This article was written for the ConsensusDocs newsletter and first appeared here.

We have all been there, though we would likely want to forget it. The nightmare project is over and after much back-and-forth negotiations over dueling claims, the parties finally reach an agreement to settle their dispute. The lawyers prepare a global settlement agreement that the principals for each party sign. This headache is finally over, right? Perhaps not.

A basic legal principal is that “fraud vitiates all”. While sounding eminently reasonable in the abstract, it will not stop an unscrupulous party who suffers buyer’s remorse from calling foul and alleging that they were defrauded in an attempt to unwind a deal. Faced with an after-the-fact fraud claim, a party seeking to enforce the settlement will invariably flip through the agreement to see what provisions they can rely upon to stop their counterpart from unburying the hatchet and reviving the dispute.

Avoiding Contract Obligations: Fraudulent Inducement

It is well accepted that a party can avoid performing a contract that was obtained by fraud. This particular species of fraud is referred to as fraudulent inducement and is predicated on a party’s duty to refrain from inducing another to enter into a contract by use of false representations. Like a garden-variety fraud claim, the party advancing the claim faces a high hurdle. Fraudulent inducement requires proof of a material misrepresentation made with knowledge of its falsity (or affirmatively asserted but without knowledge of its truth) and with the intent that the misrepresentation should be acted on by the other party.

Despite fraud being a difficult claim to prove, that does not mean it will not cause one to expend significant time and money to defeat it. As a result, settlement agreements often contain certain provisions intended to ensure finality, the two most common being the merger clause and “disclaimer of reliance” clause. However, courts are clear that only the latter provision provides the necessary protections against collateral attacks to a settlement agreement.

Merger Clause: “Close” Only Counts in Horseshoes and Hand Grenades

A merger (or integration) clause seeks to demonstrate the parties’ intent that their written contract is to be considered fully integrated, that is, that all the terms come within in the four corners of the contract. For instance the ConsensusDocs 200 Owner and Constructor Agreement states at section 13.1 states:

EXTENT OF AGREEMENT Except as expressly provided, this Agreement is for the exclusive benefit of the Parties, and not for the benefit of any third party. This Agreement represents the entire and integrated agreement between the Parties, and supersedes all prior negotiations, representations, or agreements, either written or oral.

An effective merger clause prevents a party from invoking the parol evidence rule to introduce evidence of terms not contained within the written contract. The parol evidence rule is substantive contract law (as opposed to a rule of evidence) which establishes a legal presumption that any prior or contemporaneous agreements (oral or written) are merged into the final written agreement. Thus, absent a showing of fraud, accident, or mistake, evidence of such contemporaneous agreements that contradicts the express terms of the signed written contract will be deemed immaterial regarding the contract dispute and ignored by a court.

On its face then, a merger clause seemingly guards against a fraudulent inducement claim since the alleged misrepresentation would be a prior or contemporaneous agreement. However, state courts have routinely ruled that a merger clause, standing alone, does not prevent a party from suing for fraudulent inducement.[1] The rationale underlying these decisions is that a merger clause does not contain any express language where a party disclaims reliance on any prior representations made in connection with negotiating the written agreement. Instead, a merger clause merely provides that no prior statements were made, or they were rolled up into the written agreement. Courts will not tolerate “murkiness;” they expect parties to clearly define their intentions with respect to disclaiming reliance on another’s statements.[2]

Disclaimer-of-Reliance Clause: Do What You Say And Say What You Mean

Unlike a merger clause, a disclaimer-of-reliance clause satisfies a court’s expectation of drafting clarity. By expressly disclaiming and waving reliance on a counterpart’s representations, such clauses operate to bar a fraudulent inducement by directly addressing an essential element of a fraud claim—reliance. For instance:

The parties represent and warrant that neither has relied on any promises or representations by any other party in agreeing to the terms of this agreement or in deciding to execute this agreement. Each party is relying on its own judgment and each has been represented by legal counsel in this matter.

