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Can contract protect you from claims of fraud and punitive damages
February 12, 2019
Notice:  Concierge Clients have been advised of contract updates as a result of this case analysis
Can contract protect you from claims of fraud and punitive damages
            Can the alarm contract protect you against claims of fraud in the inducement of the contract?  How about exemplary and punitive damages, do you think the alarm contract can protect you against those damages?
            Fraud in the inducement can generally be described as thus: “Fraud in the inducement occurs when a party enters into an agreement knowing it is a contract as well as understanding its purpose but signs or makes the agreement based on false information given to them. Fraud in the inducement is illegal. Contracts found to be fraud in the inducement are voided, which results in dismissal of contractual duties.”
            We see claims of fraud in the inducement all the time in alarm collection cases.  Subscribers claiming that all kinds or misrepresentations were made during the sale process.  But there can be another fraud in the inducement that you must be aware of.  This would be fraud by omission or non-disclosure.  
            A seller of airplanes was sued for compensatory, exemplary and punitive damages.  The long and short of it is that the plane didn’t have a new engine, but a used engine.  The jury awarded compensatory and punitive damages.  A number of issues important to the alarm industry were discussed in the case.  Here are a few of them.
            “Fraud by non-disclosure, a subcategory of fraud, occurs when a party has a duty to disclose certain information and fails to disclose it. To establish fraud by non-disclosure, the plaintiff must show: (1) the defendant deliberately failed to disclose material facts; (2) the defendant had a duty to disclose such facts to the plaintiff; (3) the plaintiff was ignorant of the facts and did not have an equal opportunity to discover them; (4) the defendant intended the plaintiff to act or refrain from acting based on the nondisclosure; and (5) the plaintiff relied on the non-disclosure, which resulted in injury. See Bradford v. Vento (explaining that there must be a duty to disclose);  In general, there is no duty to disclose without evidence of a confidential or fiduciary relationship.  A fiduciary duty arises “as a matter of law in certain formal relationships, including attorney-client, partnership, and trustee relationships.”  A confidential relationship is one in which the “parties have dealt with each other in such a manner for a long period of time that one party is justified in expecting the other to act in its best interest.”  see also Meyer v. Cathey,(recognizing that an informal relationship giving rise to a duty may also be created by a “special relationship of trust and confidence [which] exist[s] prior to, and apart from, the agreement”. An informal relationship giving rise to a duty may also be formed from “a moral, social, domestic or purely personal relationship of trust and confidence.” There may also be a duty to disclose when the defendant: (1) discovered new information that made its earlier representation untrue or misleading; (2) made a partial disclosure that created a false impression; or (3) voluntarily disclosed some information, creating a duty to disclose the whole truth.
            So the first issue for us is, do alarm companies owe any special duty to their customers such that a failure to advice or a misrepresentation would give rise to a claim for fraud in the inducement?  I can tell you that customers raise that defense all the time.  In one case the customer claimed that the alarm company did not disclose that radio was available.  When the phone wire was cut just preceding the burglary the customers sued.  The judge found that the customers at least raised a good defense and that the failure to disclose would have to await a full trial.  That case caused me to create the Disclaimer Notice, a document in which the subscriber acknowledges that all kinds of equipment and services were offered and declined, and also where the alarm company should detail customary components and services that the customer has declined [such as installing detection devices in obvious areas].  Yes the All in One does state that more and better equipment was offered, but the Disclaimer Notice is separate, a second document confirming the nature of the transaction.
            Keep in mind that most alarm companies have promotional material as well as a website making all kinds of claims and representations regarding the efficacy of the alarm company’s products and services.  Indeed, the recent ADT fire case is such an example.  So failure to disclose and the possibility that a security company, especially a licensed security company, ought to disclose, is a reasonable argument.
            But, what about protecting against claims of fraud in the inducement, as well as the different kinds of damages that can flow from such conduct?  Compensatory damages are the actual damages that a customer can claim.  In the alarm scenario, claims for compensatory damages could include the cost of replacing an inadequate system or the damages suffered when the alarm didn’t work as intended.  Exemplary, or punitive, damages are not compensatory and are designed to punish the defendant for outrageous or morally culpable conduct and to deter the defendant and others from engaging in the same behavior in the future.   Punitive damages in alarm cases would be rare [I am not aware of any cases where punitive damages have been awarded].  
            Most of you are familiar with the protective provisions in the Standard Form Agreements.  Among other provisions, we have a Limited Warranty, Exculpatory Clause and Limitation of Liability Provision.  We know these provisions hold up against breach of contract and negligence.  But what about fraud in the inducement, and can these provisions protect against punitive damages?
