Rosen Harwood Blog

The Merger Clause: Essential Defense or False Protection?

What protection do merger clauses really provide?

The success of a breach of contract claim may depend on the presence of a merger or integration clause. One of the most common provisions you will find in a contract, merger clauses state that the contract is a complete and final agreement between the contracting parties. Merger clauses seem like a strong protection for contracting parties because they prevent parties from later arguing breach of contract based on information not within the four corners of the document. However, an aggrieved party that may be precluded from recovery on a breach of contract claim due to a merger clause in the contract may well have an avenue for recovery by instead arguing fraudulent inducement – i.e. that he was fraudulently induced into entering into the contract.

For example, before selling a lake house to Buyer, Seller told Buyer that Buyer would have the option to purchase a boat slip once the slips had been built. Relying on the Seller’s representation, Buyer purchased the house. The contract to purchase the home contained a merger or integration clause but did not mention the Seller’s promise to give the Buyer an option to purchase a boat slip. Seller later refused to allow Buyer to purchase a boat slip. The merger clause prevents Buyer from introducing information not included in the contract regarding the option to purchase the boat slip to establish a breach of contract claim.

There is, however, a way to circumvent the language of a merger clause to dispute a contract.  The Alabama Court of Civil Appeals has recently stated a clear position that merger clauses do not bar a claim of fraudulent inducement of the contract containing the clause.[1] In the example above, inspired by the facts presented in Jones, although the Buyer may not be successful on a breach of contract claim due to the presence of a merger clause, he may be able to introduce information outside of the four corners of the contract to show that the Seller fraudulently induced him to enter into the contract.[2]  In other words, but for the Seller’s representation that Buyer would be able to purchase a boat slip, Buyer would not have entered into the contract to begin with.

A breach of contract claim is used by the non-breaching party to a contract to recover damages from the party who has breached the provisions of the contract.  In order to succeed on a breach of contract claim, a party must prove: (1) the existence of a valid contract binding the parties; (2) his own performance under the contract; (3) the other party’s nonperformance; and (4) that the breach has caused him some type of damage.[3]  On the contrary, a fraudulent inducement claim allows a party to argue that he would not have entered into the contract in the first place but for the fraudulent inducement of the other party to the contract. To succeed on a fraudulent inducement claim, a party must establish: (1) there was a false misrepresentation; (2) the misrepresentation concerned a fact material to the contract, (3) a party to the contract relied on that fact, and (4) then suffered damages as a proximate result of the reliance.[4]

In proving that he or she relied on the misrepresentation, a party must prove that that reliance was reasonable under the circumstances.[5] This is referred to as the “reasonable reliance principle.” Courts do not allow recovery if the circumstances are such that a reasonably prudent person exercising ordinary care would have discovered the true facts.[6] This principle prevents parties from completely turning a blind eye to the terms of the contract and using fraudulent inducement as a means to invalidate the contract.

Although a merger clause won’t defeat the use of extraneous documents to prove a fraudulent inducement claim, the “reasonable reliance principle” forces the contracting party making the claim to prove more than Alabama previously required under the “justifiable reliance principle.” Jurisdictions employing the “justifiable reliance principle” look at whether the plaintiff justifiably relied on the representation. This principle provides a much lower threshold than the reasonable reliance principle as it only asks whether the representation was “so patently and obviously false that the [plaintiff] must have closed his eyes to avoid the discovery of the truth.”[7] Alabama’s use of the “reasonable reliance principle” affords more protection to those against whom fraudulent inducement claims are brought.

Not only can a fraudulent inducement claim be proven by materials outside the contract despite the presence of a merger clause, but the consequences of a successful fraudulent inducement claim are also greater than those for breach of contract. A party succeeding on a breach of contract claim may only recover damages caused by that breach. A successful fraudulent inducement claim may void the contract and open the losing party to money damages for the winning party’s reliance, as well as punitive damages.[8]

So, it is important that contracting parties not rely solely on the presence of a merger clause to create a clean record as to the parties’ relationship and transaction. To protect against potential fraudulent inducement claims, parties should disclose all material facts regarding the transaction in writing, even those that may typically not be included in a final contract. Material facts are those which are significant, important, or essential to a reasonable person in deciding whether to enter into the specific contract. In the above example, the inability to purchase the boat slip would be a material fact, as Buyer considered the ability to purchase a boat slip, once constructed, to be an important factor in determining whether to purchase the lake house. Further, if records exist that create a dispute about those material facts, those disputes should be explained, and disposed of, in a party’s disclosure of those facts. Disclosure of material facts and a clean record related to any previous dispute about those facts, along with a merger clause, should help protect a contracting party from information outside the four corners of the document being used successfully in either a fraudulent inducement or breach of contract claim.

 

 

 

[1] Jones v. The Village at Lake Martin, LLC, No. 2160650, 2018 WL 387912 (Ala Civ. App. Jan. 12, 2018); McCullough v. Allstate Property & Casualty Ins. Co., No. 2160497, 2018 WL 387844 (Ala. Civ. App. Oct. 27, 2017)

[2] Jones and McCullough may take a more sweeping position than previously stated, as extraneous documents have historically been disallowed to show reliance if considered to be part and parcel of the subject matter of a disputed contract that contains a merger clause. See, Alabama Elec. Coop., Inc. v. Bailey’s Construction Co, Inc., 950 So. 2d 280, 283-89 (Ala. 2006) (disallowing certificates of insurance as evidence of reasonable reliance of an additional insured when the actual insurance policies were in dispute).

[3] Capmark Bank v. RGR, LLC, 81 So.3d 1258, 1267 (Ala. 2011) (citing Reynolds Metals Co. v. Hill, 825 So.2d 100, 105 (Ala. 2002)).

[4] Auto-Owners Ins. Co. v. Abston, 822 So.2d 1187, 1196 (Ala. 2001).

[5] Torres v. State Farm Fire & Casualty Co., 438 So.2d 757 (Ala. 1983).

[6] Bedwell Lumber Co. v. T & T Corp., 386 So.2d 413, 415 (Ala. 1980).

[7] Southern States Ford, Inc. v. Proctor, 541 So.2d 1081, 1091-92 (Ala. 1989).

[8] Hobson v. American Cast Iron Pipe Co., 690 So.2d 341, 344-45 (Ala. 1997).

Ann L. Reardon

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Nicole B. Hampton

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