Such clauses allow sophisticated parties represented by counsel to disclaim reliance on representations about a specific matter in dispute.

Given the severity of their intended outcome, courts closely scrutinize the language of a disclaimer-of-reliance clause in determining its enforceability. For instance, Texas courts, traditionally known for their staunch “freedom of contract” jurisprudence, have developed a multi-factor test to determine a disclaimer-of-reliance clause’s enforceability. A party seeking to enforce the clause must show: (1) the terms of the contract were negotiated (rather than boilerplate) and during negotiations the parties specifically discussed the issue which has become the topic of the subsequent dispute; (2) the complaining party was represented by counsel; (3) the parties dealt with each other in an arm’s length transaction; (4) the parties were knowledgeable in business matters; and (5) the release language was clear.[3]

Though the outcome of a disclaimer-of-reliance clause can be harsh, courts have made clear that they will not allow a party to un-ring the bell. As a Delaware court wrote:[4]

To fail to enforce non-reliance clauses is not to promote a public policy against lying. Rather, it is to excuse a lie made by one contracting party in writing—the lie that it was relying only on contractual representations and that no other representations had been made—to enable it to prove that another party lied orally or in a writing outside the contract’s four corners. For the plaintiff in such a situation to prove its fraudulent inducement claim, it proves itself not only a liar, but a liar in the most inexcusable of commercial circumstances: in a freely negotiated written contract. Put colloquially, this is necessarily a “Double Liar” scenario.

The Texas Supreme Court shared a similar sentiment, observing that “[p]arties should not sign contracts while crossing their fingers behind their backs.”[5]  For commercial players, then, there is little sympathy for parties trying to undo a deal on the basis of alleged fraud.

Conclusion: It Ain’t Over ‘til It’s Over

Knowing that post-contract signing protests of misrepresentation are easily made, parties should be diligent in drafting settlement agreements to ensure finality. A boots-and-suspenders approach cannot hurt in order to prove the parties’ intent that the settlement agreement is both fully integrated and neither party is relying on statements made by the other side, such as:

This Agreement represents the entire settlement agreement between the Parties with regard to the Dispute and supersedes any and all prior settlement agreements between the Parties related to the Dispute. Each Party expressly warrants that it has carefully read this Agreement, understands its contents, and signs this Agreement as its own free act. Each Party expressly warrants it has not relied on any promises or representations by any other Party or counsel for any other Party in agreeing to the terms of this Agreement or in deciding to execute this Agreement. Furthermore, each Party expressly warrants it is not relying upon a legal duty, if one exists, on the part of another Party (or another Party’s employees, agents, representatives, or attorneys) to disclose any information in connection with the preparation, negotiation, or execution of this Agreement. It is expressly understood and agreed by the Parties that no Party may ever assert any allegation of failure to disclose information on the part of another Party or its employees, agents, representatives, or attorneys as a ground for challenging this Agreement. The Parties further waive and release any and all claims of fraudulent inducement arising from, in connection with, or relating to this Agreement which the Parties now or in the future have or hold or have at any time held.

After an arduous project and tense post-closeout negotiations, clarity and verbosity are your friend in making sure the deal is fully and finally done.

For more information, please contact Cornelius F. “Lee” Banta, Jr.

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[1] See, e.g., Italian Cowboy Partners v. Prudential Ins., 341 S.W.3d 323 (Tex. 2011); Lorne v. 50 Madison Ave. LLC, 32 Misc.3d 1226 (N.Y. Sup. Ct. 2011); Kronenberg v. Katz, 872 A.2d 568 (Del. Ch. 2004).

[2] Kronenberg v. Katz, 872 A.2d 568, 593 (Del. Ch. 2004).

[3] Forest Oil Corp. v. McAllen, 268 S.W.3d 51, 60 (Tex. 2008).

[4] Abry Partners V, L.P. v. F & W Acquisition LLC, 891 A.2d 1032, 1058 (Del. Ch. 2006).

[5]Forest Oil Corp. v. McAllen, 268 S.W.3d 51, 60 (Tex. 2008).