

2. Id.

3. Id. at * 11

4. Id. at **8-9

 

 

Illegality Defense Doesn’t Defeat HVAC Subcontractor’s Damage Claim Versus General Contractor on Chicago Transit Authority Project (N.D. 2015)

I’ve written before on the illegality defense to breach of contract suits.  It’s bedrock contract law that an agreement to do something criminal (example – murder, arson, selling drugs, etc.) is unenforceable against the person who doesn’t perform (example: if I fail to pay a hit man, he can’t sue me for the $). 

The illegality defense also applies in the civil context where it can defeat an agreement that runs afoul of a State or Federal statute.  The policy underpinning for the illegality rule is that it would make a mockery of the justice system if you could sue to enforce an agreement to commit a crime.

Energy Labs, Inc. v. Edwards Engineering, 2015 WL 3504974 (N.D.Ill. 2015) examines contractual illegality in the context of a high-dollar subcontract to supply HVAC equipment to the Chicago Transit Authority (CTA).

The plaintiff air conditioning parts subcontractor was hired by the defendant to provide parts in connection with the defendant’s contract with the CTA.  When the defendant found out that plaintiff was procuring its parts in a foreign country, it cancelled the contract since the Buy America Act, 49 U.S.C. s. 5323 (“BAA”) required the parts used in the CTA project to be made in the U.S.

Plaintiff sued to recover damages resulting from the defendant’s contract cancellation since plaintiff had already designed and started making the HVAC parts.  Defendant moved to dismiss on the basis that the contract was illegal since it violated the BAA.

The court denied the motion to dismiss.  While the general rule is that a contract that violates a Federal statute is normally unenforceable, the court said the rule isn’t automatic.  Instead, the court considers the “pros and cons” of enforcing the putative illegal contract taking into account the benefits of upholding the contract against the drawbacks of doing so.

Even if a contract isn’t illegal, a Federal court can still refuse to enforce it when doing so would violated a clear congressional goal or policy. 

Illegality also applies where a contract isn’t illegal on its face but requires a contracting party to commit an illegal act carrying out its obligations. 

To determine whether a contract violates a Federal statute, the court compares the four-corners of the contract to the statutory text and any interpreting case law.(*3).

Here, the court found that the contract wasn’t explicitly illegal.  The purchase orders submitted by the general contractor defendant didn’t require it to pay for plaintiff’s services with Federal funds.  The defendant was free to pay the plaintiff with its own funds; not the government’s. 

In addition, the BAA doesn’t outlaw the sale of all foreign-made air conditioning units to government agencies like the CTA.  It instead only applies to projects that are paid for at least in part with Federal funds.  As a consequence, the contract wasn’t illegal on its face.

Next, the court rejected the defendant’s argument that allowing plaintiff to enforce the contract violated public policy.  In the procurement contract context, where there is a mandatory contract term that is based on a strong Federal policy, this policy is read into the contract by operation of law. 

However, this so-called Christian doctrine1 only applies to parties that contract directly with the government; not to subcontractors like the plaintiff.  This is because subcontractors contract with general contractors, not with the government. 

To impose a Federal procurement edict on a subcontractor who often doesn’t even know he is contracting for government work is plainly unfair. (*5).

Afterword:

An interesting discussion of the illegality defense in somewhat arcane context of Federal procurement rules.  The court gave a constricted reading to the illegality rule and looked at the underlying fairness if the contract was defeated. 

The fact that the plaintiff performed extensive work before termination figured heavily in the court’s analysis.  Another key ruling is that only general contractors, not subcontractors like the plaintiff here, have the duty to inquire into applicable procurement requirements.

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1.  G.L. Christian and Associates v. United States, 312 F.2d 418 (1963).

Contractor’s Legal Malpractice Suit Can Go Forward In Case of (Alleged) Misfiled Mechanics’ Lien: IL 1st Dist.

Construction Systems, Inc. v. FagelHaber LLC, 2015 IL App (1st) 141700, dramatically illustrates the perilous consequences that can flow from a construction contract’s failure to identify the contracting parties and shows the importance of clarity when drafting releases intended to protect parties from future liability.

