No-Reliance Clauses and Fraud Pleading Requirements – IL Fed Court Weighs In

The Case: Walls v. VreChicago Eleven, LLC, 2016 WL 5477554 (N.D.Ill. 2016)

Issues:  1/ Viability of ‘no-reliance’ clauses and as-is clauses in commercial real estate contracts; and 2/ Fraud pleading requirements under Federal Rules of Civil Procedure

Facts: Property purchaser plaintiffs claimed they were fraudulently induced to buy property by defendants who falsely claim the property was garnering annual rentals of $171K and the lease guarantor was a multi-million dollar business.

A few months after the purchase, the tenant (a KFC restaurant) fell behind in rent and informed plaintiff it could only pay $70K in annual rent.   Plaintiff evicted the KFC operator and re-leased it to a substitute tenant who paid less than the former (evicted) tenant.

Plaintiff sued the seller and its broker for fraud in the inducement and negligent misrepresentation. The defendants moved to dismiss.

Result: Motions to dismiss denied.

Reasons:

A standard no reliance provision is a type of contractual exculpatory clauses and provides that a purchaser is not relying on any representations of the seller that are not specifically spelled out in the purchase contract.

The purpose of a no reliance clause is to preemptively head off a fraud action by eliminating the reliance element that is a required component of a fraud claim.

No reliance clauses serve useful purpose as they insure that the transaction and any litigation stemming from it is based on the parties’ writings rather than unreliable memories and not subject to the risk of fabrication.

At the same time, exculpatory clauses are not favored under Illinois law and must be clear, explicit and unequivocal to be enforced.

Here, the court found the no reliance clause ambiguous.  First, the clause only spoke to representations or warranties of the seller; it said nothing about seller’s silence or omissions.  At least one Illinois court has held that a non-reliance clause only applies to affirmative fraud (e.g. representations, assertions of fact) and not to fraudulent concealment – defined as silence in the face of a duty to speak.  See, e.g. Benson v. Stafford, 941 N.E.2d 386, 410 (2010).

A second reason the court declined to dismiss the suit at the pleadings stage was because the no-reliance’s clause’s scope was unclear.  It found plausible plaintiff’s position that its claims that defendant misrepresented annual rent projections and the guarantor’s financial health exceeded the reach of the no-reliance clause.

A final reason the Court found the no-reliance clause ambiguous was because it was couched in the contract’s As-Is paragraph.  Because of this, it was reasonable  to conclude for the sake of argument that the no-reliance language only governed the condition of the property – not the tenant’s expected rents or the guarantor’s financial condition.

Textual ambiguity aside, the court turned to whether the no reliance clause was enforceable.  To determine the clause might be enforceable, the court considered (1) the clause’s ambiguity, (2) plaintiff allegations of seller’s misstatements contained in written offering and sales brochure documents (instead of in the purchase contract), (3) plaintiff’s claims that defendants impeded plaintiff’s pre-sale due diligence efforts, and (4) the assertion that defendants orchestrated a plan to deceive the plaintiffs and induce them to buy the property.

According to the court, there were too many disputed fact issues to decide that the no reliance clause was enforceable.  As a result, it was premature to dismiss plaintiff’s claims without the benefit of discovery.

Pleading Standards for Fraud – Rule 9(b)

The court also addressed the pleading standards for fraud in Federal court.

Rule 9(b) provides that a fraud plaintiff allege with particularity the circumstances that constitute fraud.  Specifically, the plaintiff must plead the who, what, where, when and how of the fraud.  The reason for elevated pleading rules for fraud is because of a fraud claim’s potential for severe harm to a business’s reputation.  The law requires a more thorough pre-complaint investigation than other causes of action so that fraud claims are factually supported and not extortionate or defamatory.

But when the details of a fraud are within the exclusive possession of a defendant, the fraud pleading rules are relaxed.  In such a case, the plaintiff must still allege the grounds for his/her suspicions of fraud.

Here, the plaintiff’s fraud allegations were premised on statements contained in the sales contract, the offering circular and sales brochure.  In addition, the plaintiff provided detailed facts supporting its claims that the defendants misled plaintiffs concerning the tenant, the annual rent and the guarantor’s fiscal status.  The Court found the plaintiff’s complaint adequately stated a fraud claim sufficient to survive a motion to dismiss.

Afterwords:

No reliance clauses are enforceable but they must be ambiguous and clearly encompass the subject matter of a lawsuit;

Fraud requires heightened pleading but when the critical fraud facts are solely in the defendant’s domain, the plaintiff is held to less pleading particularity.