            Again I want to turn to the aircraft case.  Here are a few excerpts that are instructive:
            This Court has held that a damages-limitation clause is a limited warranty that is the basis of the bargain and will limit recovery to the limited damages. S.W. Bell Tel. Co. v. FDP Corp (holding that the damages-limitation clause was valid to bar a breach of warranty claim but not valid “insofar as it purported to waive liability” for a deceptive act under the Deceptive Trade Practices Act (DTPA) ). We have also suggested, however, that pre-injury releases for gross negligence may be void as a violation of public policy in the personal injury context. See Fairfield Ins. v. Stephens Martin Paving, LP, (indicating that “[o]utside the insurance context, it is worth noting that this Court has suggested that a person's pre-injury waiver of another's liability for gross negligence is against public policy”); Mem'l Med. Ctr. of E. Tex. v. Keszler(explaining that post-accident release is not invalid); Crowell v. Hous. Auth. of City of Dall (acknowledging that courts have found a housing authority's exemption from liability to its tenants for negligence as contrary to public policy).
            We have long recognized the strongly embedded public policy favoring freedom of contract.  And, absent a compelling reason, courts must respect and enforce the terms of a contract that the parties have freely and voluntarily made. See 
Bradberry, 526 S.W.3d at 482 (noting that individuals and entities can “control their destiny and structure their business interactions through agreements with other competent [individuals or entities] of equal bargaining power, absent violation of law or public policy”). “[P]arties have the right to contract as they see fit as long as their agreement does not violate the law or public policy.”  (explaining that “parties can contractually waive certain substantive and procedural rights”).
            Limitation-of-liability clauses, however, are generally valid and enforceable. But if the fiduciary duty owed is breached due to fraudulent conduct, punitive damages may be awarded.  (that clear and convincing evidence of fraud allows for an exemplary damages award); (that a plaintiff may recover exemplary damages under a breach of fiduciary duty claim if the breach was intentional); (an intentional breach of fiduciary duty may result in recovery of punitive damages and that “intentional” breach means that the party holding the fiduciary duty “intended to gain an additional unwarranted benefit”). 
            Now we get to the crux of this issue:
            "As the plaintiffs point out, we have held that “fraud vitiates whatever it touches.” (fraud prevents the statute of limitations period from running until the fraudulent inducement was, or should have been, discovered). The court reasoned that “a buyer cannot be bound by an agreement waiving exemplary damages if the seller commits fraud by nondisclosure.”  (opining that “[t]o conclude otherwise would allow a seller to deliberately fail to disclose material facts to entice a buyer to enter a contract and then shield himself from damages to which the buyer is entitled”). We have never held, however, that fraud vitiates a limitation-of-liability clause. We must respect and enforce terms of a contract that parties have freely and voluntarily entered.  Rather than seeking rescission of the agreements based on Bombardier's fraudulent conduct, the plaintiffs have tried to enforce the agreements, seeking an award of actual damages, while at the same time seeking to strike the limitation-of-liability clauses to receive an exemplary damages award.  (“Rescission is an equitable remedy that operates to extinguish a contract that is legally valid but must be set aside due to fraud, mistake, or for some other reason to avoid unjust enrichment.”). In 
Italian Cowboy Partners, Ltd. v. Prudential Insurance  we explained that “when sophisticated parties represented by counsel disclaim reliance on representations about a specific matter in dispute, such a disclaimer may be binding, conclusively negating the element of reliance in a suit for fraudulent inducement.”  We further explained that fraudulent inducement is not always a ground to set aside a contract, stating that in certain circumstances a contract's terms may preclude a claim for fraudulent inducement with “a clear and specific disclaimer-of-reliance clause.” . Similarly, Bombardier and the purchasing parties—sophisticated entities represented by attorneys in an arms-length transaction—bargained for the limitation-of-liability clauses to bar punitive damages. In balancing the competing interests between protecting parties from “unintentionally waiving a claim for fraud” and “the ability of parties to fully and finally resolve disputes between them,” we believe parties can bargain to limit exemplary damages.  We note that the purchasing parties did not waive a claim for fraud; they only waived the ability to recover punitive damages for any fraud. As such, the valid limitation-of-liability clauses must stand."  citations omitted.  Case is:  Bombardier Aerospace v. Spep Aircraft  opinion delivered: February 1, 2019  Supreme Court of Texas

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Ken Kirschenbaum,Esq
Kirschenbaum & Kirschenbaum PC
Attorneys at Law
200 Garden City Plaza
Garden City, NY 11530
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516 747 6700