The plaintiff contractor sued its former law firm (the Firm) for failing to properly perfect a mechanics lien against a mortgage lender on commercial property.  The plaintiff alleged that because of the Firm’s lien perfection failure, the plaintiff was forced to settled its claim for about $1.3M less than the lien’s worth (about $3M). 

In the underlying lien case, the plaintiff and defendant Firm got into a fee dispute and the Firm withdrew.  The Firm turned over its file to the plaintiff after the plaintiff made a partial payment of the outstanding fees (owed to defendant Firm) and signed a release (the “Release”). The Release, which referenced “known and unknown” claims and contained “without limitation” verbiage, was signed by the plaintiff in 2004.  Plaintiff filed the current malpractice suit in 2009.

The trial court entered summary judgment for the Firm on the basis that the Release immunized the Firm from future claims.  Plaintiff appealed.

Held: Reversed

Rules/Reasons:

Reversing summary judgment for the Firm, the First District first applied the relevant rules governing written releases in Illinois.

a release is a contract and is governed by contract law;

– a release will be enforced as written where it’s clearly worded

– the scope and effect of a release is controlled by the intention of the parties;

– the intention of the parties is divined by reference to the words of the release and a release won’t be construed to defeat a claim that was not contemplated by the parties when they signed it;

– A “general” release will not apply to specific claims where a party is unaware of other (specific) claims;

– Where one party to a release owes the other a fiduciary duty (e.g. lawyer-client), the party owing the fiduciary duty has the burden of showing that it disclosed all relevant information to the other party.

(¶¶ 25-28).

Here, the court gave the Release a cramped construction.  It held that it didn’t apply to the malpractice suit since that case wasn’t filed until 5 years after the Release was signed and there was no evidence that the plaintiff knew that the Firm possibly flubbed the lien filing when it (the plaintiff) signed the Release.  This lack of evidence on the parties’ intent raised a disputed fact question that required denial of summary judgment.

Next, the court turned to the Firm’s judicial estoppel argument – that the plaintiff couldn’t sue for malpractice since it obtained a benefit in the underlying lawsuit (a settlement payment of $1.8M from the competing lender) by claiming it was an original contractor and not a subcontractor.  Judicial estoppel applies where (1) a party takes two positions under oath, (2) in separate legal proceedings, (3) the party successfully maintained the first position and obtained a benefit from it; and (4) the two positions are inconsistent.  (¶ 37).

The issue was paramount to the underlying lien case because if the plaintiff was a subcontractor, it had to comply with the 90-day notice requirement of Section 24 of the Lien Act.  But if it was a general or original contractor, plaintiff was excused from the 90-day notice requirement.  Based on this factual uncertainty, the court found the plaintiff had a right to pursue alternative arguments to salvage something of its approximately $3M lien claim.

The court also agreed with the plaintiff that it could recover prejudgment interest on the legal malpractice claim.  Since that claim flowed from the underlying allegation that the Firm failed to perfect plaintiff’s lien, and since Section 21 of the Illinois Mechanics Lien Act allows for prejudgment interest (770 ILCS 60/21), the plaintiff could add the interest it would have recovered to the damage claim versus the Firm. (¶ 48).

Afterwords:

1/ A broad release can still be narrowly interpreted to encompass only those claims that were likely in the release parties’ contemplation.  If a claim hadn’t come to fruition at the time a release is signed, the releasing party can argue that an expansive release doesn’t cover that inchoate claim;

2/ Judicial estoppel requires more than alternative pleadings or arguments.  Instead, the litigant must take two wholly contradictory statements and obtain a benefit from doing so.  What’s a “benefit” is open to interpretation.  Here, the plaintiff received $1.8M on its lien claim in the earlier litigation.  Still, this wasn’t a benefit in relation to the value of its lien – which exceeded $3M;

3/ If the underlying claim – be it common law or statutory – provides for pre-judgment interest, then the later malpractice suit stemming from that underlying claim can include pre-judgment interest in the damages calculation.