A loan is only as good as its documents. This series reviews the potential implications that may go unnoticed in boilerplate language and the importance of customizing standard language in loan documents from one transaction to the next.
Cutting Off Fraud Claims with a Merger Clause
A few weeks ago, I wrote about using merger clauses that negate reliance as a way to bar claims of fraud in the inducement. While the Texas Supreme Court has yet to hold that parties can negate reliance at the inception of a relationship, a recent appellate court decision does precisely that. So today we are going to look at the Schlumberger case and its progeny in more detail, and examine how those cases might affect another common contract clause that negates reliance—the “as-is” covenant in a real estate lease or purchase agreement.
Just to review, a standard merger clause is that provision (usually found in the last section of a contract) that states that all the parties’ agreements are set forth in the document, and any prior agreements are merged into the current contract. A standard merger clause serves several purposes:
- it invalidates and supersedes all prior agreements;
- it eliminates the authority of the contracting parties’ agents to modify the terms; and
- absent ambiguity, it limits the evidence to be considered in interpreting the contract to the four corners of the agreement.
That’s a pretty powerful little boilerplate provision, but it can do even more.
In Schlumberger Tech. Corp. v. Swanson, 959 S.W.2d 171, 177 (Tex. 1997), the Texas Supreme Court held that a merger clause in a post-dispute settlement agreement sufficiently negated reliance so as to preclude a claim that the settlement was induced by fraud, where it specified that no party was relying on any statement or representation of any other party. That disclaimer, however, applied only to pastdisputes between the parties.
A decade later the Texas Supreme Court extended the ability to disclaim reliance to a settlement agreement resolving both past and future claims, where the disclaimer of reliance was “all-embracing.” Forest Oil Corp. v. McAllen, 268 S.W.3d 51 (Tex. 2008).
Both the Schlumberger and Forest Oil cases left open the question whether a disclaimer of reliance in a pre-dispute agreement could negate any claim of fraud in the inducement of that agreement. The Texas Supreme Court sniffed around the edges of that issue in Italian Cowboy Partners, Ltd. v. Prudential Ins. Co. of America, 341 S.W.3d 323 (Tex. 2011). The issue in Italian Cowboy was whether a disclaimer of representations in a lease contract was a standard merger clause, or a disclaimer of reliance clause that would bar a claim of fraud in the inducement. Here’s what the lease said:
14.18 Representations. Tenant acknowledges that neither Landlord nor Landlord’s agents, employees or contractors have made any representations or promises with respect to the Site, the Shopping Center or this lease except as expressly set forth herein.
14.21 Entire Agreement. This lease constitutes the entire agreement between the parties hereto with respect to the subject matter hereof, and no subsequent amendment or agreement shall be binding upon either party unless it signed by each party . . .
The Court (with three justices dissenting) held these provisions did not cut off a fraud in the inducement claim for two reasons. First, the language expressed an intent to have a standard merger clause only. Second, even if there was an intent to negate reliance, the language here did not do so by “clear and unequivocal language”—the standard set in Schlumberger. The Court reaffirmed the principle that a contract fraudulently induced may be avoided, and a standard merger clause does not bar such a claim.
Italian Cowboy is still significant, though, because it did not hold that disclaimer of reliance is only effective in settlement agreements, where the parties wish to finally resolve their disputes and end their dealings. To the contrary, the Court in Italian Cowboy implied that with the right “magic words,” a merger clause in a lease could negate reliance. But in that circumstance, “[a] lease agreement, as here, which is the initiation of a business relationship, should be all the more clear and unequivocal in effectively disclaiming reliance and precluding a claim for fraudulent inducement . . . .”
It was probably inevitable that a Texas appellate court, reading this language, would conclude that a properly worded merger clause could bar fraud in the inducement claims arising out of a pre-dispute agreement. And that’s exactly what the San Antonio Court of Appeals did in the case of Dragon Fish LLC v. Santikos Legacy Ltd., No. 04-11-00682-CV (Tex. App. --San Antonio, May 2, 2012, no pet. h.). In Dragon Fish, commercial tenants sued their landlord and the developer for fraud in the inducement, claiming that in marketing materials and elsewhere, they had been told there would be residences in the development to support retail traffic. The court tossed out the claim, finding that the following clause in the lease negated reliance, and thus barred a claim of antecedent fraud:
Landlord and Tenant hereby acknowledge that they are not relying upon any brochure, rendering, information, representation or promise of the other, or an agent or broker, if any, except as may be expressly set forth in this lease.
What’s the magic word? Rely. Relying. Reliance.
“As-is” Provisions and Reliance-Negating Merger Clauses: A 1-2 Knockout Punch
Real estate lawyers should be particularly aware of how a disclaimer of reliance in combination with an “as-is” or “with all faults” provision in a lease1 or purchase agreement can cut off just about any claim relating to the condition of a property.
When a client agrees to purchase or lease commercial property "as is," the buyer/tenant agrees to make its own appraisal of the bargain and accepts the risks of the agreement. Prudential Ins. Co. of Am. v. Jefferson Assocs., Ltd., 896 S.W.2d 156, 161 (Tex.1995). In Prudential, the Texas Supreme Court approved the enforcement of "as is" clauses under certain circumstances. As long as the buyer is not induced by fraud into accepting the "as is" provision, the legal effect of the provision is to negate the causation element essential to recovery on claims associated with the physical condition of the property. Prudential, 896 S.W.2d at 161; Lee, 120 S.W.3d at 467-68. As the Court explained, contractual disavowal of reliance upon any representation is an important element of an arm's-length transaction and is binding unless set aside.Prudential, 896 S.W.2d at 161. Finally, an "as is" agreement negates the causation element essential to recovery on DTPA theories, fraud (excluding, of course, fraud in the inducement of the "as is" agreement), negligence, and breach of the duty of good faith and fair dealing. Id.
When considering the enforceability of an "as is" clause, courts generally consider five factors: (1) the sophistication of the parties, (2) the terms of the "as is" agreement, (3) whether the "as is" agreement was freely negotiated, (4) whether the agreement was an arm's length transaction, and (5) whether there was a knowing misrepresentation or concealment of a known fact. Procter III v. RMC Capital Corp., 47 S.W.3d 828, 833 (Tex.App.—Beaumont 2001, no pet.) (distilling Prudential into five-factor test). Although not an independent factor, whether the buyer was represented by counsel is also important. See Id. at 833-34.
It stands to reason that in the presence of a merger clause that disclaims reliance, the fifth factor drops from consideration. Moreover, if an “as is” clause can only be defeated if procured by fraud, having a disclaimer of reliance in the merger clause of a lease or purchase agreement for property makes the “as is” clause essentially bulletproof. While no case appears to have dealt with the interaction between these two provisions, I would expect the result to be fatal to any attempt by a tenant/buyer to avoid the as-is provision. Whichever side of the transaction you are on, be sure to look for these clauses and understand what they really mean, especially in combination.
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